Sharing some short notes and qus of BFM Unit 8 .. will update more later on. Hope you like it. Happy Reading :)
Correct me if any answer is wrong.
👉Risk: Risks as uncertainties resulting in adverse outcome, adverse in relation to planned objective or expectations.
👉'Financial Risks' are uncertainties resulting in adverse variation of profitability or outright losses.
Uncertainties associated with risk elements impact the net cash flow of any business or investment.
Under the impact of uncertainties, variations in net cash flow take place. This could be favorable as well as unfavorable
The possible unfavorable impact is the 'RISK' of the business
Variability in net cash flow would be high in such cases and because of that it may result in higher profits or in adverse situations, higher losses. it is call a business with higher risk.
Similarly, if variability in net cash flow is lower, it will result in lower profits and lower losses and the business would have lower risk.
Lower risk implies lower variability in net cash flow with lower upside and downside potential.
Higher risk would imply higher upside and downside potential.
Zero Risk would imply no variation in net cash flow. Return on zero-risk investment would be low as compared to other opportunities available in the market.
Risk and Return relationship:
Example from book
Addtional return is also called risk premium or cost of risk. Higher the risk is higher would be premium.
👉RAROC (Risk Adjusted Return On Capital)
Risk in business or investment is netted against the return from investment it is called Risk Adjusted Return on Investment.
Higher the risks in a business model, higher would be the capital requirement and return expectations. and viceversa. This is the linkage between risk, return and capital.
Basic Risk management done by process as under:
1. Organization for Risk Management
2. Risk Identification
3. Risk Measurement
4. Risk Pricing
5. Risk Monitoring and Control
6. Risk Mitigation
1. Organization for Risk Management:
Risk management organisation consists
- Board of Directors
- The Risk Management Committee
- Committee of senior-level executives
- Risk Management support group
They can done by making management policies, review mechanisms and reporting, auditing system etc.
The Board of Directors has the overall responsibilities for management of risks.
2. Risk Identification:
All transactions have one or more of the major risk like liquidity risk, interest rate risk, Market risk, default or credit risk or operational risk.
All these risks some risks can be manage by policy or decisions.
Risk identification consists of identifying various risks associated with the risk taking at the transaction level and examining its impact on the portfolio and on capital requirement.
Example: from book
3. Risk Measurement
Risk's quantitative measures of risks can be classified into 3 categories:
a. Based on Sensitivity
b. Based on Volatility
c. Based on Downside Potential.
a. Based on Sensitivity : It is change in market value due to 1% change in interest rate. Example page no 174
Rate gap is the sensitivity of the interest rate margin of the banking book.
Duration is the sensitivity of investment portfolio or trading book. usually, market risk model use sensitivities widely.
b. Volatility:
Volatility is the standard deviation of the values of the variables. Standard deviation is the square root if the variance of the random variable.
Computation of Historical volatility based on defined time series.
Volatility over a time horizon 'T' = Daily volatility * Sqr. root of 'T'
Example: in MCQ
Volatility would be more if the time horizon is more
so, volatility give variation around the average of target variable both side upward and downward.
c.Downside Potential:
Downside potential only take loss and ignore profit potential.
Downside potential is the most comprehensive measure of risk as it integrates sensitivity and volatility with the adverse effect of uncertainty.
Downside potential measure is most relied by banking and financial services indutryand regulators.
The Value at Risk (VaR) is a downside risk measure.
Value at Risk (VaR) is a method of assessing the market risk using standard statistical techniques.
It is a statistical measure of risk exposure and measures the worst expected loss over a given time interval under normal market conditions.
so, VaR is simply a distribution of probable outcome of future losses that may occur on a portfolio.
4. Risk Pricing:
In Banking transactions bank has to maintain necessary capital which is not productive and other probabilities of loss associated with all risk.
Example: Page no 176
Risk Pricing is decided by:
1. Cost of Deployable funds
2. Operative expenses
3. Loss probabilities
4. Capital Charge
5. Risk Monitoring and control:
There is setting of risk limits based on economic measures of risk while ensuring best risk adjustment return, keeping in view the capital that has been invested in the business.
