RM Lecture 1 Flashcards
What are the two essential components of risk according to Holton?
Exposure and uncertainty.
How does the Oxford dictionary define risk?
Exposure to the possibility of loss, injury, or adverse circumstances.
Give an example of market risk mentioned in the lecture.
The EUR/USD exchange rate tomorrow or the 6-month Euribor rate on a specific date.
What is credit risk?
The risk of a borrower defaulting on debt obligations (e.g., loan repayment).
What triggered the 2007–2008 global financial crisis?
The subprime mortgage crisis, compounded by Lehman Brothers’ bankruptcy.
What loss did Société Générale incur in 2008?
€4.9 billion due to unauthorized trades by Jérôme Kerviel.
Which event caused a 75% USD capitalization loss in Asia (1997)?
The Asian financial crisis (Indonesia, Korea, Malaysia, Thailand).
How is risk magnitude often quantified?
Through variance, volatility, or the range of possible outcomes.
Name a post-1970 factor that increased financial risks.
Collapse of the Bretton-Woods system (fixed exchange rates).
Define operational risk.
Risk arising from human/technical errors or accidents (e.g., IT failures).
What is liquidity risk?
Uncertainty in executing transactions at desired price/volume.
Why do regulators care about risk management?
To enforce capital buffers and protect financial system stability.
How does convexity improve risk approximation?
It accounts for curvature in price-yield relationships.
Calculate PVBP for a bond.
PVBP = Value at (rates + 0.01%) – Value at original rates.
Which risk bucket is most exposed in a 20-year bond?
Longer maturity buckets (e.g., 20-year) due to higher interest rate sensitivity.
For a 5-year bond (FV=€100, yield=6%), compute the exact value.
B=1001.065=€74.73B=1.065100=€74.73
Why does the first-order Taylor approximation underestimate ΔB?
It ignores convexity (non-linear relationship between bond price and yield).
What is risk mapping?
Identifying risk factors (e.g., interest rates) and their impact on a position’s value.
What is the purpose of bucket risk analysis?
To isolate interest rate risk exposure at specific maturity points.
Why might firms or individuals intentionally take on risk?
To pursue potential rewards (e.g., higher returns, strategic advantages).
What is the goal of achieving ‘optimal risk exposure’?
Balancing risk and reward to align with an entity’s risk appetite and objectives.
Name three examples of financial risk factors.
- Interest rate changes (e.g., ECB decisions)
- Credit spreads of risky bonds
- Commodity price fluctuations
What is a ‘risk factor’ in risk mapping?
A variable (e.g., interest rates, stock prices) that directly impacts the value of a position.
Define legal risk.
The risk that financial contracts become unenforceable due to legal challenges or regulatory changes.
