Sec D - Enterprise Risk Flashcards
Capital Adequacy Ratio
Capital adequacy refers to the required amount of capital that banks and financial institutions are required to have per regulatory requirements
CAR = Tier 1 Capital + Tier 2 Capital
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Risk Weighted Assets
Tier 1 Capital = common stocks, retained earnings
Tier 2 Capital = general loss reserves, undisclosed reserves, hybrid debt-capital
instruments
Business Risk
Business risk is the potential for loss or the risk of actual profits being lower than anticipated.
It comprises 5 subcategories of risk:
1) Hazard Risk — natural catastrophes
2) Financial Risk — credit risk, liquidity risk, market risk (trading).
3) Operational Risk — potential loss due to operational failures from employees, systems, processes
4) Compliance Risk — governmental regulation
5) Legal Risk — loss due to legal proceedings
5) Strategic Risk — poor or incorrect business decisions
7) Political Risk — taxes, eminent domain, political
upheaval
Inherent Risk
Inherent risk is the exposure to loss as part of an activity without any risk management activities.
Residual Risk
Residual risk is the risk that remains after risk management measures have been taken.
Key Steps in Risk Management Process
Key Steps in Risk Management Process =
- Set the organization’s tolerance for risk.
- Identify existing risks.
- Assess the probability and potential for loss from each risk.
- Prioritize risks.
- Respond to risks, tanging from acceptance (no action taken) to avoidance (abandoning the activity).
- Continue to monitor risks for any changes in impact or probability.
Qualitative risk assessments
P |
r High Prob | High Prob
o Low impact | High impact
b mitigate thru | risk management
a planning | process to reduce risk
b ———————————————-
i Low Prob | Low Prob
l Low impact | High Impact
i accept risk | transfer risk
y | (insurance)
P o t e n t i a l i m p a c t
Cash flow at risk
cash flow at risk is the unfavorable cash flow that may incurring a period of time given a specific level of confidence.
i.e., the risk that they will not receive their expected cash flow‘s during a period of time, worst case.
Earnings at risk
Earnings at risk measure the amount of the change net income during a specific period due to changes in interest rates only
Earnings Distributions and EPS Distributions
Earnings distributions and earnings per share (EPS) distributions provide information about the profitability of a company either as a whole or per common share.
Value at Risk (VaR)
Value at Risk (VaR) provides a common measure for the amount that an investment could lose during a given period, assuming normal market conditions.
Historical method — simplest, assumes history repeats itself
Parametric method (aka variance-covariance method) — Assumes a normal distribution in returns, uses expected return and standard deviation
Monte Carlo method — randomly creating various scenarios for future rates and estimating the change of value for each scenario
Enterprise Risk Management (ERM) objectives
Enterprise Risk Management (ERM) objectives:
- Strategic: high level goals to company’s success
- Operations: day-to-day activities to increase efficiency
- Reporting: reliability of financial and operational reporting
- Compliance with all laws and regulations
ERM components
ERM components:
- Internal Environment
- Objective Setting
- Event Identification
- Risk Assessment
- Risk Response
- Control Activities
- Information and Communication
- Monitoring
Benefits of COSO ERM
Benefits of COSO ERM:
- Better information that supports improve decision making.
- Anticipate risks earlier and more reliably, identify pursue new opportunities.
- Respond to deviations in expected results more quickly and decisively.
- Improve collaboration, trust, and information sharing
Coefficient of Variation (CV)
Coefficient of Variation (CV) =
Standard deviation of an asset /
Expected return of the asset
the higher the CV, the higher the risk