Requirements:
- Strong management information system for reporting,
- Monitoring and controlling risk.
- Well laid down procedures.
- Saperate department with clear detail responsibility for management risk.
- Periodical review and evaluation.
6. Risk mitigation :
When risks arise from uncertainties associated with the risk elements, risk reduction is achieved by adopting strategies that eliminate or reduce the uncertainties associated with risk elements is called risk mitigation.
Risk mitigation can be done by diversification and portfolio risk.
Risk associated with a portfolio is always less than the weighted average of risks of individual items in the portfolio.
👉👉👉👉👉👉👉👉👉👉 MCQ 👈👈👈👈👈👈👈👈👈👈
1. RAROC FULL form ?
ans- Risk adjusted return on investment
2. zero risk would imply .... variation in net cash flow?
a. no
b.high
c. low
3. Who has the overall responsibility for management of risks?
Ans- The Board of Directors
4. .... is the review committee of line management.
Ans- The committee of seniour level executives
5. ..... characterises the stability or instability of any random variable
Ans- Volatility
6. Investment in Post office time deposit is:
a. Zero risk investment
b. low risk investment
c. medium risk investment
d. high risk investment
Ans- a
7. Zero Risk investment implies:
a. Zero variation in cash flow from investment
b. investment in zero coupon bonds
c. Investment on corporate bonds
d. investment in bank fixed deposit
Ans- a
8. Which of the following statements is correct
a. Higher the rish, higher would be the premium
b. Lower the risk , lower would be the premium
c. lower the risk, higher would be the risk premium
d. none is correct
Ans- a
9. what is the most critical function of Risk Management?
a. Controlling the level of risk to an organization's capacity
b. identification of risks
c. estimating the cost of risks
d. measurement of risk
Ans- a
FORMULA: Volatility over a time horizon,T= Daily Volatility* Sqrt of T
10. If the daily volatility of a stock is 1.5% , the monthly volatility would be..?
Ans- 1.5*SQRT (30)
=1.5*5.48
=8.22
11. Monthly volatility of a stock at 10% , then its daily volatility based on 25 working days in a month is ...?
Ans- 10/sqrt(25)
= 10/5
=2
12. Daily volatility of stock is 0.5%. What is its 10 day volatility?
Ans-0.5*Sqrt(10)
= 0.5*3.16
=1.58
13. Daily volatility of stock is 0.2%. What is its 10 day volatility?
Ans-0.2*Sqrt(10)
= 0.2*3.16
=0.63
14. Daily volatility of stock is 2%. What is its monthly volatility?
Ans-2*Sqrt(30)
= 10.95%
15. Risk can be measured based on...
a. sensitivity
b. volatility
c. downside potential
d. all of these
Ans- d
16. Volatility would be ...if Time Horizon is more.
a. more
b. less
c. equal
d. none of these
17.With volatility , it is possible to estimate... of the target variable with a reasonable accuracy.
a. upside potential
b.downside potential
c both a and b
d none of these
Ans- c
18. Black and Scholes option formula is used to calculate...
a. sensitivity
b. implicit volatility
c. upside potential
d. none of these
Ans- b
19. If the volatility per annum is 25% and the number of trading days per annum is 252, find the volatility per day.
a. 1.58%
b. 1.60%
c. 158
d. 15.8
Ans-a
20. .... is the variability of the price, upward or downward
a. swap
b. deal
c. volatility
d. duration
Ans- c
21. If daily volatility of the exchange rate of a particular currency wer 0.75%, its fortnight volatility would be
a. 3.70%
b. 2.80%
c. 1.4%
d. 7.2%
Ans- b
22. Risks can be mitigated through ...........?
Ans- Diversification
23. A risk is:
Correct me if any answer is wrong.
👉Risk: Risks as uncertainties resulting in adverse outcome, adverse in relation to planned objective or expectations.
👉'Financial Risks' are uncertainties resulting in adverse variation of profitability or outright losses.
