Risk Concepts

Question 1

state 3 differences between risk and uncertainty

Answer 1

• Risk can be quantified, uncertainty cannot.
• Risk is necessarily negative; uncertainty can be negative or positive.
• Risk can be insured, uncertainty cannot.

Question 2

what are the three characteristics of black swan events

Answer 2

1. Outlier
2. Impactful
3. Prone to be rationalized after the fact.

Question 3

name 5 Canadian regulators and who they regulate

Answer 3

• BCBS: global rules
• OSFI: banks and insurance.
• FSRA: credit unions
• CDIC: banks
• IIROC: investment dealers

Question 4

what are financial risks

Answer 4

risks that are unavoidable in generating profits.

Question 5

what is a difference between financial and non-financial risks?

Answer 5

financial risks are quantifiable, non-financial risks are not.

Question 6

what are 3 types of financial risk

Answer 6

credit, market and liquidity.

Question 7

what are non-financial risks

Answer 7

risks that are inherent to the business

Question 8

what are three types of non-financial risks

Answer 8

operational, cybersecurity, money laundering

Question 9

what is the risk management framework?

Answer 9

1. First line: business line.
2. Second line: control functions.
3. Third line: the firm’s governance, and audit.

Question 10

at which step in the risk management framework is the risk profile defined?

Answer 10

first line by the business line

Question 11

at which step in the risk management framework are the risk limits defined

Answer 11

the second line by the control functions.

Question 12

what are 5 types of models

Answer 12

• Regulatory capital models
• Pricing models
• Risk models
• Business decision-making models.
• Stress testing models.

Question 13

what are 6 sources of model risk?

Answer 13

• inaccurate, inappropriate or incomplete data.
• Inappropriate specifications.
• Flawed assumptions and mathematical errors.
• Code bugs
• Improper usage.
• Inadequate monitoring/controls.

Question 14

what are the 4 levels of the risk hierarchy?

Answer 14

1. risk profile
2. risk limits
3. risk appetite
4. risk capacity

Question 15

define risk profile

Answer 15

risk current amount of risk

Question 16

define risk limits

Answer 16

the total amount of risk that management is willing to accept

Question 17

define risk appetite

Answer 17

the total amount of risk the board is willing to accept

Question 18

define risk capacity

Answer 18

the total amount of risk a firm can take on without failing

Question 19

what are the two ways in which a company can go bankrupt

Answer 19

1. insolvency: when a firm gradually loses money over time until it owes more than it owns.
2. illiquidity: when a firm suddenly doesn’t have enough cash to cover its outflows.

Question 20

what is a desired equity/assets ratio

Answer 20

8%

Question 21

what is a criticism of the E/A ratio?

Answer 21

it is too crude since it doesn’t take into account what the assets and liabilities are.

Question 22

what is the effect of increased deposits on E/A

Answer 22

E/A decreases since assets increase

Question 23

what is the effect of increased earnings (interest) on E/A

Answer 23

E/A increases since assets and equity are both increased by a constant

Question 24

what is the effect of dividends on E/A

Answer 24

E/A decreases since assets and equity are both decreased by a constant

Question 25

what it the effect of a change in asset classes on E/A

Answer 25

E/A is unchanged

Question 26

what is risk weighted asset

Answer 26

adding different weights to asset classes, an improvement over the E/A

Question 27

what is the formula for RWA

Answer 27

RWA=12.5⋅EAD⋅K

Question 28

what are three characteristics of Basel 1

Answer 28

* Introduction of RWA * Introduction of exposure to a derivatives counterparty. * Introduction of VaR

Question 29

what are 4 characteristics of Basel 2

Answer 29

* Introduction of internal models to assess credit worthiness: PD, EAD, LGD. * Introduction of an operational risk component to RWA. * Introduction of the 3 pillars: capital adequacy, supervisory review, and disclosure requirements. * Introduction of netting

Question 30

what are 2 characteristics of Basel 2.5

Answer 30

* Supplement GMR and SR with a version calibrated on a stressed historical period so more capital is required. * Introduction of the incremental risk charge

Question 31

what is the incremental risk charge

Answer 31

Estimation of MTM losses from migrations in the credit book.

Question 32

what are 3 characteristics of Basel 3

Answer 32

* Liquidity requirements * Leverage ratio * Standardized approach to counterparty credit risk.