Risk Management and Financial Institutions

Cover
Title Page
Copyright
Contents in Brief
Contents
Business Snapshots
Preface
Chapter 1 Introduction: Risk‐Return Trade‐offs
	1.1 Risk vs. Return for Investors
	1.2 The Efficient Frontier
	1.3 The Capital Asset Pricing Model
	1.4 Arbitrage Pricing Theory
	1.5 Risk vs. Return for Companies
	1.6 Risk Management by Financial Institutions
	1.7 Credit Ratings
	Summary
	Further Reading
	Practice Questions and Problems (Answers at End of Book)
	Further Questions
Part I Financial Institutions
	Chapter 2 Banks
		2.1 Commercial Banking
		2.2 The Capital Requirements of a Small Commercial Bank
		2.3 Deposit Insurance
		2.4 Investment Banking
		2.5 Securities Trading
		2.6 Potential Conflicts of Interest in Banking
		2.7 Today's Large Banks
		2.8 The Risks Facing Banks
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 3 Insurance Companies and Pension Plans
		3.1 Life Insurance
		3.2 Annuity Contracts
		3.3 Mortality Tables
		3.4 Longevity and Mortality Risk
		3.5 Property‐Casualty Insurance
		3.6 Health Insurance
		3.7 Moral Hazard and Adverse Selection
		3.8 Reinsurance
		3.9 Capital Requirements
		3.10 The Risks Facing Insurance Companies
		3.11 Regulation
		3.12 Pension Plans
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 4 Fund Managers
		4.1 Mutual Funds
		4.2 Exchange‐Traded Funds
		4.3 Active vs. Passive Management
		4.4 Regulation
		4.5 Hedge Funds
		4.6 Hedge Fund Strategies
		4.7 Hedge Fund Performance
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
Part II Financial Markets
	Chapter 5 Financial Instruments
		5.1 Long and Short Positions in Assets
		5.2 Derivatives Markets
		5.3 Plain Vanilla Derivatives
		5.4 Non‐Traditional Derivatives
		5.5 Exotic Options and Structured Products
		5.6 Risk Management Challenges
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 6 The OTC Derivatives Market
		6.1 A Reference Point: Exchange‐Traded Markets
		6.2 Clearing in OTC Derivatives Markets
		6.3 Post‐Crisis Regulatory Changes
		6.4 Impact of the Changes
		6.5 CCPs and Bankruptcy
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 7 Securitization and the Global Financial Crisis
		7.1 The U.S. Housing Market
		7.2 Securitization
		7.3 The Losses
		7.4 What Went Wrong?
		7.5 Lessons from the Global Financial Crisis
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 8 Volatility
		8.1 Definition of Volatility
		8.2 Implied Volatilities
		8.3 Are Daily Percentage Changes in Financial Variables Normal?
		8.4 The Power Law
		8.5 Monitoring Daily Volatility
		8.6 The Exponentially Weighted Moving Average Model
		8.7 The GARCH(1,1) Model
		8.8 Choosing between the Models
		8.9 Maximum Likelihood Methods
		8.10 Using GARCH(1,1) to Forecast Future Volatility
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 9 Correlations and Copulas
		9.1 Definition of Correlation
		9.2 Monitoring Correlation
		9.3 Correlation and Covariance Matrices
		9.4 Multivariate Normal Distributions
		9.5 Copulas
		9.6 Application to Loan Portfolios: Vasicek's Model
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 10 Valuation and Scenario Analysis
		10.1 Volatility and Asset Prices
		10.2 Risk‐Neutral Valuation
		10.3 Scenario Analysis
		10.4 When Both Worlds Have to Be Used
		10.5 The Calculations in Practice
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
Part III Market Risk
	Chapter 11 Value at Risk and Expected Shortfall
		11.1 Definition of VaR
		11.2 Examples of the Calculation of VaR
		11.3 A Drawback of VaR
		11.4 Expected Shortfall
		11.5 Coherent Risk Measures
		11.6 Choice of Parameters for VaR and ES
		11.7 Marginal, Incremental, and Component Measures
		11.8 Euler's Theorem
		11.9 Aggregating VaRs and ESs
		11.10 Back‐Testing
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 12 Historical Simulation and Extreme Value Theory
		12.1 The Methodology
		12.2 Accuracy of VaR
		12.3 Extensions
		12.4 Computational Issues
		12.5 Extreme Value Theory
		12.6 Applications of EVT
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 13 Model‐Building Approach
		13.1 The Basic Methodology
		13.2 Generalization
		13.3 The Four‐Index Example Revisited
		13.4 Extensions of the Basic Procedure
		13.5 Risk Weights and Weighted Sensitivities
		13.6 Non‐Linearity
		13.7 Model‐Building vs. Historical Simulation
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 14 Interest Rate Risk
		14.1 Types of Rates
		14.2 Calculating Risk Measures
		14.3 Principal Components Analysis
		14.4 The Management of Net Interest Income
		14.5 Duration
		14.6 Convexity
		14.7 Generalization
		14.8 Nonparallel Yield Curve Shifts
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 15 Derivatives Risk
		15.1 Delta
		15.2 Gamma
		15.3 Vega
		15.4 Theta
		15.5 Rho
		15.6 Calculating Greek Letters
		15.7 Taylor Series Expansions
		15.8 The Realities of Hedging Derivatives
		15.9 Hedging Exotic Options
		15.10 Scenario Analysis
		15.11 Approximate Analytical Results
