Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

ERM > Risk Management > Flashcards

Risk Management Flashcards

1
Q

Broad Market Risk Portfolio Strategies (3)

A
  1. Diversification of Assets in Portfolio
  2. Strategy appropriate for liabilities
  3. Derivatives to hedge risk
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

Market Risk Management Activities (5)

A
  1. Setting and Monitoring Policies
  2. Setting and Monitoring Limits (overall, by asset class, individual security and counter-party)
  3. Reporting
  4. Capital Management
  5. Risk Portfolio Strategies (diversification,matching, hedging)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

Components of Market Risk Policies

A
  1. Roles and Responsibilities
  2. Delegation of Authority and Limits
  3. Risk Measurement and Reporting
  4. Valuation and Back-Testing
  5. Hedging Policy
  6. Liquidity Policy
  7. Exception Mangement
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

Pros (3) and Cons (8 risks) of Derivatives

A 
Pros:
- Cost compared to trading underlying
- Flexibility (tailored)
- Speed of Exposure Changes
Cons:
- Associated Risks:
  - Counterparty
  - Aggregation/Concentration
  - Operational
  - Liquidity
  - Basis Risk
  - Loss of Upside
  - Reputational
  - Settlement
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

Reducing Counterparty Risks Derivatives (2)

A
  • Cash Deposits/Margin for Exchange Traded Contracts

- Financial securities acceptable to counterparty (collateral) for over the counter contracts.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

Define Normal Backwardation and Contango

A

Normal Backwardation: Futures price below expected value of future spot price (high demand for short positions by owners of asset)
Contango: Above expected value of future spot price (strong demand for long positions due to storage costs)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

Define Optimal Hedge Ratio and Number of Contracts

A

Optimal Hedge Ratio = psigma_s/sigma_f
where sigma_s = std of spot price of asset, sigma_f = std of spot price of futures.
Multiply Hedge Ratio by Portfolio/Value of futures contract

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

Managing FX Risk

A

Hedged for bonds, but not for equities due to complex exposure.

  1. Currency forwards and futures (based on current spot price and interest rates in both countries).
  2. Currency Swaps (series of forward)
  3. Currency Options
  4. Netting revenues
  5. Leading and Lagging for anticipated movements
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

Difficulties in Hedging Exposure to Options

A
  1. Number of derivatives is large >m^2 (m, 1/2m(m+1) vegas and gammas)
  2. Significant costs of rebalancing limits frequency, often done daily in dynamic delta hedging
  3. Lack of suitable traded derivatives or poor liquidity
  4. Separation from overall portfolio delta,gamma and vegas from individual assets, therefore managed using limits (traders and firm)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

Managing Interest Rate Risk

A
  1. Direct Exposure (direct impact on cashflows)
    - Forward Rate Agreements
    - Caps and Floors
  2. Indirect Exposure (PV of future cashflows)
    - Cashflow matching (removing all market risk, often idealistic benchmark)
    - Interest rate swaps (removing only interest rate risk)
    - Swaptions (one sided protection)
    - Immunisation (Protecting present value, only works for small parallel shifts in yield curve, requires frequent rebalancing)
    - Model point hedging (optimum set of assets to minimize difference between asset and liability cashflows at reference points in future)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

Requirements for Immunisation

A
  1. PV of cashflows is equal for assets and liabilites
  2. Discounted mean term for
    cashflows of each is equal (duration)
  3. Convexity of assets > liabilities
    (Change in duration/Change in interest rate)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

Difficulties of Cashflow Matching (3) and Immunisation (remaining 5)

A
  1. Suitable assets not available
  2. Uncertain future cashflows
  3. Expected future cashflows may change frequently, costly to alter portfolio.
  4. While PV cashflows is matched, timing isn’t
  5. Protects PV only to changes in interest rate, but not all issues of timing and amounts (c.f. cashflow matching)
  6. Only applies for small changes in interest rates
  7. Only for parallel shifts in yield curve
  8. Requires regular rebalancing.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

Types of Margins in Exchange Traded Contract

A
  1. Initial Margin (function of size and anticipated volatility)
  2. Marking to Market Process (adds/subtracts from margin in line with market movements)
  3. Maintenance margin (must be maintained after mark to market process)
  4. Variation Margin (top up amount required in mark to market process)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

What is Dynamic Hedging

A

Can be difficult for writers of options to find opposite trades (since few writers in market), and must therefore find other ways of maintaining delta neutral portfolios. This is dynamic hedging, made difficult by cost of frequent rebalancing.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

Risks of Delta, Gamma and Vega non-neutrality

A
  1. Delta - Risk of change in asset values.
  2. Gamma - Risk of requiring frequent, costly rebalancing, and risk inbetween.
  3. Vega - Risk of incorrectly specified parameter.
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

Key Factors of Cashflow Matching

A
  1. Nature of liabilities (fixed monetary amounts or linked to either prices, interest rates).
  2. Term over which liabilities are payable
  3. Currency in which liabilities are payable
17
Q

OTC vs Exchange Traded Contracts

A

Exchange Traded:

