MindMap Gallery FRM1-Fundamentals of Risk Management
FRM1 - A mind map of the basics of risk management. It shares basic knowledge, portfolio management, advanced risk management, risk cases, and ethics. Let’s take a look at it together.
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This is a mind map about bacteria, and its main contents include: overview, morphology, types, structure, reproduction, distribution, application, and expansion. The summary is comprehensive and meticulous, suitable as review materials.
This is a mind map about plant asexual reproduction, and its main contents include: concept, spore reproduction, vegetative reproduction, tissue culture, and buds. The summary is comprehensive and meticulous, suitable as review materials.
This is a mind map about the reproductive development of animals, and its main contents include: insects, frogs, birds, sexual reproduction, and asexual reproduction. The summary is comprehensive and meticulous, suitable as review materials.
Risk management basics
theme
Exogenous exogenous liquidity risk, retail investors, spread
endogenous endogenous liquidity, institutions, price
basic knowledge
measure risk
Quantitative methods
sensitivity analysis
VaR
Qualitative methods
Scenario analysis
pressure test
Tail risk events, extreme value theory EVT
systemic crisis
Manage risk
process
identifyidentity
type, understanding
analyze
Quantify
assessassess
Impact, knock-ons indirect impact, repercussion continued adverse impact
manage
Avoid: avoid, terminate the business or change strategies or ban outsourcing
keep/retain retain part of the risk under risk appetite
Reduce mitigate: Reduce exposure, reduce frequency of occurrence
Transfer transfer: derivatives, structured products, insurance
three lines of defense
Business lines that face various risks in business
Dedicated risk department
Internal Audit
Weigh risks & benefits
economic capital
Based on economic risk
regulatory capital
Regulators stipulate that greater than economic capital
Risk-adjusted return on capital RAROC=reward/risk
enterprise risk management
Risk appetite appetite, willing to accept
The board of directors communicates with senior management to determine the company's risk appetite
risk hedging
Advantages (stable, controllable)
Reduce revenue cash flow volatility
The stock price is stable and attracts investors
Control financial performance
Synergy effect to ensure operation
Derivatives may be cheaper than insurance
Disadvantages (bugs, deviations, high demands)
Risk type identification error
Error measurement
Difficulty recognizing changes in market structure
devil trader
Management's attention deviates from the main business, resulting in losses
Requires professional skills and knowledge
Compliance costs
Board of Directors
Responsibilities
Represent the interests of shareholders
independent from management
Shape and oversee the core role of Oversight Risk Management
risk management committee
Responsibilities
Set company risk appetite
Review the governance of all significant risks annually
Approval of risk infrastructure
Supervising banks’ lending and investment portfolios in the current environment
Review policy guidelines and risk management infrastructure
CRO
Establish a comprehensive risk management method ERM to specifically implement risk-related business decisions
Dotted line solid line reporting system
risk advisory directorrisk advisory director
Independent directors, risk experts, provide advice
The Audit Committee
Members are independent and objective
Ensure financial and regulatory reporting accuracy
Ensure legal, compliance meets best practice standards
Remuneration Committee
independent from management
Should be aligned with the long-term interests of shareholders and stakeholders, based on RAROC
Portfolio Management
basic concept
Measure benefits
average return
measure risk
standard deviation, variance
modern portfolio theory
utility theory
A>0
risk aversion
A=0
risk neutral
A<0
risk aversion
indifference curve
portfolio return
Portfolio Risk
efficient frontier
The tangent point between the utility curve and the efficient frontier is the optimal investor portfolio
Capital Allocation Line CAL
Risk-free assets Risky assets
CML: special CAL
All investors have been expecting
CAPM model
hypothesis
investor
Risk aversion, maximum utility, rational investor
Same single holding period
Homogeneous expectations
Risk-free interest rate lending
price taker
assets and markets
Information is fully disclosed
No taxes
Investment is unlimited
All assets are tradable
including manpower
β measures systemic risk
Risk-free asset β=0
Market portfolio β=1
SML Securities Market Line
below sml: overestimate
above sml: underestimate
SML vs CML
performance measurement
Sharpe ratio
The slope of CAL, suitable for evaluating the performance of under-diversified portfolios, total risk
Treynor ratio
SML line slope, combination degree systematicity Risk-based returns, suitable for fully diversified portfolios
Jensen Alpha
Excess returns exceeding CAPM expectations
Sortino Ratio Sortino SR
tracking error tracking error TE
The standard deviation of the return of the actively managed portfolio minus the underlying portfolio
information ratio IR
Also known as performance appraisal ratio appraisal ratio
Excess returns from excess risk (active management)
arbitrage pricing theory
CAPM strengthened
multifactor model
Fama-French three-factor model
SMB small market capitalization - large market capitalization Portfolio income,
HML has high book-to-market ratio minus low book-to-market ratio Portfolio income
Growth stocks: low book-to-market ratio
Value stocks: high book-to-market ratio
Advanced risk management
in principle
Risk data integration principles
overall
governancegovernance
Strong governance arrangements, risk analysis and overall risk management framework
Data architecture and IT infrastructure
Same data, same model, same price
ability
Accurate and true
Roughly automated
whole
All important risk data
timeliness timeliness
Adaptability
adaptive ad hoc
Risk reporting principles
precise
Comprehensive, comprehensive
certain frequency
release
Confidential, interested parties
regulator principles
regular review
Timely remediation and supervision
Cooperate with relevant departments to supervise and review
Comprehensive Risk Management ERM
Comprehensive, integrated
Integrated risk management approach
Integrated risk transfer strategy
Integrate risk management into company operations
Avoid over-hedging, which may offset sectors
concentration risk
Geographic industry concentration
product concentration
supplier concentration
ERM dimensions
Target: risk appetite, etc.