Uncertainties associated with risk elements impact the net cash flow of any business or investment.
Under the impact of uncertainties, variations in net cash flow take place. This could be favorable as well as unfavorable
The possible unfavorable impact is the 'RISK' of the business
Variability in net cash flow would be high in such cases and because of that it may result in higher profits or in adverse situations, higher losses. it is call a business with higher risk.
Similarly, if variability in net cash flow is lower, it will result in lower profits and lower losses and the business would have lower risk.
Lower risk implies lower variability in net cash flow with lower upside and downside potential.
Higher risk would imply higher upside and downside potential.
Zero Risk would imply no variation in net cash flow. Return on zero-risk investment would be low as compared to other opportunities available in the market.
Risk and Return relationship:
Example from book
Addtional return is also called risk premium or cost of risk. Higher the risk is higher would be premium.
👉RAROC (Risk Adjusted Return On Capital)
Risk in business or investment is netted against the return from investment it is called Risk Adjusted Return on Investment.
Higher the risks in a business model, higher would be the capital requirement and return expectations. and viceversa. This is the linkage between risk, return and capital.
Basic Risk management done by process as under:
1. Organization for Risk Management
2. Risk Identification
3. Risk Measurement
4. Risk Pricing
5. Risk Monitoring and Control
6. Risk Mitigation
1. Organization for Risk Management:
Risk management organisation consists
- Board of Directors
- The Risk Management Committee
- Committee of senior-level executives
- Risk Management support group
They can done by making management policies, review mechanisms and reporting, auditing system etc.
The Board of Directors has the overall responsibilities for management of risks.
2. Risk Identification:
All transactions have one or more of the major risk like liquidity risk, interest rate risk, Market risk, default or credit risk or operational risk.
All these risks some risks can be manage by policy or decisions.
Risk identification consists of identifying various risks associated with the risk taking at the transaction level and examining its impact on the portfolio and on capital requirement.
Example: from book
3. Risk Measurement
Risk's quantitative measures of risks can be classified into 3 categories:
a. Based on Sensitivity
b. Based on Volatility
c. Based on Downside Potential.
a. Based on Sensitivity : It is change in market value due to 1% change in interest rate. Example page no 174
Rate gap is the sensitivity of the interest rate margin of the banking book.
Duration is the sensitivity of investment portfolio or trading book. usually, market risk model use sensitivities widely.
b. Volatility:
Volatility is the standard deviation of the values of the variables. Standard deviation is the square root if the variance of the random variable.
Computation of Historical volatility based on defined time series.
Volatility over a time horizon 'T' = Daily volatility * Sqr. root of 'T'
Example: in MCQ
Volatility would be more if the time horizon is more
so, volatility give variation around the average of target variable both side upward and downward.
c.Downside Potential:
Downside potential only take loss and ignore profit potential.
Downside potential is the most comprehensive measure of risk as it integrates sensitivity and volatility with the adverse effect of uncertainty.
Downside potential measure is most relied by banking and financial services indutryand regulators.
The Value at Risk (VaR) is a downside risk measure.
Value at Risk (VaR) is a method of assessing the market risk using standard statistical techniques.
It is a statistical measure of risk exposure and measures the worst expected loss over a given time interval under normal market conditions.
so, VaR is simply a distribution of probable outcome of future losses that may occur on a portfolio.
4. Risk Pricing:
In Banking transactions bank has to maintain necessary capital which is not productive and other probabilities of loss associated with all risk.
Example: Page no 176
Risk Pricing is decided by:
1. Cost of Deployable funds
2. Operative expenses
3. Loss probabilities
4. Capital Charge
5. Risk Monitoring and control:
There is setting of risk limits based on economic measures of risk while ensuring best risk adjustment return, keeping in view the capital that has been invested in the business.
Requirements:
- Strong management information system for reporting,
- Monitoring and controlling risk.
- Well laid down procedures.
- Saperate department with clear detail responsibility for management risk.
- Periodical review and evaluation.
