PART III

Risk Management
The Controls Cycle

• Identification of requirements
• Enforcement of controls
• Development of controls
• Review controls &
requirements
• The role of Capital
Management
 Managing Interest Rate Risk

• Duration & Convexity

- Impact of changing interest rates on
asset & liability values
- Effective duration
• Economic Value
• Use of duration to manage interest
rate risk – duration gap
• Interest rate derivatives
- Forward rate agreements
- Interest rate Swaps
- Interest rate future
• Practical issues with use of duration as
tool
• Mark – to – Market accounting issues
• Gap analysis
• Managing FX risk
- Forwards contracts
- Currency swaps

Trading
• Reasons to trade
- Spot forward , future markets
- Current business requirements , hedging
• Arbitrage
- Interest rate party
- Interest rate futures
- Stock index future
 - Exchange
- Options ( call – put Party )
- Holding Company
• Speculation – outright positions
• Fundamental Speculation
- Equities , foreign exchange , interest &
credit
• Short selling
• Reversion to mean
- Trading volatility – advanced option
Strategies
• Technical analysis

Managing trading risk

• First order price risks
• Realization risks
• Model risks
• Value at risks ( VAR )
• Statistical
- Distributions , standard deviation ,
confidence Levels , holding periods
• Portfolio diversifications
- Correlation , application to Portfolio
VARs
- Portfolio examples
• Multiple Variable Dependency
- Foreign Currency bond , Forwards
• Risk Factor decomposition & aggregation
• VAR Conversion
- Common holding period & Confidence
level
 Managing credit risk
• Expected versus unexpected losses
• Default Probabilities
- Sources , cyclicality , time frame ,
changing conditions
• Losses in event of default
• Non – normal distributions
- Estimating system Level Losses
• Loss distributions by loan type
• Proprietary ( internal ) databases
- Internal ratings , decomposition &
aggregation
• Portfolio diversification
• Providing for credit losses
- Incentives , methods , regulatory
requirements
• Bad Loan Resolution
- Foreclosure , liquidation ,
restructuring

Capital management

• Forms of Capital
- As funding source , risk , economic &
regulatory capital
• Capital allocation & return measures
• Excess of regulatory capital
• Capital allocation & diversification
• The Original Basel Accord
- Key Features & exclusions
 - Unintended consequences
• The Market Risk amendment
• The New accord – Basel II
- External & Internal ratings
• Who’s afraid of the Basel Accord?