Structure: Board of Directors, Risk Management Committee, CRO, System
risk measurement metrics
ERM strategies, transfers and more
Corporate risk culture
Internal culture: process system
External culture: economic cycle, industry regulation, political factors
ERM advantages
Disadvantages: expensive
increased organizational effectiveness, high organizational efficiency, top-down
better risk reporting
improved business performancebetter performance
ERM management program composition
Corporate Governance
Business line management
Portfolio Management
risk transfer
Risk Analysis
Data and technical resources
stakeholder management
ERM tools
sensitivity analysis
pressure test
Scenario analysis
Dodd-Frank Act stress tests, DFAST, banks over $10 billion
Comprehensive Capital Analysis and Reviews, CCAR, banks above US$50 billion
responsibility
ERM is handled by the CRO
Dotted line reporting mechanism, generally the CRO reports to the CEO and CFO
In extreme cases, report to the Board of Directors
risk case
08Analysis of Financial Crisis
History background
House price bubble and low interest rate environment
subprime loans
High defaults, high interest rates
Preferential interest rate teaser rate: The interest rate is low in the first few years, and then the interest rate rises
credit transfer mechanism
Traditional methods: insurance, deposit, mortgage, etc.
securitization
buy-and-hold
originate-to-distribute, OTD
Transferring bank risks to investors
Bank sets up SIV to invest in structured products
The contribution of OTD model to the financial crisis
structured products
CDS credit default swap
Default insurance
short-term wholesale debt market
repurchase agreement repo
Low price mortgage, high price repurchase
haircut, discount part
asset-backed commercial paper, ABCP
Accounts receivable, installments as collateral for revolving financing
Liquidity crunch hits
Maturity mismatch between assets and liabilities
MBS depreciation
Market participants are worried
Short-term bond retail market financing freeze
rollover,repo,ABCP
Valuation uncertainty and opacity
Rating agency issues
data issues
Use historical data
Data comes from the issuer
No long-term data on subprime loans is available for rating
rating shopping purchase rating
Rating bias
financial disaster
Interest Rate Risk
Case: S&L industry
American Savings and Loan Association the saving and loan, savings and loan crisis
Description: Make money by riding the yield curve, then lose money when the interest rate curve reverses, save the mortgage, and continue to lose money
Warning: To manage interest rate risk, use asset liability management and duration matching tools
Liquidity risk
Case: Lehman Brothers
During the downturn of the real estate industry, short-term financing and high leverage are still used to develop housing mortgage loan securitization products, which requires extremely fast capital return and tight liquidity.
The business model is too radical, the proportion of high-risk businesses is high and concentrated, derivatives are too innovative, and risk control is weak.
Market information collapses, more collateral is needed, and ultimately bankruptcy
Case: Continental Illinois
Continental Bank of Illinois
The business is highly concentrated on corporate business, which suffers from the debt crisis of developing countries, huge losses, inability to borrow money domestically, borrowing at high interest rates abroad, exposure to operating difficulties, and bank runs.
The business is too concentrated on crude oil and natural gas, and the financing depends too much on the batch market.
