Week 4

Question 1

What has happened to number of residential loans in the last years

Answer 1

They have decreased over the last years

Question 2

What is happening to the buy-to-let as share of a portfolio of real estate

Answer 2

it is declining

Question 3

What is credit risk?

Answer 3

Risk that a contracted payment is not going to be paid to a borrower

Question 4

Who puts a price on the risk

Answer 4

the market and it is built into the market purchase price

Question 5

What is the credit spread

Answer 5

Part of the price that is due to credit risk

Question 6

What do typical models that banks and financial institutions use to model risk contain?

Answer 6

• Conditions of the general economy and those of the specific firms as inputs
• It generates the credit risk as outputs

Question 7

How to get the estimate of the amount of economic capital needed to support credit risk activities

Answer 7

Banks use an analytical framework that relates required economic capital for credit risk to their portfolio’s probability distribution function of credit losses.

Question 8

Mechanisms for allocating economic capital against credit risk assume that the shape of pdf can be approximated by distributions that could be parametrised by mean and standard deviations of what?

Answer 8

portfolio losses

Question 9

What are the 2 components of credit risk?

Answer 9

Expected loss: amount of credit loss the banks expects to experience in it’s credit portfolio over it’s horizon

Unexpected loss: measure of the bank’s risk in its credit portfolio

Question 10

What is the std. dev. of the credit loss PDF and what is it used for?

Answer 10

average deviation of expected losses it is used to measure unexpected loss

Question 11

What is stress loss?

Answer 11

if the sum of expected loss and unexpected loss shows bank can’t meet it’s credit obligation and profit. This is represented by stress loss.

Question 12

What 2 problems that banks have to overcome to mamange credit risk

Answer 12

• adverse selection
• moral hazard

Question 13

What are the 5 principals banks use to manage credit risk and tell what each principal entail

Answer 13

1) Screening and monitoring
- screening, monitoring and enforcement

2) Long-term customers
- reduces cost of information collection
- easier to screen bad credit

3) Loan comitments
- promotes long term relations
- good for information gathering

4) Collateral and compensating balances
- property promised if borrower defaults

5) Credit rationing
- Lender refuses loan for any amount no matter what rate
- Lender willing to loan less than borrower would like

Question 14

What does a bank’s balance sheet contain for assets and liabilities + equity

Answer 14

Question 15

How does interest rate changes and volatility affect financial institutions

Answer 15

Question 16

What is gap analysis

Answer 16

method of measuring the sensitivity of a bank’s profit to changes in interest rates

Question 17

What is Basic gap analysis

Answer 17

amount of rate sensitive liabilities subtracted from amount of rate sensitive assets multiplied by change in interest rates

Question 18

What is maturity bucket approach?

Answer 18

Measures the gap for several maturity subintervals called maturity bucket

Question 19

what is standardised gap analysis

Answer 19

Account for different degrees of rate sensitivity among rate sensitive assets and liabilities

Question 20

What is duration analysis and it’s formula

Answer 20

measures the sensitivity of the market value of the bank’s total assets and liabilities to change in interest rates.

Question 21

What does the duration analysis use and what is it based on?

Answer 21

Macaulay’s concept of duration which uses the weighted average duration of a financial institution’s assets and of it’s liabilities to see how net worth responds to a change in interest rates.

Question 22

What do both gap and duration analysis suggest happens to banks if interest rates rise?

Answer 22

they suffer only if rate sensitive liabilities are more than assets

Question 23

What do both gap and duration analysis suggest happens to banks if interest rates fall?

Answer 23

they gain only if rate sensitive liabilities are more than assets

Question 24

If a bank is subject to substantial interest rate risk, how can it eliminate intrest rate risk?

Answer 24

• Shortening duration of assets
• Lengthen the duration of its liabilities

Question 25

What are off balance sheet activities?

Answer 25

They generate income but do not appear on balance sheet

Question 26

Give examples of off-balance sheet activities

Answer 26

• loan sales
• generation of fee income
• trading activates and risk management techniques: financial futures, options for debt,

Question 27

What are internal controls to reduce the principal-agent problem

Answer 27

• Separation of trading activities and bookkeeping
• Limits on exposure
• Value-at-risk
• stress testing

Question 28

What are climate risks classified into?

Answer 28

• Physical risks: landslides, floods, wildfires storms etc.
• Transition risks: related to process of adjustment to low carbon economy

Question 29

What are climate risk driver?

Answer 29

• Physical risks
• Transition risks

Question 30

How do the financial risks from climate risk drivers arise

Answer 30

Question 31

What is the linkage between climate, economy & financial stability

Answer 31

Question 32

What are the risks that bank’s face and how they manage them?

Answer 32