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Chapter 9-Market Risk (9.3 Type of Market Risk (2. IR risk (traded…
Chapter 9-Market Risk
9.1 Financial Market Activities
9.1.1 Functions and Roles of Financial Markets
The role of financial market in an economy
2) Efficient allocation of capital
3) Risk transfer
1) Access (or deploy) short-term liquidity
4) Facilitate international trade
9.1.2 Types of Financial Markets
Capital market
efficient allocation of capital
Debt capital markets
Equity capital market
Foreign exchange market
different ccy is traded
facilitate the exchange of goods, services, investment among different countries by allowing conversion of one ccy to another
Importer
Expoter
exchange rate regime
fixed exchange rate
ties the rate to gold/other country's ccy
hard exchange
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soft exchange
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floating exchange rate
market determine
pure without any intervention by govy
floating with discretionary intervention
hybrid exchange rate
1.Money market
short term maturity,least risky
3) Bank deposit-liability owned by bank to depositiors
4) Banker's Acceptance-issued by corporation and guaranteed by commercial bank
2) Commercial papers - promissory note issued by corporate
5) Certificate of deposit-fixed term and fixed IR
1) Treasury bills,issued by govy
6) Repurchase agreement(REPO)- contractual agreement between 2 parties where one party agrees to sell securities to another party at a specified price with the commitments to repurchase the securities on a later date at a other specified price.
Derivatives market
transfer of risk using risk management product by hedging
9.2 Definition-BIS
Risk of losses in on and off balance sheet positions arising from movements in market prices.
market risk is the risk of loss in the value of a bank's financial instruments due to changes in market conditions
Earning
unrealized and realized losses
Economic or balance sheet value
impact on assets and liabilities
9.2.1 Trading Book and Banking Book
Trading Book
1) Assets that are liquid and easy to trade
2)Assets to be fair valued on a daily basis
3)Changes in the fair value are reflected in the P&L
daily valuation and mark to market
Historical cost
measured at initial acquisition cost through their lives
changes have no impact to the bank
Fair value
measured at fair value at the initial acquisition cost at inception
changes in FV will impact P&L or equity
Banking Book
1) assets that are less liquid and are intended to be held on a longer-term horizon.
2) Daily valuation is not required
9.3 Type of Market Risk
2. IR risk
traded
bank's position in debt securities
irrbb(gap risk)
mismatch due to maturity position between assets and liabilities
tenor of deposit liabilities(short term) and lending assets (long term)-negative gap
IR and Bond Price
inverse relationship
IR increases, the bank's holdings in debt securities decline in value
3. Equity Price risk
systematic/beta risk
cant be diversified
measured in beta
beta<1, less volatile than the general risk.stock remain stable even during the economic recession, utility industry stocks
beta=1, same as market
high beta, high risk, more volatile, beta>1 , cyclical stocks
high technology stocks, retail industry, consumer discretionary ,manufacturing, small capitalization, biotechnology
non systematic risk
can be eliminated with diversification
negative news on a specific company
labour problem
adverse industry developmets
weather disturbance in the primary place of operation
1. FX risk
Business Risk
country's or a company's long-term competitive positions
Translation/revaluation risk
changes bought by changes in the reported domestic ccy currency accounting
Transaction risk
foreign ccy denominated receivables and payable.
4. Commodity price risk
hard commodities
energy, industrial metal and precious metals commodities
soft commodities
agricultural that are weather dependent and perishable in nature
livestocks,softs, grains and seeds
risk due to
1)adverse movements in spot price of commodities and investment demand
9.4 Market Risk Management process
Mitigation and control
limits
various risk measures, i.e. exposures, sensitivity, probabilistic/statistical, potential loss, actual loss
new product approval
new product/services, significant changes in the features of existing products
Monitoring and reporting
BOD,Board Risk Comm, Market Risk management function
Assessment and measurement
severity and probability,magnitude of loss
sensistivity measures
adverse movement in single risk factor
probabilistic /statistical measures
var,statistical estimate of potential losses, CI and time horizon
notional exposure
face amount of the transaction
scenario analysis/stress testing
complement VaR, with extreme losses beyond CI, breaks in normal conditions
1.Identification
sources and type of risks