Session 7

Question 1

Just know about the 2008 crisis

Answer 1

Not even gonna bother repeating it

Question 2

How can you manage credit risk?

Answer 2

Using a collateral

Question 3

How do you manage credit risk in exchange-traded markets?

Answer 3

You set up an initial margin (aka deposit). Trades are monitored daily and in case of need the seller/lender may ask for a variation margin (margin call)

If you don’t know this ask me directly because idk how to explain it simply in writing (Andrea)

Question 4

What is a maintenance margin?

Answer 4

Its the limit which if crossed there is a margin call is executed.

Asking the buyer/borrower to deposit more money in the margin account.

Question 5

How do you manage credit risk in OTC markets?

Answer 5

Clearinghouses

Question 6

Why do regulators demand the use of CCPs (central counterparties) in OTC derivatives?

Answer 6

To reduce systemic risk

Question 7

What is the portfolio expected loss?

Answer 7

The sum of individual expected losses

Question 8

Which is bigger, portfolio UL or individual UL

Answer 8

Individual ULs due to diversification effects

Question 9

How do you calculate EL?

Answer 9

EAD * PD * LGD = EL

Question 10

What is Probability of Default (PD)?

Answer 10

average percentage of obligors that default in a rating grade in the course of one year

Question 11

What is Loss Given Default (LGD)

Answer 11

gives the percentage of exposure the bank might lose if the borrower defaults.

Question 12

What is Exposure at Default (EAD)

Answer 12

the outstanding amount (drawn amounts plus likely future draw-downs of yet unused lines) in case the borrower defaults

Question 13

What DOESN’T EL measure?

Answer 13

The variation in a risky asset’s value (that’s UL)

Question 14

How do you find UL?

Answer 14

EAD*K

Question 15

What is a recovery rate?

Answer 15

The average rate at which different types of debt recover their loan

Question 16

How do you find capital using EL and UL?

Answer 16

(EL-provisions) + UL

Question 17

What is the movement over time of expected exposure in an IRS?

Answer 17

Diffusion: risk goes up an then plateaus
+
amortization of the cashflows

Question 18

What happened on the Basel committee?

Answer 18

This was a gathering of the representatives for biggest central banks on the world to agree on some issues.

Question 19

What is the mission of Basel I ?

Answer 19

Basically standardization of minimum capital requirements and solvency.

Specifics => the standardization of regulations relating to the calculation and monitoring of the solvency ratio of banks and financial institution

Question 20

What are the prerogatives (Privileges) of Basel 1?

Answer 20

none really, the Central Bankers ensured that it had no Supra-national powers.

Meaning that each country needed to adopt it on their own. Like an EU directive.

Question 21

What are the types of stress scenarios introduced in basel 2?

Answer 21

• Sensitivity
• Historical
• Hypothetical (or theoretical)
• Adversaries

Question 22

What is the Confidence level and risk horizon on the stress scenarios?

Answer 22

confidence level is 99.9% and the risk horizon is 1 year

Question 23

What was the key innovation of the 1988 BIS accord? (Basel 1)

Answer 23

Cooke Ratio

Question 24

What is a capital adequacy ratio (CAR)?

Answer 24

The amount of capital a bank has as a percentage of its total risk-adjusted assets

Question 25

What is the CAR in the Cooke Ratio

Answer 25

8%

Question 26

What are the two tiers of capital introduced on Basel 1?

Answer 26

Tier 1: Equity non-cumulative preferred stock Tier 2: Cumulative preferred stock 99-y debenture (Company bond) Subordinated debt

Question 27

What are the three pillars of the Basel 2 reform?

Answer 27

Minimum Capital Requirements Supervisory Review Market Discipline

Question 28

What are the three credit risk approaches of Basel 2

Answer 28

1. The Standardized Approach 2. The Foundation Internal Ratings Based (IRB) Approach 3. The Advanced IRB Approach

Question 29

What are the improvements done on Cooke Ratio implemented on Basel 2?

Answer 29

The methods account for operational risk Included into consideration more business lines, like corporate finance, asset management Different calculations of methods for credit, market and operational risk.

Question 30

How do you calculate the capital required using IRB?

Answer 30

(Var(99.9%) one year risk horizon)-(Expected one year loss)

Question 31

How is the second pillar of Basel 2, "Supervisory review" , enforced?

Answer 31

They included 4 key principles to follow when supervising the capital requirements.

Question 32

How is the third pillar of Basel 2, "Market Discipline" , enforced?

Answer 32

This is enforced increasing the disclosure by a bank of its risk assessment procedures and capital adequacy

Question 33

What are the 4 key principles of supervision that Basel 2 included to satisfy its second pillar?

Answer 33

1 - Banks need a process to asses their capital adequacy 2 - supervisors should evaluate INTERNAL capital adequacy 3 - They need to be above the minimum regulatory capital 4 - Supervisors should intervene FAST if the capital drops bellow the minimum levels.

Question 34

What are the 7 disclosures that banks should disclose introduced on Basel 2 included to satisfy its third pillar?

Answer 34

1. The entities in the banking group to which Basel II is applied and adjustments made for entities to which it is not applied 2. The terms and conditions of the main features of all capital instruments 3. Total Tier 1 capital held 4. Total Tier 2 capital held 5. Capital requirements for credit, market, and operational risk 6. Other risks exposures and the assessment methods used 7. The structure of the risk management function and how it operates.

Question 35

What is a clearing house?

Answer 35

A clearing house for over-the-counter (OTC) exchanges is a financial intermediary that facilitates the settlement of trades by acting as a counterparty to both buyers and sellers. It helps manage counterparty risk by guaranteeing the fulfillment of trades and ensuring the smooth processing of transactions in OTC markets.

Question 36

What does PD stand for? (EL & UL)

Answer 36

Probability of Default (PD)

Question 37

What does LGD stand for? (EL & UL)

Answer 37

Loss Given Default (LGD)

Question 38

What does EAD stand for? (EL & UL)

Answer 38

Exposure at Default (EAD)

Question 39

What is a cohesive risk measure?

Answer 39

Sub-additivity Monotonicity Homogeneity Cash Invariance

Question 40

Is VaR a cohesive measure?

Answer 40

Nope