Notesale: Turn your study into money

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Goal: Maximise the expected return, while maintain the risk @ risk tolerance level
Risk budget could be:
- A single metric (Portfolio beta, Value ar Risk, portfolio duration, or return variance)
- Constructed based on categories of investments (Domestic equities, Domestic debt securities, international equities, international debt securities)
- allocated by identifying specific risk factors that comprise the overall risk of the portfolio (interest rate risk, equity market risk, FX rate risk)

Financial / Non-financial risks

Financial risks : arise from exposure to financial markets
- Credit risk : Uncertainty about whether the counterparty will fulfill its contractual obligations
- Liquidity risk : Risk of loss when selling an assets when sales price < FV of assets
- Market risk : Uncertainty about the market price od assets (stocks, commodities, currencies) and interest rates
Non-financial risks : from the operation of the organisation, and from sources external to the organisation
- Operational risk : Risk of loss from human errors or faulty organisational processes
- Solvency risk : Risk of unable to continue to operate due to run out of cash
- Regulatory risk : risk of change in regulatory environment → ↑ costs or restrict ac vi es
- Governmental or political risk (including tax risk) : risk of political acties outside a specific regulatory framework (e
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:↑ tax rate) → ↑ costs
- Legal risk : uncertainty about exposure to future legal action
- Model risk : risk of incorrect asset valuations
- Tail risk : Risk that extreme events are more likely to happen than analysis
- Accounting risk : Risk of incorrect organisational's accounting policies and estimates
- Mortality risk (individuals) : Risk of debt
- Longevity risk (individuals) : Risk of living longer than expected
Those risks are inter-dependent, and interactions are many and frequent

Method for measuring risks

Measure risk for specific asset types:
- Standard deviation : Measure the volatility of asset prices and interest rate
- Beta : Measure the market risk of equity securities and portfolio
- Duration : Measure price sensitivity of debt securities to changes in interest rates
Measure risks for derivatives
- Delta : Measure sensitivity of derivatives values to the price of underlying asset
- Gamma : Measure sensitivity of delta to the change in the price of underlying asset
- Vega : Measure sensitivity of derivatives values to the volatility of the price in underlying asset
- Rho : Measure the sensitivity of derivative values to changes in the risk-free rate
Tail risk : uncertainty about the probability of extreme negative outcomes
Value-at-Risk (VaR) : minimum loss over a period that will occur with a specific probability
** There are various method of calculating VaR
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Conditional VaR : expected value of loss, given that the loss exceeds a minimum account
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g
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g
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Typically when benefits of reducing/eliminating risk are greater than the cost
Bear risks efficiently, via diversification
Risk tranfer: Transfer risk to another party (e
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: Insurance)
- Surety bond : insurance company agrees to make payment if a third party fails to perform the term and agreement of the contract
- Fidelity bond : insurance company agrees to pay for losses from employee theft or misconduct
Risk shifting: Change the distribution of possible outcoes, mainly via using derivatives
** Criterion for choosing among risk modification method: comparison of costs and benefits of risk modification

Concepts

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