RISK AND FINANCIAL INSTITUTIONS
ECONOMICS 2191A-001
Department of Economics
Western University
D. McKeon
September 2015
Office SSC 4052
Office Hours: W,F: 11:30-12:30
Class: T: 8:30-10:30; TH: 8:30-9:30
Classroom: UCC 56
Email: dmckeon@uwo.ca
Registration

Market risk
PART I
Some of these trading losses have been spectacular.
For example, in 2008, rogue trader Jrme Kerviel of
French bank Socit Gnrale lost US$7.1 billion in
trading European stock index futures, and in July 2012,
JPMorgan Chase reported a lo

iRB method
These are from the text appendix
The standardized approach to measuring credit
riskweighted asset values for DTIs under Basel
III.
Rather than using the standardized approach,
banks with a sufficient number of internal credit
risk rating grad

VAR
From Hull ch 20 FOM
VaR and Regulatory Capital
Regulators base the capital they require banks to
keep on VaR
For market risk they use a 10-day time horizon and a
99% confidence level
For credit risk they use a 99.9% confidence level and
a 1 year ti

Ch 12 liquidity risk
The global financial crisis of 20082009
was, in part, due to liquidity risk.
As mortgage and mortgage-backed
securities markets started to experience
large losses, credit markets froze and
banks stopped lending to each other at
anyt

REVIEW QUESTIONS FOR CAPITAL ADEQUACY CH 20.
1Why are regulators concerned with the levels of capital held by an FI compared to a non-FI?
Regulators are concerned with the levels of capital held by an FI because of its special role in society. A
failure o

Stress VaR and Systemic Risk Indicators
Private Sector Applications of How to Measure Systemic Interconnectedness
IMF Conference On Operationalizing Systemic
Risk Monitoring
Richard Berner
Chief U.S. Economist
Co-Head, Global Economics
May 28, 2010
Courte

Market risk III
Expected shortfall
ES, also referred to as conditional VaR and
expected tail loss, tells us the average of the
losses in the tail of the distribution beyond the
99th percentile, i.e., if 1 in every 100 days
there is a loss, ES tells us th

Capital Adequacy
The primary means of protection against the risk
of insolvency and failure is an FI's capital. This
leads to the first function of capital, namely:
To absorb unanticipated losses with enough
margin to inspire confidence and enable the F

Liquidity risk part 2
BIS Liquidity Risk Measures
BISs Basel Committee on Banking Supervision (BCBS) developed two regulatory standards for
liquidity risk supervision. The standards are intended to enhance tools, metrics, and
benchmarks that supervisors c

duration supplement
Edited by
D. McKeon
What is Duration?
Example(IN CLASS)
Modified Duration
So Durtion combines all three aspects of
a bond:
Coupon rate cash flow
Interest rate determines present value of
cash flows
Maturity weights each cash flow
I

Options II
HEDGING INTEREST RATE RISK WITH
OPTIONS
Next, we analyze macrohedging rather than
microhedging. The whole balance shet:
Suppose the FI manager wishes to determine the
optimal number of put options to buy to insulate the FI
against rising rate

Futures II
The Problem of Basis Risk
changes in spot and futures prices or values
are not perfectly correlated. This lack of
perfect correlation is called basis risk. In the
previous section, we assumed a simple world
of no basis risk in which:
R/(1 + R

Default intensities
Estimating Default Probabilities
Alternatives:
Use historical data we will look at this one.
Use bond prices or asset swaps
Use CDS spreads
Use Mertons model
Risk Management and Financial Institutions
2e, Chapter 14, Copyright Joh

assign 2 on var and market risk.
1 .Bank Three has determined that its inventory of 20 million and 25 million is subject to market risk.
The spot exchange rates are $1.25/1 and $1.60/1, respectively. The values of the spot
exchange rates of the euro and t

Credit risk 2
2016
Term structure derivation of credit risk
We can imply a market based risk by looking
at the spread between corporates and govt
bonds.
Helps an FI decide if they wish to lend or not
Note the risk here is assessed by credit
agencies no

Non parallel shifts of the yield curve
and Principal Components analysis.
Portfolios
Duration and convexity can be defined similarly for portfolios of bonds
and other interest-rate dependent securities
The duration of a portfolio is the weighted average

assign 1
1. Calculate the duration of a two-year corporate bond paying 6 percent interest
annually, selling at par. Principal of $20,000,000 is due at the end of two years.
A. 2
years.
B. 1.91
years.
C. 1.94
years.
D. 1.49
years.
E. 1.75
years.
2. Calcula

CH 9 ASSIGN sept 222 post post
1 What is the difference between book value accounting and market value accounting?
Book value accounting reports assets and liabilities at the original issue values. Market value
accounting reports assets and liabilities at

Risk and Financial Institutions
intro
Risk > the types that are relevant to the
balance sheet and the operations of primarily
banks.
- their loans
- portfolios they manage
- products they offer
Huge current topic especially since
consumers are very risk

Convexity
Convexity
The convexity is the measure of the
curvature and is the second derivative
of price with respect to yield (d2P/dy2)
divided by price
Convexity is the percentage change in
dP/dy for a given change in yield
2
d P
2
dy
Convexity
P
2
Corr

Make sure you go through these and understand them dont just look at the answers!
part 1 ()
1. West Coast Bank offers one-year loans with a 9 percent stated or base rate, charges a 0.25 percent
loan origination fee, imposes a 10 percent compensating balan

duration supplement
Edited by
D. McKeon
What is Duration?
example
Modified Duration
So Durtion combines all three aspects of
a bond:
Coupon rate cash flow
Interest rate determines present value of
cash flows
Maturity weights each cash flow
I
II
III
Wh

Market risk IV
Internal models
Basel requires the following process to be followed by large FIs using
internal models to calculate the market risk capital charge:
In calculating one-day VaR, the FI must define an adverse change as being
in the 99th percen

1.
What is meant by market risk?
Market risk is the risk related to the uncertainty of an FIs earnings on its trading portfolio caused
by changes in market conditions such as interest rate risk and foreign exchange risk. Market risk
emphasizes the risks t