Download NYU_class7

Review of the Major Risk Types
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Market Risk
– Sensitivity to the parameters of our pricing functions
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Credit Risk
– Probability that the other side fails to live up to a contract
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Liquidity Risk
– Not enough funds on hand to manage daily cash management needs
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Operational Risk
– System failures, human mistakes
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Reputation Risk
– Are we doing the right thing? Ethics matter.
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Fraud
– Sometimes people do bad things
Questions a Risk Manager May Ask…
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How sensitive am I to interest rate changes?
– Fed action
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Fed tightening/easing
FOMC desk “Quantitative Easing”
– Supply and demand
– The market’s view : “implied” future interest rate environment
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How exposed am I to a particular Issuer?
– They may request a bank loan and we want to know how much debt they have
outstanding
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How is my risk distributed in my trading book?
– By rating, by maturity bucket, by issuer
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What does history tell us about what to expect in the future?
– VaR :“Value a Risk”
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How much capital should I have on hand for a rainy day (VaR is an input)
What extreme moves should I test for (that may not have already happened)?
– Stress testing vs. “expected” moves
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How do I know I have just the right amount of capital (not too much)?
Questions a Risk Manager May Ask (cont.)
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Are we net long or short, and where in the term structure?
How did my risk profile change during the day, from yesterday, last week,
last month?
– “Position” Pnl
– “New business” (trading activity from beginning of day to close of day)
– Risk of new portfolio - where did risk change come from? Which position(s)?
How much PnL did I realize?
– Realized vs.. unrealized PnL
– Mark to Market
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Does the desk have a view?
Historical VaR & Stress Testing
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What does this mean: “95% 1 day VaR is $1mm”
What is VaR primarily used for?
Limitations of VaR
Run pricing scenarios on total book and calculate total risk:
- All yields by +10, +50, +100, +150, +200 basis points
- All yields by -10, -50, -100, -150, -200 basis
- Tilt up and down (flattener/steepener)
Need historical data to calculate day over day P&L changes
We will treat these as pricing scenarios applied to our trading book today
Full re-val VaR vs stored sensitivity approximation