Session 7 Flashcards
Just know about the 2008 crisis
Not even gonna bother repeating it
How can you manage credit risk?
Using a collateral
How do you manage credit risk in exchange-traded markets?
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)
What is a maintenance margin?
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.
How do you manage credit risk in OTC markets?
Clearinghouses
Why do regulators demand the use of CCPs (central counterparties) in OTC derivatives?
To reduce systemic risk
What is the portfolio expected loss?
The sum of individual expected losses
Which is bigger, portfolio UL or individual UL
Individual ULs due to diversification effects
How do you calculate EL?
EAD * PD * LGD = EL
What is Probability of Default (PD)?
average percentage of obligors that default in a rating grade in the course of one year
What is Loss Given Default (LGD)
gives the percentage of exposure the bank might lose if the borrower defaults.
What is Exposure at Default (EAD)
the outstanding amount (drawn amounts plus likely future draw-downs of yet unused lines) in case the borrower defaults
What DOESN’T EL measure?
The variation in a risky asset’s value (that’s UL)
How do you find UL?
EAD*K
What is a recovery rate?
The average rate at which different types of debt recover their loan
How do you find capital using EL and UL?
(EL-provisions) + UL
What is the movement over time of expected exposure in an IRS?
Diffusion: risk goes up an then plateaus
+
amortization of the cashflows
What happened on the Basel committee?
This was a gathering of the representatives for biggest central banks on the world to agree on some issues.
What is the mission of Basel I ?
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
What are the prerogatives (Privileges) of Basel 1?
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.
What are the types of stress scenarios introduced in basel 2?
- Sensitivity
- Historical
- Hypothetical (or theoretical)
- Adversaries
What is the Confidence level and risk horizon on the stress scenarios?
confidence level is 99.9% and the risk horizon is 1 year
What was the key innovation of the 1988 BIS accord? (Basel 1)
Cooke Ratio
What is a capital adequacy ratio (CAR)?
The amount of capital a bank has as a percentage of its total risk-adjusted assets
What is the CAR in the Cooke Ratio
8%
What are the two tiers of capital introduced on Basel 1?
Tier 1:
Equity
non-cumulative preferred stock
Tier 2:
Cumulative preferred stock
99-y debenture (Company bond)
Subordinated debt
What are the three pillars of the Basel 2 reform?
Minimum Capital Requirements
Supervisory Review
Market Discipline
What are the three credit risk approaches of Basel 2
- The Standardized Approach
- The Foundation Internal Ratings Based (IRB) Approach
- The Advanced IRB Approach
What are the improvements done on Cooke Ratio implemented on Basel 2?
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.
How do you calculate the capital required using IRB?
(Var(99.9%) one year risk horizon)-(Expected one year loss)
How is the second pillar of Basel 2, “Supervisory review” , enforced?
They included 4 key principles to follow when supervising the capital requirements.
How is the third pillar of Basel 2, “Market Discipline” , enforced?
This is enforced increasing the disclosure by a bank of its risk assessment procedures
and capital adequacy
What are the 4 key principles of supervision that Basel 2 included to satisfy its second pillar?
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.
What are the 7 disclosures that banks should disclose introduced on Basel 2 included to satisfy its third pillar?
- The entities in the banking group to which Basel II is applied and adjustments made for entities to
which it is not applied - The terms and conditions of the main features of all capital instruments
- Total Tier 1 capital held
- Total Tier 2 capital held
- Capital requirements for credit, market, and operational risk
- Other risks exposures and the assessment methods used
- The structure of the risk management function and how it operates.
What is a clearing house?
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.
What does PD stand for? (EL & UL)
Probability of Default (PD)
What does LGD stand for? (EL & UL)
Loss Given Default (LGD)
What does EAD stand for? (EL & UL)
Exposure at Default (EAD)
What is a cohesive risk measure?
Sub-additivity
Monotonicity
Homogeneity
Cash Invariance
Is VaR a cohesive measure?
Nope
