FRM-Part I - Book 1

PEARSON

ALWAYS LEARNING

2017 Financal Risk

Manager (FRM®) Exam Part I Foundations of isk Management

Seventh Cusom Edion for the Global Assocaion of Rsk Professionas

@GARP

    

011  Fn na (R P I o 0 on n of of R R Mag Mag, , S di by Glal o o o  k ia ia C@ 207 20 7 y Per Educt, I. A h  Per ust ust Edt. Ed t.

PEARSON

ALWAYS LEARNING

2017 Financal Risk

Manager (FRM®) Exam Part I Foundations of isk Management

Seventh Cusom Edion for the Global Assocaion of Rsk Professionas

@GARP

    

011  Fn na (R P I o 0 on n of of R R Mag Mag, , S di by Glal o o o  k ia ia C@ 207 20 7 y Per Educt, I. A h  Per ust ust Edt. Ed t.

Copyght© 2017 26 2015, 2014 23, 2012, 2011 y Peason Education Ic.  A rg eserve. easo usom don s pygh ves aela wen expessly fo hs vome by he elo/s as wel as e lalon self I oes not cover the nivida seecons heei a t apeaed esewhere. Perissio  rept ese as bee otained y earso Ecao, Inc. o is edo ony. Fther repoducon by ay meas, eecronc or manca ncudng ocopyng an erding, or y any ioatio stoage or reteva sysem mus be arrage wi e divdua ygh hoes noe GrI owlecnt Is made t t fllowl urs f rmlMlon t reprint malal righ or nro b hm: na of Rk Mnm, Mnm, y Mce Ees rom e sna Croy Dan Gaai ad Rot Mark (204) by peission o McGaw-Hi Companes.

"Copoe Rs Management: A Pme y Mlcel Couhy Dan aal an Roe Mak ene om e En  o Rik Mngn Mngn (4) by emsson of cw Comaes "Corpoe oveace ad Ris Manageent,• y Miche Croy, Dan aai and Rot Mark, ere rom The  en f Rk Mngemen (204), by perissio o McGaw Companes "Wha s R?• y James Lm ened om  Rk Mngemen: Fr Incn  Co (201), on Wiey & Sos Ic. "sk Maagee Goveace Cle ad s lg s• by Re M S ee fo FRN nom l Rw edea Resee a o New Yo inaca ste by Seve Ae, ernted om Fal Rk Mngemen: A one Gu  Mngg M  Ci Rk (013) oh Wey & Sos Ic ecipherng e qdy ad Ced Cch 207-208," y Mas K. Buneeier, ere rom Jul  om eve 13 o.  , by pession o American cooic sociaio

etig Up  Seed o e Fnacia Crsis: A One eeedReader's Gie by Gay Goton ad Anew etck, er m Joul of nom Leue SO o  by pesson o Amecan omc Asscaon Rs aagemen ues Wha ae ey and Wen D ey apen?• by Ren Sz ened om rnl o ld orpor nc 0 o 4 (8 y emsson of he ao Te Sadard Cpita Asset cing oe by Edwi  Eto et a. repe o Mo O eo nd nn A (4) Jon Wey & Sons Ic "Apylg he M o emace Measueen Sige-Index eormace Measueen Indicatos, by Noe  Aenc an Veroie L Sor, ernt m O eo nd nc An (23 on Wiey & Sons Inc "Age Pcg eo an uaco Moes o sk ad etr, y Zv Boe, Aex Kane and Aan J, arcus repe ro Inen (23 y emsson o cw Comaies. nclples o ecve aa Aggegao an Rs Repog• ene fom Bl ommt on Bn/ng Sun Pubn (23 y ermsso o Ba Comee on Bankng Sevison.

