Risk Mgmt and Capital Requirements in Banking
Lecture 3.1 Vorlesung 19.02.2014
Lecture 3.1 Vorlesung 19.02.2014
Kartei Details
| Zusammenfassung | Diese Lernkarten bieten einen umfassenden Überblick über das Risikomanagement und die Kapitalanforderungen im Bankensektor, geeignet für Universitätsniveau. Sie decken Themen wie die wirtschaftlichen Gründe für Risikomanagement, die Vermeidung von finanziellen Notlagen, die Bewertung von Risikoprofilen und die Anwendung von Modellen wie CAPM ab. Besonders nützlich sind sie für Studierende und Fachleute, die sich mit der Minimierung von Risiken, der Optimierung von Portfolios und der Bewertung von Kapitalanforderungen auseinandersetzen möchten, um fundierte Entscheidungen in der Finanzwelt zu treffen. |
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| Karten | 31 |
| Lernende | 1 |
| Sprache | Deutsch |
| Kategorie | Finanzen |
| Stufe | Universität |
| Erstellt / Aktualisiert | 20.02.2014 / 24.04.2014 |
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According to Donald Rumsfeld there are risks that are known knows, known unknown and unknown unknowns. What is the meaning of those phrases?
known knowns = risk we know and can measurable
known unknowns = risk we know, but not measurable
unknown unknowns = risk we don't know and therefore not measurable
A farmer is sowing soybeans today and harvest in future. Which two factors have impact on the value of the harvest? And how does the formula looks like?
Factors that have an impact on the value of the harvest: Change in Price and Change in Quantity
According to Neumann - Morgenstern
1. Which shape has an utility function for risk aversion?
2. Which condition has to be exist regarding utility of expected value and expected utility?
1. concave
2. U(E((x)) > E(U(x))
According to Neumann - Morgenstern
1. Which shape has an utility function for risk neutrality?
2. Which condition has to be exist regarding utility of expected value and expected utility?
1. linear
2. E(U(x)) ? U(E(x))
Which are the 4 Axioms of Expected Utility according Neumann - Morgenstern?
1. Completeness
2. Transitivity
3. Continuity
4. Substitution
What does the Allais Paradox describes?
Decision1: Choose between (A) an 80% chance of $4000; (B) $3000 for sure.
Decision2: Choose between (C) a 20% chance of $4000; (D) a 25% chance of $3000.
Which axiom is violated?
unsufficient description of human behavior towards risk.
B over A; C over D --> result violates the substitution axiom (= common ration effect)
From decision1 to decision2 one goes from a certain to a uncertain situation. In this case certainty creates additional value.
What is the statement of the Asian Disease Example?
People act risk-aversely when dealing with gains/profits.
People are getting riskier by dealing with losses.
Market Risk
1. Potential of loss because of unexpected changes in market prices
2. generally symmetrical distribution
Example: Depreciation of USD leads to decline in the CHG value of USD assets.
Credit Risk
1. Potential of loss because of an unexpected default of a debtor.
2. generally non-symmetrical
Business Risk
1. Potential of loss because of an unexpected development in business.
2. generally symmetrical distibution
Operational Risk
1. Potential of loss because of an unexpected process failure or event
2. non symmetrical
Generic Risk Management Process
graphic
Which slope has the risk profile of the framer resp. buyer?
What is the context of those profiles?
1. risk profile of farmer = upward; risk profile of buyer = downward
2. The risk profile of the buyer is the opposite of the buyer's risk profile
How can two parties eliminate the price risk?
Forward (OTC) / Futures
The value of assets and liabilities are reduced if interest rates rise.
What is the net risk profile of the total balance sheet?
* liabilties work like an hedge
* Assets -5 ; Liabilities -2 --> net change = -3
How do you minimize volatility of a portfolio?
combine risk profiles and make use of volatility anr correlation between risk factors (e.g. prices, interest rate, etc.)
Combination of two (correlated) risky assets (A and hedge H) to a portfolio of minimum risk.
correlatioon: p
risk measure: variance of returns = (σ^2)
How to find the optimal hedge rate (h*) that leads to a minimal portfolio risk (std^2)?
correlation: p
standard deviation (std) of asset and hedge
Example:
if h = -1.2 --> Per unit of asset A (long postion) 1.2 units of the hedge product H have to be sold (short postion)
if h = 0 --> don't hedge!
Graphic of optimal hedge with 0<p<1
h* = optimal hedge leads to minimum risk
What happens when risk costs (e.g. the opportunity costs of "risk capital") and transaction costs per unit of hedge are taken into account?
Tendency of hedging could change!
Portfolio hedge regarding risk costs (i > 0) and transaction cost for hedge (c > 0)
if correlation is positive / negative / zero?
short / long / don't hedge
summary of optimal hedge regadring costs and correlation
if costs = 0 we hege as much as possible
if costs > 0 the optimal hedge changes --> the chaeper the costs the more we hedge!
CAPM
1. What is the equilibrium condition?
2. What is the Efficient frontier
3. What is the Security Market Line (SML)?
4. What is the risk premium in market equilibrium?
5. What's about C in second graphic?
1. Equlibrium condition: ra=rf+Beta(rm-rf)
2. A portfolio is "efficient" if it has the best possible expected level of return for its level of risk
3. It displays the expected rate of return of an individual security as a function of systematic, non-diversifiable risk (its beta)
4. risk premium equals to zero
5. Price of the asset C is too low --> buy this asset
In equlilibrium the market has eliminated price differences.
Which risks are compensated and which are not?
only systematic risk is compensated
all other (diversifiable) risk are not compensated!
Value Contribution of Risk Management
Why is risk mgmt not a shareholder task (in the context of diversification)?
Difference between Privatly owned companies and all other companies...
Privately owned companies:
Risk preference of owners / Asymmetrical risk profile in financial distress, in taxes
All other companies: --> Asymmetries in:
1. Financial distress
2. Taxes (progressive tax scales)
3. Information asymmetries: knowledge of risk profil is unequal between shareholders and management
What happens if financial distress occurs?
Financial Distress deforms an originally symmetrical risk profile into an asymmetrical one. In addition to the losses caused by risk factor (R) financial distress leads to an acceleration in losses.
--> after passing the "point of min. equity" the losses are getting worse! --> non-linear
Incentives for Risky Projets - Example
with gambling one gets the chance of surviving!
no one cares if the company goes bankrupt with -100 or -120, therefore the company makes that risky project
How to avoid financial distress?
1. increaseequity
2. change the risk profile
Risk Management
Describe B,C,D
CD: Value contribution of risk management = (opportunity) loss prevented
--> do risk mgmt one prevents the additional loss of CD
BC: additional equity required to obtain an acceptable probability of distress in case the original risk profile is not changed.
--> BC: additional equity to absorbe losses
Risk Managemtn regarding Taxes
Risk management in progressive tax regimes reduce the average tax burden (through the reduction in profit volatility).
Economic reasons for risk management. (list of 6)
Company risk reduction for risk averse private owners
Reduction of planning costs and of the probability of financial emergency situations
Reduction in the probability of “financial distress”
Protection of required liquidity for project financing purposes
Reduction in average corporate taxes
Reduction of manager’s risk exposures and increase inmanager performance (e.g. bonus as a function of profit
=> reduction in profit fluctuation)
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