Flashcards
Risk management (flash cards)
Cards in this deck (38)
- 1Credit risk - ...Credit risk - the risk that the promised cash flows from loans and securities held by banks may not be paid in full.
- risk of default (of borrower);
- risk of delay in servicing the loan; - 2Screening - ...Screening - screen out the bad credit risks from the good ones in order to maximise the shareholders value added through credit risk management. (by acquiring info on a potential borrower - probability of default)
- 3Qualitative models - ...Qualitative models (expert system) - subjective judgement of the bank's manager on the probability of default of the borrower; used in the absence of publicly available information on the quality of the borrower.
- 4Credit decision made by several factors:1) borrower specific factors :
- reputation (=credit history);
-borrower's leverage;
- volatility of the borrower's earnings;
2) market-specific factors:
- the business cycle phase;
- level of interest rates; - 5Credit scoring models - ...Credit scoring models - mathematical models used to observe the characteristics of the loan's applicant, either to calculate the applicant's probability of default or to sort borrowers into different default risk classes.
- 6Linear probability models - ...Linear probability models - use data from past defaulters and healthy borrowers to identify the explanatory variables (e.g.: leverage, earnings) that are statistically significant in explaining why an individual or a firm defaults on a loan.
- 7Linear discrimination models - ...Linear discrimination models - divide into high or low default risk classes on their observed characteristics;
- 8Altman's discriminant function - (formula) - interpretation of formulaZ = 1,2X(1) + 1,4X(2) + 3,3X(3) + 0,6X(4) +X(5)
X(1) - working capital/total assets;
X(2) - retained earnings/total assets;
X(3) - earnings befor interests and taxes/total assets;
X(4) - market value of equity/book value of long-term debt
X(5) - sales/total assets - 9Conclusion of Altman's discriminant functionthe higher Z (Altman's function) the lower default risk
- 10Problem of credit scoring models1) discriminate only between 2 extreme cases (default, non-default);
2) no economic rationale for expecting weights and variables to remain constant over short periods;
3) ignore characteristics (e.g: reputation); - 11Newer models based on financial market data - ...Newer models based on financial market data - most relevant to the valuation of loans to large borrowers in corporate sector.
- 12Credit Metrics - ....Credit Metrics ask question "If next year is bad year, how much will the bank lose on its loans or loans' portfolio?"
Each borrower is assigned a credit rating, and a transition matrix is used to determine the probabilities that the borrower's credit rating will be high or low. - 13Credit Risk +Credit Risk + - attempts to estimate the expected loss of loans and the distribution of those losses.
- 14Monitoring - ...Monitor the borrower's activities (and their risk)
- 15Writing covenants into loans means ...loan contract contain covenants restricting or encouraging various future actions.
- 16Long-term customer relationship benefits because ...- lower cost of monitoring (for bank);
- lower interest rate (for borrower); - 17Bank refuses to make loan of any amount of borrower, who is willing to pay a higher interest rate means ...high loan rates may increase the probability of loan default, so bank would make no loan
- 18Bank makes the loan but reduces the size of the loan. Why?Because the larger the loan, the higher is the incentive of the borrower to engage in activities that increase the default risk probability.
- 19Collateral - ...Collateral are the assets used by the borrower to guarantee the repayment of the debt;
- 20Endorsement - ...Endorsement - if loan is endorsed by a third party, the 3rd party is committed to repaying the debt.
- 21Diversification - ...Diversification - achieved by lending to different types of borrowers;
avoiding a concentration of loans to one type borrower; - 22Migration analysis - ...Migration analysis - Banks monitor the credit ratings of a # of firms in an industry, A loan migration matrix provides the probability a pool of loans being upgraded, downgraded or defaulting over some period.
- 23Concentration limits - ...Concentration limits - are set by banks in terms of the proportion of the loan portfolio that can go to any single borrower or type of borrower (use in order to decrease exposures to certain industries or geog.areas)
Limit - 10% of a bank's capital - 24Liquidity risk could be from 2 sides:1) liability side - loss of funding (retail funding, wholesale funding)
2) asset side - liquidity risk could come from the ability of a bank to sell/securitise assets to raise funding. - 25Interest rate risk - ...Interest rate risk - the risk incurred by a bank when the maturities of its assets and liabilities are mismatched and there are changes in market interest rates.
- 26Refinancing risk - ...Refinancing risk - the risk that the cost of borrowing funds will be higher than the returns earned on asset investments.
- 27Reinvestment risk - ...Reinvestment risk - the risk that returns on funds to be reinvested to be lower than the cost of funds, when the bank holds shorter-term assets relative to liabilities.
- 28Market value effect - ...Market value effect - the risk refers to the change in the present value of the cash flows on assets and liabilities.
- 29Income gap analysis - ....Income gap analysis - measures the sensitivity of a bank's current year net income to changes in interest rate.
- 30Problems of income gap analsis1) only look to impact of interest rate to income;
2) ignores market value effect and income effect;
3) rate-sensitive assets and liabilities (whose interest rate are not repriced) actually have a component that is rate sensitive.
4) ignores the effect of changes in interest rates on off-balance sheet instruments - 31Duration gap analysis - ...Duration gap analysis - measures the sensitivity of a bank's current year net worth to changes in interest rate
- 32Problems of Duration gap analysis :1) measure assumes a linear relationship between interest rate and asset values;
2) relationship is convex; the higher convexity, the less useful this analysis;
3) approximation in equation;
4) works for small changes in interest rate; - 33Market risk - ....Market risk - the risk related to the uncertainty of a bank's earnings on its trading portfolio caused by changes in the market conditions: interest rate, equity return, exchange rates, market volatility, market liquidity;
- 34Value-at-risk (VaR) approach - ...Value-at-risk (VaR) approach - measures the potential loss in value of a risky asset or portfolio over a defined period for a given confidence interval.
- 35Historic data - ...Historic data - evaluation of the past performance of the asset or portfolio on the assumption that past performance is fairly accurate predictor of future performance.
- 36Problem of normal stat, distribution :1) the variance- covariance approach - assume stable correlation over time;
2) assumes normal distribution which is not always appropriate. - 37Monte carlo simulation - ...Monte carlo simulation - involves development of a model for the returns on an asset or portfolio and then randomly generating outcomes for returns to determine the distribution of outcomes.
- 38Operational risk - ...Operational risk - the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events.
Information
- Description
- Flashcards on Risk management (flash cards), created by Асема Жанадилова on 26/01/2018.
- Created by
- Асема Жанадилова
- Views
- 0
- Tags
- Rating