  1. Standardised on certain assets, indices
  2. Trading done through exchange based on market prices
  3. Settled through clearing house
  4. Clearing house acts as counterparty to buyer and seller, taking on counterparty risk
  5. Decreased counterparty risk due to pooling and collateral
  6. Highly liquid market, reducing transaction costs

OTC:

  1. Trade done at convenience of parties and no money changes hands until delivery (c.f. margin)
  2. Pricing by negotation between parties who take on counterparty risk.
  3. Very flexible in terms of underlying and delivery date
  4. Usually standard T and Cs (ISDA - International Swaps and Derivatives Association)
  5. Collateral requirements specified in credit support annex (types of security, date calculated and transferred, and minimum below which no transfer required)
  6. May be more costsly (bespoke contract administration, increased credit risk etc.)
18
Q

Factors influencing price of OTC contract

A
  1. Spot Price of Underlying
  2. Time to Delivery
  3. Expected interest rates
  4. Expected income yield on underlying
  5. Residual counterparty risk (accounting for collateral)
  6. Cost of Carry (opportunity cost of collateral, cost of storage)
  7. Bespoke administration costs
19
Q

General Methods of Managing Credit Risk

A
  1. Avoid bad risks in the first place
  2. Diversify across counterparties
  3. Monitor Exposure Regularly
  4. Take Immediate Action when default occurs
20
Q

5 Steps Credit Risk Management Process

A
  1. Policy and Infrastructure
  2. Credit Granting
  3. Exposure, Monitoring, Management, Reporting
  4. Portfolio Management
  5. Credit Review
21
Q

Credit Risk Policy and Infrastructure

A
  1. Establishing appropriate credit environment.
  2. Adopting and implementing credit risk policies and procedures
    - To ensure credit risk can be identified, measured, monitored, controlled and reported
    - policies and procedures mut be appropriate, adopted, communicated and reviewed
  3. Developing methodologies, models with appropriate systems (actual and potential exposure)
  4. Defining data standards and conventions
22
Q

Credit Granting Process

A
  1. Credit Analysis/Rating of Counter parties
    - Ratings Must be:
    • Balance effectiveness and efficiency
    • Based on judgement, modelling or both (reflecting repayment history, ability to repay and reputation, and guarantees, collateral)
    • Reviewed Regularly
  2. Credit Approval
  3. Setting terms and conditions for credit
  4. Pricing
  5. Documentation
23
Q

Credit Monitoring Principles

A
  1. Consider current and potential exposure.
  2. Monitoring at:
    - - Portfolio Level
    - -Respect of specific individuals, industries and geographies
    - -Aiming to limit concentrations and ensure diversification
    - - Track risk indicators (e.g. credit spreads) to provide early warning of possible adverse events
  3. Exposure limits
    - - Set for single counterparties, connected counterparties and other groupings
    - -Facilitate risk control, allocation of risk-bearing capacity, delegation of authority and regulatory compliance
  4. Best monitoring practice includes (trends, risk-adjusted profitablity, exposures, exceptions)
24
Q

Credit Review Process

A

Credit review group should:

  1. Review sample transactions.
  2. Test Systems
  3. Enforce Standards
  4. Check compliance with policies and procedures
  5. Results communicated to management, highlighting exceptions, deficiencies and resolution timelines.
25
Q

5 Credit Risk Techniques

A
  1. Underwriting
    - - Approve or Deny
    - - Setting terms of loan (collateral/rates)
    - -Credit-scoring, categorisation models, third-party ratings
  2. Due Diligence
    - - care reasonable should take before entering into any agreement or transaction.
    - - considering what could go wrong (incidental credit risk, other counterparty risk)
    - -based on wide range of factors including subjective information
  3. Credit Insurance
    - -Mitigate large exposures of particular types of credit risks (e.g. incidental)
  4. Credit Derivatives
    - -CDS
    - -Total Rate of Return Swaps
    - -Credit Linked Notes
  5. Securitisation
26
Q

Securitisation

A
  1. Converts bundle of risky assets into negotiable, structured, financial instruments with different risk features.
    2a) Transfers risk
    2b) May be a way to sell exposure relatively unmarkatable assets
    2c) Alternative source of finance.
27
Q

Managing Credit Worthiness

A
  1. Capital Structure (raising capital, changes in guarantees - pensions)
  2. Mix and Volume of Business Written
    2a) Write less
    2b) Change mix within class (e.g. geography)
    2c) Change mix between classes
28
Q

Credit Events (e.g. for credit derivatives/insurance)

A
  1. Bankruptsy
  2. Rating Downgrade
  3. Repudiation (refusal to pay)
  4. Not paying coupon
  5. Cross-Default (event on one is considered on another)
29
Q

Benefits of Credit Insurance

A
  1. Protect against bad debts
  2. Cover for some/all debtors
  3. Domestic/international trade
  4. Advice from experienced insurer
  5. Cover for expenses incurred
  6. Int cover for counterparty risk, debt recoveries, forward futures commitments
  7. Secure better financing

ERM (4 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions