Chapter 5: Market Risk Flashcards

1
Q

What is Volatility risk

A

The risk of price movement that are more uncertain than usual affecting the pricing of products. Has the biggest affect on options market

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2
Q

What is Market liquidity risk

A

The risk of loss through not being able o trade in a market or obtain a price on a desired product when required

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3
Q

What is Currency risk

A

The risk that adverse movements in exchange rates drastically affect the value of a portfolio or instrument

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4
Q

What is basis risk

A

This is the risk that, when hedging a position, the two instruments are not equal and opposite, but in fact behave in a similar manner

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5
Q

What is interest rate risk

A

the risk that adverse movements in interest rates will directly affect fixed-income securities, futures, options and forwards

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6
Q

What is commodity price risk

A

The risk of adverse price movements in the value of a commodity

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7
Q

What is Equity price risk

A

The risk that the share price decreases or fails to rise in line with inflation. Also includes the risk that dividends may decrease or not be paid at all

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8
Q

What are boundary issues

A

When multiple types of risk overlap/cause/affect one another

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9
Q

What are market risk limits

A

A ‘stop-loss’ and may be expressed in terms of VaR or as an absolute number

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10
Q

What do the market risk function do

A

Ownership of market risk management policy
Proactive management of market risk issues
Define escalation procedures
Validate Pricing and VaR models
Daily monitoring of risk utilization

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11
Q

What is the central tendency

A

A typical value taken from market datasets that captures the ‘essence’ of the distribution

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12
Q

What is the dispersion

A

How far values stray from the typical value

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13
Q

What are the measures of central tendency

A

Mean
Median
Mode

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14
Q

What are the measures of dispersion

A

Range
Quartile deviation
Variance
Standard Deviation

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15
Q

What is quartile deviation

A

A measure of dispersion through the middle half f the distribution

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16
Q

How to calculate quartile deviation

A

0.5(Q3-Q1)

17
Q

What is variance

A

A measure of dispersion and shows the spread of data around the mean

18
Q

How to calculate variance

A

the sum of the squares of the differences between the mean and each value divided by the number of values (Or number of values - 1 when using a sample)

19
Q

How to calculate standard deviation

A

Square root of the variance

20
Q

How often are returns within within one standard deviation of the mean

A

2/3

21
Q

What is distribution analysis

A

A statistical means of using historical data to predict future events and relies on an understanding of probability distributions

22
Q

What percentage of the data in a normal distribution will be within 2 standard deviations

A

95.5%

23
Q

What percentage of the data in a normal distribution will be within 3 standard deviations

A

99.75%

24
Q

What is regression analysis

A

A statistical tool for the investigation of relationships between variables. The effect of one variable on another.

25
Q

What is the correlation coefficient

A

It measures the strength of the relationship between two variables

26
Q

advantages of VaR

A

Provides statistical probability of potential loss
Easily understood by non risk managers
Translates all risks in a portfolio into a common standard

27
Q

Disadvantage of VaR

A

Does not specify maximum loss outside of the confidence level

28
Q

What is back testing

A

The practice of comparing the actual daily trading exposure to the previously predicted VaR figure

29
Q

What are the three ways VaR can be calculated

A

Historical simulation
The Parametric
Monte Carlo simulation

30
Q

What is the historical simulation

A

Involves looking back at what actually happened in the past and basing our view of the future o that analysis

31
Q

What is the parametric approach

A

This assumes that the distribution of possible returns can be plotted, based on a small number of factors, so that the required confidence level can be ‘read off’ the graph

32
Q

What is the Monte Carlo Simulation

A

Involves generating random set of results based on the actual underlying risk factors and again ‘reading off’ the graph

33
Q

What is the difference between stress testing and scenario analysis

A

The number of variables that are altered

34
Q

Advantages of historical simulation

A

Simple to communicate to non experts
No need to make assumptions about the distribution of returns
No need to estimate volatilities or correlations

35
Q

Disadvantages of historical simulation

A

Assumes that history will repeat itself which often is not the case

36
Q

Advantages of Parametric approach

A

The simplest way to calculate VaR
Minimal computation time
No simulations required

37
Q

Disadvantages of Parametric approach

A

The actual returns have to be normally distributed or the results will be incorrect
Cannot be used with securities such as options as not normally distributed

38
Q

Advantages of Monte Carlo Method

A

Can be used on non-normally distributed instruments