 Al dea, se mas egsee dema dema ad egsee se ma ae e ope o e eseve ownes an are used heren or decao uoses oy. easo cao Inc 330 son See ew Yo ew Yo 013  A easo easo Ecatio Coay Coay www.prsoed.com ed  e n Saes o Aeca  2 3 4 5 6 7 8 9 0 x 9 8 7 6 00000388

KS

PEARSON

ISB 0 32369 ISB 3 97832369153

011  Fn 0 n  na (R P I on ofRMag, S di di  by b y Glal Glal o o k ia ia C@ 207 20 7 y Per Educt, I. A h . Per ust Edt.

 1

RISK MNG:  HELCOPTE VIEW



What Is Ris

5

The Conllct of Risk and Reward

8

The Dange o Names

10

Numbes Ae Dangeous, Too

11

The Risk Manage's Job

12

The Past, the Futue-and This Book's Mission

13

Appendix

14

Typology of Risk Exposures

Market Risk

14

14

Inteest Rate Rsk

15

Equy Pce Rsk Foeg Exchange Risk

1 1

Commody Pce Rsk

16

Cedit Risk Creit Rsk a the Portfolio Lel

Liquidity Risk

16

Opeational Risk

19

Legal and Regulatoy Risk

19

Business Risk

19

Strategic Risk

21

Reputation Risk

21

Systemic Risk

23

CHPTER 

CORPOE K MANAGEE: A RIER

7

Why Not to Manage Risk in Theoy Theoy

28

And Some Reasons fr Managing Risk In Practice

29

Hedging Opeations versus Hedging Flnanclal Positions

30

•

.



•

•

•

18

Putting Risk Management nto Practice

31

18

Detemng the Objectve

31

Mappig he Risks

4

 011  Fn na (R P I on ofRMag, S di 0 di  by b y Glal Glal o o k ia ia C@ 207 20 7 y Per Educt, I. A h  Per ust ust Edt. Ed t.

Instruments or sk Managemen

34

Consructng and Impementng a Stegy

36

Perormance Evauaon

37

CHAPTE 3

COPOAE ENANE AD RISK MAAGEENT

CPTE

WHA ls RM?

ERM Definitions

61

The Benefits of ERM

61

Organzaona Eecveness



Risk Reporting Busness Perormance

Components of ERM

65 66

Corporate Governance Lne Managemen

Tue Risk Govenance

45

Pooo Managemen Risk Transer

A Key Tradona Mechanism: The Specal Role o he Audit Commi of the Board A Key Ne Mechansm: he Evovng oe o a Rsk Advsory Drector The Specal Role o he Risk Managemen Commtee of the Board

8

he Speca oe o he Compensaton Commtee o the Board

49

Roles and Responsibilities in Pactice

50

Rsk Anaycs Data and echnoogy Resources Sakeholder Managemen

6

4 47

Limits and Limit Standads Policies

52

Standards for Monitoring Risk

53

What Is the Role of the Audit Function?

54

Conclusion: Steps to Success

56

•

66 66 6 67 67

CPTE

RSK MANEEN EANE, CULE  AND RSK AKING  N BAN 7  

Introduction

2

Determining the Risk Appetite

3

Govenance and Risk king

76

The Organization of Risk Management



Tools and Challenges In Achieving the Optimal Level of Risk 80 Usng VaR o Targe Rsk

80

Setng ms

80 81

he ms o Rsk Measuremen

Iv

6

63

43

46

62 6

The Chief Risk Officer Setting the Scene: Coporate Governance and Risk Management

Committees and Risk Limits: Oveview

9

Contents

01 Fn na (R P I on ofR Mag, S di by Glal o ok ia C@ 207 y Per Educt, I. A h . Per ust Edt.

Incentives, Culture, and Risk Management

2

Concluslon

5

CHAPER&

FAAL DISAERS

Disasters Due to Misleading Repoting Chase Manhaan BanDsdae Secues Kdde Peabody Barngs Bank Aed Irsh Bank (AIB) non Bank o Swzeand UBS) Soci Gnrae Other Cases

Disasters Due to Lage Market Moves ongerm Capta Managemen (CM) Metalgeselscha MG

Disasters Due to the Conduct of Customer Business Bankes rust (B) JPMogan Ctgoup and Enon Other Cases

