Class%20#9%20461%20Risk%20Return0

Class%20#9%20461%20Risk%20Return0 - FI Risks and...

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FI Risks and Performance Evaluation
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2 CE Presentations TODAY: Discuss Bank Project A THURSDAY: Christina Tseng and Chad Wherley Assignment: Text, Chapter 8
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3 Class Outline 1. What is risk? 2. Types of risks for FIs Credit risk Liquidity risk Interest rate risk Market risk Insolvency risk 3. Return 4. FI performance 5. Analysis techniques
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4 1. What is risk ? How do we define risk ? FIs borrow and lend, that is their business. In doing so they expose themselves to various types of risks that exist because of the nature of their business (intermediation).
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5 2. Types of risks for FIs Total risk is the relevant concept of risk when we talk about risk and expected return and their impact on value . However, risk can be thought of as coming from different sources or FI exposures . Total risk is not just the “sum ” of these separate sources of risk, but understanding total risk exposure requires understanding the exposure to each of these risk sources.
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6 Types of risk Risk types for a financial intermediary include: Credit risk Liquidity risk Interest rate risk Market risk Insolvency risk Let us consider each (briefly) in turn.
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7 Credit risk Risk coming primarily from assets , primarily loans. Financial assets are contracts . Credit risk, or default risk, deals with the potential for violation of the terms (default) of the contracts by borrowers. Many of the contractual terms deal with future cash flows (as in loans and bonds); credit risk is the possibility that expected cash inflows will not be received (when expected or in the amounts expected) Contracts can default in other ways , too
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8 Liquidity risk Risk of not having the cash to make payments or take advantage of investment opportunities when needed. A lack of synchronization of cash in- and outflows; a net cash flow that can be negative that may be difficult (costly) to handle. We are concerned with day-to-day liquidity needs, not bank runs Ultimately we will examine how well a bank is prepared to handle negative net cash flows which will undoubtedly occur at times
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9 Interest rate risk Risk that changes in interest rates will change balance sheet values or interest cash flows in ways that affect firm value . As interest rates change, so do the
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This note was uploaded on 10/28/2011 for the course FIN 461 taught by Professor Morgan during the Fall '11 term at University of Illinois at Urbana–Champaign.

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Class%20#9%20461%20Risk%20Return0 - FI Risks and...

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