1. http://pluto.huji.ac.il/~mswiener/zvi.html 972-2-588-3049 FRM Zvi Wiener Following P. Jorion, Financial Risk Manager Handbook Financial Risk Management

2. http://pluto.huji.ac.il/~mswiener/zvi.html 972-2-588-3049 FRM Chapter 12 Identification of Risk Factors Following P. Jorion 2001 Financial Risk Manager Handbook

3. Ch. 12, HandbookZvi Wiener slide 3 Absolute and Relative Risk Absolute risk - measured in dollar terms Relative risk - measured relative to benchmark index and is often called tracking error.

4. Ch. 12, HandbookZvi Wiener slide 4 Directional Risk Directional risk involves exposures to the direction of movements in major market variables. beta for exposure to stock market duration for IR exposure delta for exposure of options to undelying

5. Ch. 12, HandbookZvi Wiener slide 5 Non-directional Risk Non-linear exposures, volatility exposures, etc. residual risk in equity portfolios convexity in interest rates gamma - second order effects in options vega or volatility risk in options

6. Ch. 12, HandbookZvi Wiener slide 6 Market versus Credit Risk Market risk is related to changes in prices, rates, etc. Credit risk is related to defaults. Many assets have both types - bonds, swaps, options.

7. Ch. 12, HandbookZvi Wiener slide 7 Risk Interaction You buy 1M GBP at 1.5 $/GBP, settlement in two days. We will deliver $1.5M in exchange for 1M GBP. Market risk Credit risk Settlement risk (Herstatt risk) Operational risk

8. Ch. 12, HandbookZvi Wiener slide 8 Exposure and Uncertainty Losses can occur due to a combination of A. exposure (choice variable) B. movement of risk factor (external variable) Dollar duration

9. Ch. 12, HandbookZvi Wiener slide 9 Exposure and Uncertainty Market loss = Exposure * Adverse movement in risk factor

10. Ch. 12, HandbookZvi Wiener slide 10 Specific Risk Market exposureSpecific risk Specific risk - risk due to issuer specific price movements

11. Ch. 12, HandbookZvi Wiener slide 11 FRM-97, Question 16 The risk of a stock or bond which is NOT correlated with the market (and thus can be diversified) is known as: A. interest rate risk. B. FX risk. C. model risk. D. specific risk.

12. Ch. 12, HandbookZvi Wiener slide 12 Continuous process - diffusion Discontinuities Jumps in prices, interest rates Price impact and liquidity market closure discontinuity in payoff: binary options loans

13. Ch. 12, HandbookZvi Wiener slide 13 Emerging Markets Emerging stock market - definition by IFC (1981) International Finance Corporation. Stock markets located in developing countries (countries with GDP per capita less than $8,625 in 1993).

14. Ch. 12, HandbookZvi Wiener slide 14 Liquidity Risk Difficult to measure. Very unstable. Market depth can be used as an approximation. Liquidity risk consists of both asset liquidity and funding liquidity!

15. Ch. 12, HandbookZvi Wiener slide 15 Funding Liquidity Risk of not meeting payment obligations. Cash flow risk! Liquidity needs can be met by using cash selling assets borrowing

16. Ch. 12, HandbookZvi Wiener slide 16 Highly liquid assets tightness - difference between quoted mid market price and transaction price. depth - volume of trade that does not affect prices. resiliency - speed at which price fluctuations disappear.

17. Ch. 12, HandbookZvi Wiener slide 17 Flight to quality Shift in demand from low grade towards high grade securities. Low grade market becomes illiquid with depressed prices. Spread between government and corporate issues increases.

18. Ch. 12, HandbookZvi Wiener slide 18 On-the-run recently issued most active very liquid after a new issue appears they become off- the-run liquidity premium can be compensated by repos/reverse repos

19. Ch. 12, HandbookZvi Wiener slide 19 FRM-98, Question 7 Which of the following products has the least liquidity? A. US on-the-run Treasuries B. US off-the-run Treasuries C. Floating rate notes D. High grade corporate bonds

20. Ch. 12, HandbookZvi Wiener slide 20 FRM-98, Question 7 Which of the following products has the least liquidity? A. US on-the-run Treasuries B. US off-the-run Treasuries C. Floating rate notes D. High grade corporate bonds

21. Ch. 12, HandbookZvi Wiener slide 21 FRM-97, Question 54 “Illiquid” describes an instrument which A. does not trade in an active market B. does not trade on any exchange C. can not be easily hedged D. is an over-the-counter (OTC) product

22. Ch. 12, HandbookZvi Wiener slide 22 FRM-97, Question 54 “Illiquid” describes an instrument which A. does not trade in an active market B. does not trade on any exchange C. can not be easily hedged D. is an over-the-counter (OTC) product

23. Ch. 12, HandbookZvi Wiener slide 23 FRM-98, Question 6 A finance company is interested in managing its balance sheet liquidity risk. The most productive means of accomplishing this is by: A. purchasing market securities B. hedging the exposure with Eurodollar futures C. diversifying its sources of funding D. setting up a reserve

24. Ch. 12, HandbookZvi Wiener slide 24 FRM-98, Question 6 A finance company is interested in managing its balance sheet liquidity risk. The most productive means of accomplishing this is by: A. purchasing market securities B. hedging the exposure with Eurodollar futures C. diversifying its sources of funding D. setting up a reserve

25. Ch. 12, HandbookZvi Wiener slide 25 FRM-00, Question 74 In a market crash the following is usually true? I. Fixed income portfolios hedged with short Treasuries and futures lose less than those hedged with IR swaps given equivalent duration. II. Bid offer spreads widen due to less liquidity. III. The spreads between off the run bonds and benchmark issues widen. A. I, II & IIIC. I & III B. II & IIID. None of the above

26. Ch. 12, HandbookZvi Wiener slide 26 FRM-00, Question 74 In a market crash the following is usually true? I. Fixed income portfolios hedged with short Treasuries and futures lose less than those hedged with IR swaps given equivalent duration. II. Bid offer spreads widen due to less liquidity. III. The spreads between off the run bonds and benchmark issues widen. A. I, II & IIIC. I & III B. II & IIID. None of the above