CHAPTER7 DEPHERIG HE IQUI AN CRE CRUNH 7- 8

8

90 91 92 93 94 96 97 99

100 100 104

105 105 106 107

Shortening he Matury Structure  o Tap ino Demand rom Money Maket Funds Rse n Popuary of Secutzed and Strucued Products Consequences: Cheap Cred and he Housng Boom

The Unfolding of the Cisis: Event Logbook

113 11 115

115

The Subpime Mortgage Cisis Asse-Backed Commerca Pape The BOR, Repo and Fedea Funds Makes Cena Banks Sep Foard Continuing Witedns o Mortgage-reated Secuities he Monone Insues Bea Seans Govenmensponsoed Enterprses: Fanne Mae and Fredde Mac ehman Bothers Mer ynch and AIG Coodnaed Bailout, Stock Market Decline, shngton Muua Wachovia, and Citibank

Ampllfylng Mechanisms and Recuring hemes

115 116 116 116 11 11 118 118 119

119

120

Borower's Balance Sheet Eecs: Loss Spia and Magin Spia endng Channe Runs on Financal Institutons Netwok Eecs Counteay Ced Rsk and Grdock Rsk

11 122 13 123

124

Concluslon 111

Banking Industry ends Leading 112 Up to the Liquidity Squeeze Secuzaon: C Poecon Poong and ranchng Rsk

112

Contents 01 Fn na (R P I on ofRMag, S di by Glal o o k ia C@ 207 y Per Educt, I. A h  Per ust Edt.

•

v

CHAPTER8 EG P T PEED  9  ON HE IN IA CRISS Intoduction

Histoical Backgound

134

he Cisis Bulld-up

135

he Panics

13

Polly Responses

143

Real Eects of the Financial Cisis

144

Conclusion

146

ISK MAEENT 9

Abstact

150

as the Collapse of Long-Tem Capltal Management a Risk Management Failue?

150

A Typology of Risk Management Fallures 152

Unknown Rsks Communcaion Faures Failures n Monitorng and Managing Risks

 vi

•

160

Summay

CHAPTER 131

Msmeasuemen of Known Rsks Msmeasuemen Due o gnoed Rsks Ignored Known Rsks Misakes n Informaion Colecion

158

130

Oveview and Timeline of the Crisis

CHAPTER9 AURES

Risk Measures and Rsk Management Faures

153 154 154 154 155 156 156

HE TANDARD CAPTAL  RIG MODE

163

The Assumptions Undelylng the Standad Capital Asset Picing 164 Model (CAPM)

165

The CAPM Derving the CAPM-A Smple  Appoach Devng the CAPMA More Rgorous Appoach

165 169

Prices and the CAPM

10

Conclusion

11

CHAPTER

PPLYG THE CM T ERFORANE MEUREET 77

Applying the CAPM to Peomance Measuement: Single-Index Peformance Measuement Indicatos 1 The Trno Measue The Shae Measue he Jensen Measure Relaionshps between he Derent Indcaos and Use of he Indcaos Extensons to the Jensen Measue The TrackingEro

Contents 01 Fn na (R P I on ofR Mag, S di by Glal o o k ia C@ 207 y Per Educt, I. A h . Per ust Edt.

178 178 19 179 181 182

The Inormaon Rato he Sono Rao Receny Deveoped RskAdjusted Return Measures

CHAPTER 12

182 183 183

RBGE RING HEO A MULTR MOE OF ISK  A UR 191

Multlfacto Models: An Overview Facor Modes o Secury Reurns

Arbitrage Picing Theory Arbitrage. Risk Arbitrage, and Equbrium WeDvers Pooos Diversifcaton an Residual Rsk in Pracce Execung Arbge he No-Arbtrage Equaton o the AP

he APT the CAPM, and the Index Model

192

211

Objectives

211

Scope and Initial Considerations

211

I Overaching Governance and Infastructue

213

Principe 1 Prncpe 2

196 197

199

202

he Fama-French (FF) hree-Facto Model

203

Summary

205

213 214

II Risk Data Aggegation Capabllltles

195

198

210

Definition

194 194

INIPL FOR FFEVE SK DATA GGREGATIO A SK EORG 209

Introduction

192

The APT an the CAPM 199 he AP an Portoo Opmization n a SngeIndex Marke 200

A Multifactor APT

CTER 3

214

Principe 3 Prncpe 4 Prncpe 

215 215 215

Principe 6

216

216

. Risk Reporting Practices Principe 7 Prncpe 8 Prncpe 9 Prncpe 10 Prncpe 11

216 21 218 218 219

IV. Supervisoy Review Tools and Cooperation

219

Prncpe 12 Principe 13 Principe 14

219 219 220

lmplementatlon lmellne and 220 Transltlonal Arangements

v.

