Session2 - handout2 - Understanding a banks performance Flashcards
An institution usually encounters 5 types of risks, which ones?
- Credit Risk
- Market Risk
- Liquidity Risk
- Operational Risk
- Strategic Risk
How is risk expressed in the “banking context” according to the Prof.?
- Your Debt is its Asset
- Your Saving Account is its Debt
- Low equity - High Leverage
- Low turnover as compared to assets
- Profit: Low as compared to asset but reasonable as compared to equity
What is meant by “Securitization”?
Turning assets into securities
Tell the story about Bill Clinton and Subprime mortgages related to Credit Risks.
Subprime prices:
Bill clinton said that “each american should be the owner of his own accommodation”.
people started to lend a lot of money, even the low-income class - US wants more people to invest due to not being risky - But this wasn’t true since (Loan / Value = 90%). - as time goes on, the value of the loan decreases
–> Loan decrease and Value increase –> (Loan/value) decreases - (see slide 15) - the rating of the securities says that nothing can happen to you if you gave AAA or so… but we were starting to swap receivables for cash which turned into a snow-ball effect and then a crisis.
The Default rate in 2004 was 15% but in 2005 it jumped up to 25%, what was the effect of this?
1) The Loss Given Default rate (LGD) became high
2) which meant that more and more people were becoming unable to pay back their loans
3) henceforth the banks were encountering liquidity problems due to this.
What does “VaR” stand for and what does it measure?
VaR = value at risk.
1) Describe with the 500 days example
2) If VaR = 8% (for instance) then this means that if we here to give out a loan of 100 then we would expected to lose 8 at the most.
In VaR, why don’t we have a CI of 100%?
Why don’t we take 100%? Let’s assume we have 100 loans (in the assets side). If I take 100% of the cases, the maximum loss is 100, which is not very helpful. That is why we refer to have a confidence level. We say that in 0,1%, we might lose above the value at risk.
What is meant by “Expected Losses”?
1) These are the loses we expect based on an average
2) Covered by Cash Flow of the bank
Is a 99.99% level of CI prudent or not? Moreover, Conservative or Not Conservative?
It’s not very prudent
What is the formula for “Total Losses” in this context?
Expected losses + unexpected losses
What is meant by “Expected Losses” and “Unexpected Losses” in this context?
EL = mean losses. Is the LT average loss. Assumed to be covered by Margin income.
UL: This is the difference between losses estimated at the 99.9 confidence level and mean losses. This is covered by equity.
According to Basel II & III regulations, how do you calculate the “Capital Requirement” for VaR? What is the definition of the componenents?
RWR∗EAD∗TR=RWA∗TR
- RWR = Risk Weighting Ratio, which Is the frequency of loss+The Severity of loss. An estimation of how likely it is that that the commitment of that/those assets isn’t fulfilled.
- RWA = Risk-Weighted Assets, All assets considered to be risky.
- EAD = Exposure at Default (according to the bank SEB –> EAD = Credit Exposure + Credit-Conversion Factor.)
- TR = Target Ratio, is the capital requirement.
What is meant by “Market Risk”?
That is the risk that arises from the movements in the level of volatility of market prices (stocks, bonds, forex etc)
Based on a confidence interval of 95% how much could you expect to earn in an annual return between year 1926 - 2006?
between -30% to +50%.
When examing the development of large stock indices, what is it that make them move?
A) Small Moves every day?
B) Big moves with a greater contribution?
B) Big moves with a greater contribution
That’s because extreme events change the name of the game.