Case: Northern Rock
Northern Rock Bank
Relying on inter-bank short-term financing to vigorously develop housing mortgage loans and securitization, it encountered a subprime mortgage crisis and ran on.
warning
Asset Liability Management
The trade-off between funding liquidity and interest rate risk
The liability period is shorter than the asset holding period - financing liquidity risk is high, conversely, interest rate risk is high
Trade-off between cost and risk reduction
Comprehensive and complete
Liquidity Stress Test
Emergency Liquidity Cushion
Hedging
Metallgesellschaft
german precious metals
At the same time, holding a short forward position in oil - short, and a long position in oil futures - long, it is theoretically foolproof.
However, the price of oil fell rapidly, and the longs lost money and the shorts made profits. The longs were unable to cash out their profits in time, and the shorts were unable to replenish their margins in time, resulting in a sudden loss of 1.3 billion US dollars.
Dynamic hedging strategies lead to
Oil prices fell sharply
backwardation to contango
Basis risk: long-term and short-term price mismatch, loss when opening a position
The position is too large and liquidity is exhausted.
Changes in accounting standards turn book losses into actual losses
warning
Changes in market environment
tax policy changes
Accounting standards changes
Hedging time, investment products, market performance
model risk
Niederhoffer
Victor Niederhoff
Profitable from selling deep out-of-the-money options on the S&P 500 without hedging. If the S&P plummets, the margin cannot be replenished in time, and the investor dies.
A business with low profits may suffer huge losses. Excessive speculation should not be allowed. There is no free lunch.
LTCM
long term capital management corp.
Strategy
Relative value strategy: mean reversion arbitrage of price differences between similar securities
Credit spread strategy credit spread strategy: bond credit spread mean reversion
Equity volatility strategy: stock option volatility mean reversion
You thought there was going to be a comeback, but Russia’s sovereign debt default tells you there’s a basement below the floor
High leverage, insufficient margin, huge losses
warning
History does not represent the future
Lack of risk diversification
Inadequate regulatory reporting of derivatives positions and trading strategies
Inadequate response to liquidity risk and credit risk, stress testing should be carried out
The London whale
london whale incident
JP Morgan Chase conducts massive trade in complex credit derivatives
The risk exposure is too large and exceeds the market’s ability to digest it.
Operational risk: The trading department can manipulate derivatives pricing, reports show fewer losses, and there are differences in derivatives pricing between different departments.
Risk management culture is not in place: internal supervision is not in place
Create a new model to underestimate risks
Proprietary trading should be strictly managed, risk exposures should be monitored in real time, and the impact of transaction scale on the market should be assessed.
financial engineering
Bankers Trust
Bankers Trust
Helping P&G and Gibson reduce financing costs
Designed complex derivatives, deceived customers, the U.S. raised interest rates, customers suffered losses, was sued, lost, and died.
Communicate rigorously and fully with customers
Unrecovered from reputational risk, acquired
Orange County
High leverage, borrow short and invest long, invest in complex derivatives, market interest rates are contrary to expectations, huge losses, bankruptcy
Buy Complex Inverse Floating Rate Bonds
Comes with leverage
Fiscal funds are not regulated and the risk exposure of investments is unclear.
Sachsen landesbank
Invested a huge amount of U.S. mortgage-backed securities and died in the face of the subprime mortgage crisis.
Experience scale should match assets and liabilities
Be familiar with the risks of the products you invest in
rogue trader
Barings
Barings & Nick Collison
Nick Leeson engaged in unauthorized excessive speculation in interest rate futures and options on the Japanese stock market, created false accounts to cover up his conduct, suffered huge losses, and bankrupted the bank
Long long positions, plummeting, huge losses
Straddle options, profit during hourly index fluctuations, large market fluctuations, huge losses
Trading and settlement positions should be separated, supervision should be improved, excess profits and losses should be paid more attention to, and cash flow that does not meet expectations should be investigated.
Reputation risk
Volkswagen
Volkswagen emissions scandal
The exhaust gas is only compliant during the test, but fails in actual driving.
Stock price drops by a third, billions of dollars in fines
Corporate Governance
Enron
Enron, financial fraud, and Anxinda's poor audit
Neither corporate governance nor auditing is good.
Introduce Sarbanes-Oxley Act SOX
cyber risk
SWIFT
Society for Worldwide Interbank Financial Telecommunication
hacker attack
Strengthen supervision and strengthen manual intervention for large transactions
Morality
Disclose what should be disclosed, and the rest depends on your own moral standards.