Contents 21 Fnc Rsna (R P I Fon of R Mag, S di by Glal o o k ia C@ 2017 y Per Educt, I. A h  Per ust Edt.

•

vi

CHTER 14

GAP CODE  OF CONDUT

Introduction

224

Code of Conduct

224

Prncples

224

Proessona Standads

224

Rules of Conduct Proessona Integriy and Ehca Conuct Confct of nees

viii

223

•

Confdentiaity

225

Fundamenta Responsbes General Accepe Pacces

225

Appllcablllty and Enforcement Index

225 225 225

Contents

01 Fn  nagr (R P I on of RMa, S Ed by Glal o o k P as. Ch@ 07 y e dut, I A   e cut dt

226

226 229

2017 FRM COITEE MEBE D Re Sz•, Eveet D. Reese Ca o Banng ad Monetay Econocs e Oho State Unvety

D Vco Ng, CA, M, Ce Rs Achec Make Rsk Manageme ad Aayss

Rchad Aook rede and CO

Dr Mahew Pie Senior naca conomi

Gba Assotn of Rk Prosnas

Federa Reserve Bank of Boston

Mchee McCahy Bec, M Rsk Maagement

Dr Samana Robe, RM SVP, Reai Cedi Modeig

Nuveen Investmens

PNC

Rchad Band, M Oeatonal Rsk Maageent

Lu Ruxa ead o Rsk Maageen

ank

Indstr and ommerc Bank of hna

D Cstope onohue M

D T Scuen e

Gba Aotn of Rk Prona

Or Vman

Hev Ge Go ead of Ierna Adi

Nick Sange CA, ead o Ris Iasrucure

London Sock Exchange

Bank o Ennd,Prudena Reguon Auhoy

Ket Isaac, FRM, V, Oeatonal Rs Manageent

Sve ovaldsson, FRM, CRO

TD Bank

Jndsbank

Goman Sachs

Wam Ma, SV

Gbal Asoiin o Rik Prosonals D Atlo Mecc CA

RO,KKR

·Chim

x 1 Fn  nar (R P I on of RMag, S Edi by Glal o o k P ias. ht@ 207 y e dut, I A h  e cut dt

I

of Ris Mangemt. Sevnth Edito by Glbal Ascato f Rk ght Rr. P s Cuom Edto

\

Learning ObJeclves

•

Aer copeng s eadng you shod be a be o: •

•

•

pan he cocep of ris and coare risk manageen wh s akg Descre he ris aageme pocess ad deify problems ad chaenges ha ca ase  te sk manageent process. Evaluate ad aply toos ad ocedues sed o measre and manage rs, cldg qantatve measres, qatave assessme, and eese rsk manageent

•

•

•

Dsngus beween expeced oss and ueced oss, ad ovde eaes of each Inerpre e eaonsip ewee is ad eward ad epai ow coics o iees ca impac is maageme. Descbe and deentae between he key casses o sks expan ow each ype o sk can arse and assess e otenta mpact of eac ype o s o a orgazao

cerpt is Chapter 7 andAppendx .7 f Te sseals  Rs Manageent Secnd Editon, by Michel Cruh Dan Gala and Rbert Mark. 1

We acknwledge the autrsip of Rb James i  ts cap.

