Term
What are the two major sources of risk?
Discuss them... |
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Definition
Business risk: risks that result from business decisions and the business environment. Includes strategic risk and the macroeconomic factors that impact a firm's operations and sales.
Financial risks: are the result of a firm's financial market activities. |
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Term
| Why have firms become more exposed to economic and financial variables over the past 20 years or so? |
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Definition
Deregulation (in banks led to increases in interest rate sensitivity)
Globalisation let to firms doing business internationally resulting in more exposure to currency changes. |
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Term
| What is a derivative contract? |
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Definition
| a contract that derives its value from an underlying security. |
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Term
Are derivatives and securities considered zero-sum games?
What does this mean? |
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Definition
Derivatives are considered zero-sum games - one sides losses will equal the other sides gains.
Securities are considered non-zero sum games. |
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Term
| Contrast absolute risk vs relative risk: |
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Definition
Absolute risk focuses on the volatility of total return
Relative risk is referred to as tracking error since it is usually measured relative to a benchmark index or portfolio. |
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Term
| Contrast directional risks vs non-directional risks: |
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Definition
Directional risks are linear risk exposures in economic or financial variables (e.g., interest rates, stock indices)
Non-directional risks are risks that have non-linear exposures or neutral exposures to changes in economic or financial variables. |
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Term
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Definition
| the risk that the price of a hedging instrument and the price of the asset being hedged are not perfectly correlated. |
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Term
| What are the two types of risk within liquidity risk? Describe them. |
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Definition
Asset-liquidity risk (aka market or trading liquidity risk) - results from a large position size forcing transactions to influence the price of securities.
Funding liquidity risk (aka cash-flow risk) - the risk that a financial institution will be unable to raise the cash necessary to roll over it's debt, to fulfill the cash, margin or collateral requirements of counterparties; or to meet capital requirements. |
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