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 16 Scenario Analysis and Stress Testing
		16.1 Generating the Scenarios
		16.2 Regulation
		16.3 What to Do with the Results
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
Part IV Credit Risk
	Chapter 17 Estimating Default Probabilities
		17.1 Credit Ratings
		17.2 Historical Default Probabilities
		17.3 Recovery Rates
		17.4 Credit Default Swaps
		17.5 Credit Spreads
		17.6 Estimating Default Probabilities from Credit Spreads
		17.7 Comparison of Default Probability Estimates
		17.8 Using Equity Prices to Estimate Default Probabilities
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 18 xVAs
		18.1 Credit Exposure on Derivatives
		18.2 CVA
		18.3 The Impact of a New Transaction
		18.4 CVA Risk
		18.5 Wrong‐Way Risk
		18.6 DVA
		18.7 Some Simple Examples
		18.8 Other xVAs
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 19 Credit Value at Risk
		19.1 Ratings Transition Matrices
		19.2 Vasicek's Model
		19.3 Credit Risk Plus
		19.4 Creditmetrics
		19.5 Credit Spread Risk
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
Part V Other Risks
	Chapter 20 Operational Risk
		20.1 Defining Operational Risk
		20.2 Types of Operational Risk
		20.3 Loss Severity and Loss Frequency
		20.4 The Standardized Measurement Approach
		20.5 Preventing Operational Risk Losses
		20.6 Allocation of Operational Risk Capital
		20.7 Use of Power Law
		20.8 Insurance
		20.9 Sarbanes–Oxley
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 21 Liquidity Risk
		21.1 Liquidity Trading Risk
		21.2 Liquidity Funding Risk
		21.3 Liquidity Black Holes
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 22 Model Risk Management
		22.1 Regulatory Guidance
		22.2 Models in Physics and Finance
		22.3 Simple Models: Expensive Mistakes
		22.4 Models for Pricing Actively Traded Products
		22.5 Models for Less Actively Traded Products
		22.6 Accounting
		22.7 What Makes a Successful Pricing Model?
		22.8 Model‐Building Missteps
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 23 Climate Risk, ESG, and Sustainability
		23.1 Climate Risk
		23.2 ESG
		23.3 Sustainability
		23.4 Greenwashing
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 24 Enterprise Risk Management
		24.1 Risk Appetite
		24.2 Risk Culture
		24.3 Identifying Major Risks
		24.4 Strategic Risk Management
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
Part VI Regulation
	Chapter 25 Basel I, Basel II, and Solvency II
		25.1 The Reasons for Regulating Banks
		25.2 Bank Regulation Pre‐1988
		25.3 The 1988 BIS Accord
		25.4 The G‐30 Policy Recommendations
		25.5 Netting
		25.6 The 1996 Amendment
		25.7 Basel II
		25.8 Credit Risk Capital Under Basel II
		25.9 Operational Risk Capital Under Basel II
		25.10 Pillar 2: Supervisory Review
		25.11 Pillar 3: Market Discipline
		25.12 Solvency II
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 26 Basel II.5, Basel III, and Other Post-Crisis Changes
		26.1 Basel II.5
		26.2 Basel III
		26.3 Contingent Convertible Bonds
		26.4 Use of Standardized Approaches and SA-CCR
		26.5 Dodd–Frank Act
		26.6 Legislation in Other Countries
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 27 Fundamental Review of the Trading Book
		27.1 Background
		27.2 Standardized Approach
		27.3 Internal Models Approach
		27.4 Trading Book vs. Banking Book
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Question
	Chapter 28 Economic Capital and RAROC
		28.1 Definition of Economic Capital
		28.2 Components of Economic Capital
		28.3 Shapes of the Loss Distributions
		28.4 Relative Importance of Risks
		28.5 Aggregating Economic Capital
		28.6 Allocation of Economic Capital
		28.7 Deutsche Bank's Economic Capital
		28.8 RAROC
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
Part VII Other Topics
	Chapter 29 Financial Innovation
		29.1 Technological Advances
		29.2 Payment Systems
		29.3 Open Banking
		29.4 Lending
		29.5 Wealth Management
		29.6 InsurTech
		29.7 Regulation and Compliance
		29.8 How Should Financial Institutions Respond?
		Summary
		Further Reading
		Practice Questions and Problems (Answers at End of Book)
		Further Questions
	Chapter 30 Risk Management Mistakes to Avoid
		30.1 Risk Limits
		30.2 Managing the Trading Room
		30.3 Liquidity Risk
		30.4 Lessons for Nonfinancial Corporations
		30.5 A Final Point
		Further Reading
Part VIII Appendices
	Chapter A Compounding Frequencies for Interest Rates
	Appendix B Zero Rates, Forward Rates, and Zero‐Coupon Yield Curves
	Appendix C Valuing Forward and Futures Contracts
	Appendix D Valuing Swaps
	Appendix E Valuing European Options
	Appendix F Valuing American Options
	Appendix G Taylor Series Expansions
	Appendix H Eigenvectors and Eigenvalues
	Appendix I Principal Components Analysis
	Appendix J Manipulation of Credit Transition Matrices
	Appendix K Valuation of Credit Default Swaps
	Appendix L Synthetic CDOs and Their Valuation
	Appendix M SIMM
Answers to Questions and Problems
Glossary
RMFI Software
Table for N(x) When x ≤ 0
Table for N(x) When x ≥ 0
Index
EULA