3 01 Fin  nagr (R P I on of RMa, S Ed by Glal o o k P as. Ch@ 207 y e dut, I. A   e cut dt

The fre cano be edced t s ncean, and o oe as eve een suessf  cosstety foecastng te stoc aket nterest ates, excage raes, or com mody cesor credt operaoa and system events wt ajor nacal catos However e nacal s a ases fom uceraiy can e managed. Indeed mch o wha disnguises moder ecooes o ose o e as s he ew aiy o deify risk, o ea sue i o apecae is cosequeces and en o ae acio accodingy, such as ranseng o igag e s One of he os oa aspecs of oden risk manageent s te alty, n ay saces o pce ss ad ensue a ss udeaen n bsiess acivies ae corecty ewarded.

Mesre  esme rsk expses

Fn smes  fles  shf r e rss

ssess efc  epses

ssess sts  eeits  istmets

hs se sequece of acves, show n ore dea  gre 11 s ofte used o defe s aageme as a oma dscle.  's a seqence tat aey us soohy  pracce Soemes smpy denyng a rsk s te crtcal obem; at oter mes arangng a eff-

Fm  rsk g seg:

cen ecoomc ranse o e rsk is e s a maes oe ris aage sad ou ro aohe (In Cape  we discss he is aageme pocess fo e e secive o a cooaon.) To he uwary, Fgue 11 gt sugges ha rsk manageme s a contna process o corpoae rsk educton. But we ust't tk of he oden atept to maste s i defensve es aoe s manageen s eay aou how fis acvey seec e ye and eve of ris a i is apopriae for em o asse. Mos usness decisons ae abo saccig crren resorces o ue nceran reuns In hs sese,  management and  takg are't oposes,  wo sdes o te same co ogeter hey drve a ou oden ecoomes. he capacy o ae fowadookig coices ao risk in eaon o rewad d o evue performce, les t te hert of e n geent process o  edrgy sccessf corporos. Ye he rise of nacia risk anagee as a foa dsc pne as een a umpy aai esecay ove he as  15 yeas. On he one ad, we have had some exraor dnary successes n risk anagee mecasms (e.g. e ack o fianca isio anrpcies i he down tun  cred aty n 20012002) ad we have seen an extaodnay growh n new nstons ta ean he ee by takg and maagg rs (e.g. edge fnds)  O te ote ad, te speaula faue to control rsk  te up to te 20072009 nacal css evealed

4

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vi

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Tsfe

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Mge

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Kee

vte errme

fndaenta weaknesses n he rsk anageme process o many baks ad he bang syse as a woe. s a res, ris aageme is now widey ackowedged as oe o e mos poweu orces i he wods fina c mkets  oh  posve d  negtve sense A skig ee s he deveope of a huge ake fo ced derivaves whch aows nsons o oai srance o oec heselves agans ced dea ad e wdeing o cred spreads (or aernaivey, o ge paid o assumig credi is as a ivesen) Cred devaives ca be used o redsbe a or a o a isio's credi is exosues o baks edge funds or ohe isioa ivesos. oweve, e misse of ced derivaves aso heed o desabize nsons dung he 20072009 crss and to fe feas o a systec edow ac n 00, an Greespa e charman of he U.S. edea Reserve oard, ade some oisic eaks aou he powe o s maagemen o prove he

