FRM Notes 2011 Unit IIIB Operational and Other Risks

FRM Notes 2011 Unit - Version January 3 2011 Fin 7400 Financial Risk Management III MANAGING NON-MARKET RISKS B Operational and Other Risks An

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Version: January 3, 2011 Fin 7400: Financial Risk Management III. MANAGING NON-MARKET RISKS B. Operational and Other Risks An organization that engages in transactions designed to manage market risk will assume credit risk. As a result, that organization will then create other risks. One of the most increasingly important risks is operational risk. But there are also a number of other risks that we will identify in this section. Operational Risk Operational risk, sometimes called operations risk , is one of the increasingly important areas of attention in risk management. Operational risk has become particularly critical in the area of banking. Banks, particularly those that are heavily involved in derivative markets, have considerable operational risk. Although corporations, the focus of this course, have operational risk as well, much of the emphasis on and what is known about operational risk comes from the banking industry. Therefore, this topic will focus a little more on banking than we have been previously doing. The Basel Committee on Bank Supervision, an international consortium of bank regulators, defines operational risk as the risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events . There are, however, a numbe r o f ways to look a t operational risk. Operational risk has often been classified as the risks associated with Processes: the systems and procedures used to record transactions People: the personnel who perform the processes Technology: the machines and software used by the people to perform the processes Events: external factors that affect the processes, people, or
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Version: January 3, 2011 Fin 7400: Financial Risk Management Human mistakes Rogue trading and fraud Weather Product liability And just about anything else bad that can happen Note that weather is on the list. Weather can be a source of operational risk, such as when storms shut down operations. Alternatively it can be viewed as a form of market risk. Companies with operations that are more directly affected by weather, such as power companies, travel companies, airlines, ski resorts, soft drink manufacturers, etc. view weather as one of the mainline sources of risk they deal with in their business. We have not dealt with this type of risk in our study of market risk, but you should be aware that there are weather derivatives designed to pay off based on measures of weather such as rainfall, snowfall, and temperature. In the context of operational risk, however, we are referring to more infrequent weather- related events that disrupt operations. Interestingly, advances in technology, while so beneficial to humankind,
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This note was uploaded on 02/28/2012 for the course FIN 7400 taught by Professor Donchance during the Fall '11 term at LSU.

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FRM Notes 2011 Unit - Version January 3 2011 Fin 7400 Financial Risk Management III MANAGING NON-MARKET RISKS B Operational and Other Risks An

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