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CISI Cards - Risk in Investment > CISI Risk - Chapter 4 > Flashcards

CISI Risk - Chapter 4 Flashcards

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1
Q

What is default risk

A

Risk of loss caused by the failure of a counterparty or issuer to meet obligations

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2
Q

What is a counterparty

A

A party of either side of a trade.

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3
Q

What is an obligor?

A

The party that has the financial obligation

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4
Q

What is the goal of credit risk management?

A

Maximize a firms risk-adjusted rates of return

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5
Q

What is issuer risk

A

The risk that the issuer defaults on its obligations

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6
Q

2 examples of issuer risk

A

Bond issuers defaults on coupon payments
Bankruptcy of issuer before redemption

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7
Q

What is pre-settlement risk?

A

The risk a firm defaults before the settlement of a transaction

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8
Q

What risk effected Northern Rock in 2007-8?

A

Credit risk - Short term loans

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9
Q

What us settlement risk

A

Default of a counterparty during a non-DVP transaction

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10
Q

What is DVP?

A

Simultaneous exchange of cash for assets

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11
Q

What is PVP

A

Payment vs Payment - Simultaneous exchange of one currency for another

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12
Q

What is RFP?

A

Receipt Free of Payment. Asset & Cash are transferred indecently of each other

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13
Q

Credit Risk boundaries - What is People

A

Adequate segregation of duties

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14
Q

Credit Risk boundaries - What is Systems?

A

The accuracy and timeliness of credit risk information to management by systems

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15
Q

Credit Risk boundaries - What is Internal Processes

A

The efficiency and effectiveness of the credit administration process

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16
Q

What two parts make up credit exposure?

A

Current exposure and potential future exposure

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16
Q

What is credit exposure?

A

The amount that could be potentially lost if a debtor defaults on its obligations

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17
Q

What is a credit risk premium.

A

The interest rate a firms pays to borrow compared with the risk free rate. Higher risk higher premium

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18
Q

What is a credit rating

A

How creditworthy a counterparty is.

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19
Q

The higher the credit rating, the higher or lower the premium?

A

Lower premium

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20
Q

4 Credit rating agencies

A

Fitch
Moods
SnP
DBRS

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21
Q

2 issues with credit rating agencies

A

Opinion based and size/amount of losses are ignored

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22
Q

What rating will a firm need to have to be Investment grade?

A

AAA-BBB

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23
Q

What rating will a firm need to have to be Speculative Grade?

A

BB-D

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24
How is potential exposure usually measured?
Statistical techniques such as Value at Risk (VAR)
25
What are hard factors in credit ratings?
Factual variables that would effect a credit rating?
26
What are soft factors in credit ratings?
Subjective variables that would effect a credit rating
27
6 specific criticisms of credit ratings
no capture of market or liquidity risk Opinion only Downgrades have not happened quickly enough Rating agencies have been too familiar with company management Recent errors of judgement in grading structured products Too reactive
28
Expected loss = ? X ? X ?
PD X EAD X LGD
29
What does PD stand for
Probability of default (%)
30
What does EAD stand for
Exposure at default (Amount)
31
What does LGD stand for?
Loss Given Default
32
What is the equation for the recovery rate?
RR = 100% - LGD
33
What is a credit event
A recognished industry trigger point
34
What are some examples of a credit event
Bankruptcy, Insolvency, receivership, failure to meet payments or a credit rating downgrade
35
What is wrong way risk
The issuing company offer up collateral of their own stocks/assets
36
What is a non-performing asset
Payments missed for 90 days or more become non-performing
37
If payments are late for a short time, what are they classed as?
Past-due
38
5 Limitations on credit risk management
Reliant on quality historical data Lack of recognition of portfolio diversification Lack of recognition of the time period of credit risk Over simplification of calculation of potential exposure Similar exposures do not have equal credit risk
39
What is a notional amount?
Charges applied on potential exposure instead of current exposure
40
What are underwriting standards?
Criteria for evaluation of a counterparties creditworthiness
41
What is a Guarantee?
Like an insurer that will pay out if the borrower does not pay back the loan
42
What is a netting agreement?
A netting agreement allows two parties that exchange cash flows to net cash flows to a single payment
43
What is a Unilateral arrangement?
One party gives collateral to another
44
What is Bilateral arrangement?
Two-sided obligations.
45
What uses bilateral arrangements?
Swap or FX trade
46
What is Netted?
The party who is the net obligor posts collateral for the value of the net obligation (They baso add up all the stuffs and provide one single large overarching collateral)
47
What is a 'Haircut'
Additional collateral used to offset rises or falls in the collaterals market price
48
How to calculate haircut?
Take the bond amount and X by the haircut %.
49
If £20 Million of AAA bonds are being held as collateral and the haircut is 4%, how much collateral is it?
20 Million + (20 Million x 1.04) = 20.8Million
50
What is asset securitisation?
Bundling loans together and selling them to investors
51
What are Loan Sales?
Selling on a loan to an investor. Sorta like re-purcahse
52
What is a Credit Default Swap (CDS)
Optional insurance to cover any potential losses from a default from a counterparty
53
What is an SPV used in?
Special Purpose Vehicles used in securitization
54
At what point will a CDS Payout?
During a credit event. Downgrades are not normally included in this
55
What is a CCP
A guarantor of all transactions, limiting the exposure to the clearing house and protecting parties from default
56
What is novation?
Two trading parties offsetting the transaction to the CCP.
57
3 ways CCPs gain resources to protect from default
Their members Fees by the exchange Other parties that do not have a direct relationship with their market
58
Who approves the credit risk management function?
Board of directors
59
What is a credit risk managment function?
Maxamise a firms risk adjusted rate of return by managing credit risk exposure with acceptable limits
60
Who implements the credit risk strategty?
Senior Managers
61
3 things that happen in a credit risk management function?
Credit risk analysis Credit decisions are made independently of trading Integrate credit risk management into general business strategy
62
How often should a firms credit risk strategy be reviewed?
Annually
62
Who is responsible for approving and reviewing the firms credit risk strategy?
Directors
62
4 things the measurement of credit risk should take account of?
Specific nature of the the credit The exposure profile The existence of collateral The potential for default
63
5 components to credit scoring systems
Age Credit history Occupation Years in current job Home owner or renting
64
What are the 2 extraordinary inputs included in a credit assessment?
Court actions and one off factors
65
What are split ratings>
A financial instrument recieves many many ratings
66
What is the most popular way of measuring Concentration risk?
Herfindahl-Hirschman index.
67
Advantage to the HHI index?
Simple computing and moderate data requirments
68
Disadvantage to the HHI index?
Not consider borrowers credit quality
69
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CISI Cards - Risk in Investment (19 decks)

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