2017 lnancal Risk Manager Exm P I: Foundations

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is aagemen

21 Finc s r (R P I oudt of R Mage S di by Glal   k ia C@ 2017 y P Educo, I. A  R P us Edo.

word ut te condoay atached to hs observatos proved o be ate mportant:  e deveoen o or paadgms for conan· ng s has ehaszed dsesio o s o ose wng and presaby ae o ea . I s is opery dsersed socks o he ovea economic sysem wl e eter absored and less ley to ceate cascadg alres ta could teaten nacal say2 In he ancia csis of 2007-2009, risk uned ou o have ee concenraed ae han disesed and is s far ro e oy earassng faue of rsk anage me n recen decades Oher caasrophes age rom e ear aire o e gia hedge fnd Longerm Cap a Maageme (C) n 1998 o he sng o naca scadas assocaed w e ena oo  e equy ad ecoogy mares (o Eno, WordCo Goa Cossng and Qwes  he Uned Saes o Pamaa n uoe and Sayam i Asa) Uortuaely rsk manageent has not cosstety een ale to preve aet dsupos o to preve bs ess accouig scandas resig rom breadowns in corporae govenace. In e case o e forme oe ee ae serios cocens a devaive akes ae i easier o ae o age amons of ris, ad ha e "herd eavor of risk anages ae a crisis ges ndeway (eg, seng s asse casses when risk easres reac a ceai eve) acay iceases mare voaiy. Sopstcated nacal engneeng layed a sgca oe i oscuing he rue economc condio ad rsk akig o fianca coanies  he nup o he 2007 2009 criss and aso heped o cove  e codion of many nonfncl coporatos drg he ey ares mienia oom ad s Aongside smper accoug misakes and uses, fianca egieeng can ead o he  vole mloson o s (and dses) aer years o fase success ae ha he s spy adig away or eng ake ove a a eae pon a of he reaso fo s aagemes mxed ecod here es wh the doueedged natue of rsk anageme ecnologes. Evey fanca srent tat allows a compay to transer rsk aso aows ote cooatons

mr  Cn l np  h Cl n r ls Wshn DC Nvr 19, 002.

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to assume a sk as a conterpay  te same maketwsey o not Mos oa, ery sk manageme mecas that allows us to cage te shae of cash ows, such as deferg a negatve ocoe o he fe, may wok o e shore enefi of oe gro o sakeodes n a fi (eg., managers) a e same ime ha  s desroyng ogem vaue for anoher gro (e.g. shareodes or pensiones In a wod ha is iceasingy dve y rsk manageen coceps ad ecnooges, we need o ook ore caeuy a he icreasigy uid and come are o sk isef, ad a how o deene whehe ay cage n a cooaons is oie sees e ieess o saeoders We eed to mae sre we ae a east as leate  te laguage o s as we are n he agage of ewad

WHAT IS RISK? We'e all aced wh rs n ou everyday ves. Ad alogh s s a asract te, ou ara huma ndersadng o te tradeos between rsk and eward s prety sopstcated. Fo exampe n or esoa lves, we ntutvely udestand te dffeece ewee a cos a's aready been bdgeed for (i is arace, a e dcabe or epeced oss) and a uepeced cos a is wos a caasopic oss o a agde we eyond osses see i he course of norma day ife). In acula, we udestand tat s s ot syoymos wt e siz o a cos or of a loss After a some o the coss we expect  day fe are vey lage ndeed  we tk  terms of ou n udgets od, fxed mo gage ayens, coege fees, ad so o ese coss are g, u hey are no a ea o ou amions because tey re esoy predctble nd e redy alowed fo  or ps. he ea rsk is a ese coss w sddey se n an eiey neeced way, o ha some ohe cos wi appear from nowhere and sea e oney we've se aside fo or expeced olays Te s les  how a e ou coss ad reveues eay ae. In aca, we cae aout how lely  s a we'll econter a loss g eoug o se ou lans (oe that we ave o desed hroug soe pece o pesoal sk manageent such as tag o a xedrae otgage, setng asde savgs fo a rany day and so on).

Chape 1

Risk Mangemet: A Helcopter Vi

1�inc Rsa (R P I Fo ofR Mag, S di by Glal o o k ia @ 207 y Pe Educt, I. A   Pe ut Edt.