6. Risk mitigation :
When risks arise from uncertainties associated with the risk elements, risk reduction is achieved by adopting strategies that eliminate or reduce the uncertainties associated with risk elements is called risk mitigation.
Risk mitigation can be done by diversification and portfolio risk.
Risk associated with a portfolio is always less than the weighted average of risks of individual items in the portfolio.
👉👉👉👉👉👉👉👉👉👉 MCQ 👈👈👈👈👈👈👈👈👈👈
1. RAROC FULL form ?
ans- Risk adjusted return on investment
2. zero risk would imply .... variation in net cash flow?
a. no
b.high
c. low
3. Who has the overall responsibility for management of risks?
Ans- The Board of Directors
4. .... is the review committee of line management.
Ans- The committee of seniour level executives
5. ..... characterises the stability or instability of any random variable
Ans- Volatility
6. Investment in Post office time deposit is:
a. Zero risk investment
b. low risk investment
c. medium risk investment
d. high risk investment
Ans- a
7. Zero Risk investment implies:
a. Zero variation in cash flow from investment
b. investment in zero coupon bonds
c. Investment on corporate bonds
d. investment in bank fixed deposit
Ans- a
8. Which of the following statements is correct
a. Higher the rish, higher would be the premium
b. Lower the risk , lower would be the premium
c. lower the risk, higher would be the risk premium
d. none is correct
Ans- a
9. what is the most critical function of Risk Management?
a. Controlling the level of risk to an organization's capacity
b. identification of risks
c. estimating the cost of risks
d. measurement of risk
Ans- a
FORMULA: Volatility over a time horizon,T= Daily Volatility* Sqrt of T
10. If the daily volatility of a stock is 1.5% , the monthly volatility would be..?
Ans- 1.5*SQRT (30)
=1.5*5.48
=8.22
11. Monthly volatility of a stock at 10% , then its daily volatility based on 25 working days in a month is ...?
Ans- 10/sqrt(25)
= 10/5
=2
12. Daily volatility of stock is 0.5%. What is its 10 day volatility?
Ans-0.5*Sqrt(10)
= 0.5*3.16
=1.58
13. Daily volatility of stock is 0.2%. What is its 10 day volatility?
Ans-0.2*Sqrt(10)
= 0.2*3.16
=0.63
14. Daily volatility of stock is 2%. What is its monthly volatility?
Ans-2*Sqrt(30)
= 10.95%
15. Risk can be measured based on...
a. sensitivity
b. volatility
c. downside potential
d. all of these
Ans- d
16. Volatility would be ...if Time Horizon is more.
a. more
b. less
c. equal
d. none of these
17.With volatility , it is possible to estimate... of the target variable with a reasonable accuracy.
a. upside potential
b.downside potential
c both a and b
d none of these
Ans- c
18. Black and Scholes option formula is used to calculate...
a. sensitivity
b. implicit volatility
c. upside potential
d. none of these
Ans- b
19. If the volatility per annum is 25% and the number of trading days per annum is 252, find the volatility per day.
a. 1.58%
b. 1.60%
c. 158
d. 15.8
Ans-a
20. .... is the variability of the price, upward or downward
a. swap
b. deal
c. volatility
d. duration
Ans- c
21. If daily volatility of the exchange rate of a particular currency wer 0.75%, its fortnight volatility would be
a. 3.70%
b. 2.80%
c. 1.4%
d. 7.2%
Ans- b
22. Risks can be mitigated through ...........?
Ans- Diversification
23. A risk is:
(a) related to illness, which does not affect the human life.
(b) related to events which do not affect the profits of the organization.
( c) related to unplanned event with financial consequences resulting in loss.
( d) a certain event, where outcome is known.
(b) related to events which do not affect the profits of the organization.
( c) related to unplanned event with financial consequences resulting in loss.
( d) a certain event, where outcome is known.
Ans-c
24. Risk Management includes all of the following processes except...
a. Risk Monitoring and Control
b. Risk Identification
c. Risk Avoidance
d. Risk Response Planning
Ans- c
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