Risks

Question 1

Risk for a bank

Answer 1

o Credit Risk
o Market Risk
o Operational Risk
o Liquidity Risk

Question 2

Credit Risk

Answer 2

Failure of a borrower to meet its loan obligations
o Specific form of counterparty risk

Default by a borrower can be defined in many ways:
o Length of time past the due payment date
o Default on other obligations
o Breach of contractual conditions (e.g. covenants)

Credit risk can be amplified by concentration risk

Question 3

What are the different sources of Market Risk

Answer 3

Volatility risk
o Risk of price/interest rate changes being more uncertain than expected
o Can lead to financial losses on instruments held e.g.
Options held in the trading book
- The value of options issued by the bank become
more valuable to holders if volatility increases
(which increases potential losses to the bank)

Currency risk
o Risk of adverse movements in exchange rates
- Can lead to losses if assets and liabilities are mismatched by currency

Basis risk
o Basis risk occurs when a risk exposure is hedged with an offsetting exposure in another instrument, but that instrument does not behave in an identically opposite manner to the risk exposure.

Interest rate risk
o This is the adverse movement in interest rates
* Too high => higher interest income, but also higher funding costs and higher loan defaults
* Too low => low interest income, while funding costs may not reduce as much; second order economic effects

Liquidity risk
* Risk of not being able to trade in a market, and related to this,
* Risk of not being able to obtain prices on desired products

Commodity price risk
* Risk of adverse price movement in the value of a commodity

Question 4

What are the different sources of Operational Risk

Answer 4

People
Internal Processes
Systems
External events

Question 5

Briefly discuss Liquidity Risk.

Answer 5

Liquidity risks can relate to a firm, a market, or an asset.

In all three circumstances liquidity risk is the risk of not having access to cash when needed e.g.
* A firm not having ready access to cash
* Participants in a market not easily being able to convert positions into cash
* An asset not being easily sold and converted to cash

Direct consequences of liquidity risk could be:
* Insolvency risk
* Financial losses due to needing to borrow, or sell assets for less than what they are worth, or payment of penalties

Question 6

Key risks under life insurance

Answer 6

• Mortality, morbidity and longevity
• Investment risk
• Expenses, not met by premium loadings or charges
• Early withdrawals, before the initial expenses have ben recovered
• New business volumes being too high or too low
• Credit risk
• Operational risks

Question 7

List the key risks under healthcare products

Answer 7

A
1. Claim frequency, benefit amount, volatility and settlement delays

2. Accumulations of risk, catastrophes, and a large number of large risks
3. Investment risk
4. Expenses being higher than expected
5. Poor persistency, i.e. high lapses and low renewals
6. Poor plan mix due to upgrades, downgrades and anti-selection
7. Underwriting risk ie failure to disclose pre-existing conditions
8. Credit risk
9. Operational risk
10. Availability of claims data

Question 8

8 Key risks under general insurance contracts

Answer 8

1. Claim frequency, amount, volatility and delays.
2. Accumulations of risk (geographical & by class of business) and catastrophes.
3. Investment risks.
4. Expenses higher than expected.
5. Poor persistency (high lapses, low renewals).
6. New business volumes too high or too low (too high = new business strain; too low = not enough business to spread overhead expenses across)
7. Credit risk (reinsurer or broker)
8. Operational risk (fraud, systems failure, regulatory changes)

Question 9

List the key risks associated with using data

Answer 9

Data are inaccurate or incomplete, leading to erroneous results or conclusions
Data are not credible due to insufficient volume, particularly for extreme outcomes.
Data are not sufficiently relevant to the intended purpose
Historical data do not reflect what will happen in the future (abnormal events; significant random fluctuations; not up to date; homogeneous groups change)
Chosen data groups are not optimal
Data are not available in an appropriate form for the intended purpose
Lack of confidence in the data leads to a lack of confidence in the results obtained from using it