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5

Ths dayoday analogy akes  easer to undestad te derece bewee he sk maagemet conceps o expeced Jo (o exected coss ad unexpeced Jo (o uexeced cost. derstandg hs dffeece s he ey o ndersadg mode rs anageen coces sc as econoc caia ario and rs adjsed prcng. (Howeve his s o e ony way o defie sk.) Oe of te key dfferences eween ou ttve conceton o rs ad a ore forma treament of t s te use of sastcs o dene he exte and oteal cos o any exposue. To deveo a ner or uexected oss, a ak ris aager s deies e ris facos ha see o dve voay i any oucoe (Bo 11) and hen uses sasca anayss o cacuae e oaes of varos ocomes o te oston or ofoo ude consdeato Ts pobaby dsbuton ca e used  varous ways. o eape he sk aager g po he area of te dsbon (e te exet o oss ta he son wod find woryng gve e roaiy of is oss occrg (e.g is  a i 10 o a in 10,000 cance? The dsbon ca also e reaed to te nstutons staed "rs appete fo ts vaous acvtes. or exape as we dscss n Cape 3, te seo s cotee a te ak mgh have se odares on he aon of rsk a te nstuton s wng to take by secfyng e maim oss i s wig o oeae a a given eve of codece such as We ae wing o coneance a  ecen chance of a $50 on oss rom ou adig dess on any given day. Snce the 007009 nancal crss rsk aages have ted o move away rom a overdependence on hsocasastca teatmets of s. Fo example, hey ave ad more emhass on scenaro anayss ad sress esng, which eamne he pac or ocomes o  gven dverse sceo o sress on  m (or ot foo) he scero my be chosen not on he bss of sascal anayss bu stead sy ecase t s o plausle ad sutaly severeessetaly a udgmen ca. Howeve  can be dfclt and peras wse o emove saisica aproaches fo e pce enrey. o eampe, n e more sophscaed fors of sce aio aayss, e fi wi eed o eaie ow a chage  a gven macroeconomic aco (e.g. nem poye ae eads o a chage in a gve is facor (e.g. e poaiy o defau of a copoaion. Ma ing his ink amos ineviay meas ookig ac o he

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Risk Factors and the Modelng of Rsk In order o easre s te s aayst ft seeks to denty te ey aco ha see kely o case  voay i e eus o e posiio or oroo nder consideaion o empe, n he case o an equiy vesen, e rsk facor wi e he voaiiy of he sock price (caegozed i e aped o is cape as a ake is) whic ca be esaed n  varios ways. In hs case, we idened a snge s facor Bu e umer of ris cos ha are cosidered n a is aayssad ncded  ay s modengvares consdeay deedig on oh e probe and e sohsco o te proc o expe, n te ece as, ak s aayss gh ave anayed e sk of an neresae posion n ems o he effec of a sige risk facore.g he yed o auy o govene onds assumng ha he yeds or a mariies are eecy coreaed B is oeaco mode apoac igoed e s ha he dynamic o te tem suctue of nterest ates s drven y ore factorse.g. te orward ates Nowaday leadng a aaye her erestrae exosues usg a least two or hree actos. uher, e risk manager us aso measue e ece o the s faco on eac ohe te stastcal measre o whch s he "covarace. Dseaglg he eecs o muple sk factors ad uafyg he fuece of each s a ay comlcaed ndertakg especally wen covaace ale over te (.e. s o n te odele's eology here s oen a disnc diffeece in e beavor and eaonsip of risk facors dung ora bsiess condios and dung sessu codions such as fiaca crises Uder ordary mare codios, e behavor o is fctors s eltvely ess dffcult to pedct becuse i does o change sigcay in e shor and medm er: uue eavor can be eraoaed, to soe exent fom ast eomance owever dung stessul codtons e behavo o s faco ecomes far ore uedcae ad pas behavio may offe ltle e  edctng tue eavor t's a s pon ha sascay measable sk eaens o un io he id o nmeasae ncerany ha we dscuss i Bo 1-2.

past to examne the ate o the statscal reatoshp etwee macroeconomc acos ad rsk actos thoug a degree o dgen must also be factored no the aalyss.

2017 nancal Rsk anager Eam Pa I : Foudaios of Risk Managmt 01 Fn na (R P I on ofR Mag, S di by Glal o o k ia C@ 207 y Per Educt, I. A h  Per ust Edt.

The se of satsca economc and stess testng con cets ca mae sk manageent sond pety eccal. But the s aage s spy dong oe foaly wha  we all d o when we ask oseves  o pesonal ves, "How ad wt easo gh hs oblem get? he saisca modes can aso hep n cig sk o pic ig he nsens a he o eae o migae e sks Wat does o dstncton between expeced loss ad nexeced loss mea  ems of ng a faca usess sch as a specfc bang bsness ne We te eece ced loss fo a ced cad potoo, fo eame, ees o how much e a eecs o ose o aveage as a esu of aud ad defas by cadodes ove a eod of me say oe yea  he case of age ad welldvesed ofolos (.e., most cosue ced potoos expeced loss acconts o amos a losses a ae nced n noma es ecause  s by den ton, edctable, execed loss s geeay vewed as one of he coss of doig bsiness, ad deay  s ced io e podcs and sevces ofeed o e cusoe o ced cads, he eeced oss s ecoveed by chagig e siesses a cea commssio (2 o 4 ece) and y cagng a spead o he csome on any borowed moey ove ad above he baks fndng cos (i.e. e ate te bak pays o ase uds  te moey aets ad esewee). he ban ecoves mndae oeat g costs, such as te salaes t ays tees n uch te same way he eve of oss assocaed wi a age sadad ced cad pooio is eavey edcabe ecase he o foo s made  of neous esized eosues ad e fones of os cusoes os of he ime, ae o cosely ted o one anohe On te whoe yo ae ot mch moe lely to lose you job oday because yo eghbo os hes last wee Tee ae soe motant excepos o s, o couse. Dug a pooged ad seee ecesson yo fones may ecome uch moe coeaed wh hose o yo negbo pacay  you  wok n e same ndsy and ve  a pacaly vule ale egon Even n he elavey good tes te fotnes of sma loca bans, as well as the cad ofolos, ae soewha dve y socoecooc chaactescs. A cooae oa pofoo, oweve eds o e mch "mie han a ea pofoo e, hee ae moe g oas emoe, f we oo a ndusy daa on com mecia oa osses ove a eiod of decades 's c

moe apae a in soe yes osses spke wad o eece oss eves, dve y sk facos a sud dely eg to ac togete. Fo exape e default ate fo a bak ta leds too heavly to te echnology seco  wl e dven no just by te heah of ndvda oow es b by he usness cycle of he tecoogy secto as a whoe Whe te technology seco ses, mang loas  wl loo sfee fo a extended peod; when te ecoomc a coes, t wl soa ay ane ha as allowed ledg to ecome oo coceated aong sla o ieeaed oowes. So coreaon ske edecy fo hngs o go wrog ogeheis a ao co we evlg he sk of ths d o pofoo The endecy o gs to go wong togete snt con fed to te csteg o deas amog a potfoo of comeca boowes Whoe casses o is acos ca egi o ove ogee, oo  he wod o ced isk, ea esaened oas ae a faous eae of hs ey ae often secued wh ea esae collateal, wc teds to lose vaue a exacly e sae me ha he default ate fo popety developes ad ownes ses. In ts case te "ecoveyae s o ay deaed loan s tse closey coeaed wt he defaultate s e wo sk ac tos acg togete ca soemes foce losses abuply skywad. In fact anywhee n he wold tat we see sks (ad no st ced sks) tat ae umpy .e. n lage ocs, such as vey lage loas ad ha ae dve  s facos that nde cetan ccumstaces ca ecome ned ogehe (e, that ae coeated), we can edc ha a cea tmes g "nexeced losses wll be ealed We can y o esimae ow bad is pobem s by ooig a he hsoica seeiy o ese evens  eaio o ay s facos ha we dee and e eamng e paence o ese s facos e.g he ype ad concenio of ea esae coae) n e aca pofoo ude eamao  O genea oi imediaey pas why ak es ecame so ecied ao new cedi s ase tecooges suc as cedt devaves. These bak es wee't ookg o educe pedctable eves o loss Insead he ew sents seemed to offe ways to put a ca on he oe of g nexpeced losses and all the cata coss ad ucetanty tat these bng he cocepio o sk as nepeced oss ndens wo ey coces ha we dea wh i moe deai ae in ths oo: vaueask (VaR) and ecooc capal. VaR

Chaper 1

Risk Management: A Helcopte View

1Fn na(R P I on ofR Mag, S di by Glal o o k ia C@ 207 y Per Educt, I. A h  Per ust Edt.

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