Covering market risks, operational risks, liquidity risks and analyzing risks and quantifying financial impacts.
MARKET RISK
1. Equity and property risk - losses arising due to drop in equity prices.
2. Currency risk - losses arising due to adverse movements in exchange rates.
3. Basis risk - arising because the yields on instruments of varying risk quality, liquidity and maturity don't move together; affecting the assets and liabilities of the company independently.
4. Reinvestment risk
5. Concentration risk
6. ALM risk
7. Off balance sheet risk - losses arising from assets or liabilities not shown on the balance sheet eg payments required under futures agreements with zero value at the balance sheet date.
8. Interest rate risk - losses arising due to change in interest rates.
OPERATIONAL RISK
1. Human capital risk - failure to attract and retain well-trained personnel
2. Management control risk - failed internal controls, disciplines etc.
3. Systems risk - systems failures
4. Strategic risk - management failure to implement appropriate business plan, make decisions, allocate resources and adapt to changing environment.
LIQUIDITY RISK
1. Liquidation value risk - risk of having to realise assets in adverse market
conditions
2. Affiliated company risk - risk of difficulty in realisation of interests in an
affiliated company
3. Capital market risk - risk of inability to obtain funding from outside the company or group.
ANALYSE RISKS AND QUANTIFY FINANCIAL IMPACT
1. Historical simulation - Taking the observed values of risk factors from the past and applying the range of values observed to the current portfolio.
2. Value at risk (VaR) analysis - Assumes that the risk factor has a Normal distribution. The standard deviation of the risk factor is derived and the mean assumption is set. The limiting value of the risk factor for a particular confidence level can then be determined by taking the mean plus or minus a defined multiple of the standard deviation.
3. Collective models - These models have two components – a probability model for the frequency or incidence of the risk event and for the severity or quantum of the loss resulting from the risk event.
4. Aggregate models - When it is not possible to develop the probability of frequency/incidence and severity/quantum of loss separately, aggregate models may be used.
5. Stress analysis or stochastic modelling techniques - The 'stress', is the quantum by which the variables modelled are varied, either one at a time or together, to determine the amount of capital required. The 'stress' can be determined with reference to expert opinion, historical observation or VaR techniques.
OPINIONS
1. Some risk events are relatively easy to analyse, as there is a large amount of statistical data already available.
2. The model selected should, as far as possible, be able to analyse risks with their distribution pattern.
3. If little or no data is available for a particular risk or if the available data may not be suitable to be used in the model, a value judgement has to be made about the likely impact of the risk on the financials of the company.
4. The risks can be analysed separately and then combined using formulae that reflect their corelations or dependencies.
5. some risks can be grouped in a combined model and can be represented by some common variables (e.g. interest rates, inflation etc.) that influence these risks.
6. An appropriate time horizon and confidence level will need to be determined for calculating the risk exposures.
7. Frequently used approaches include looking at the holding period for a risk (i.e. the time for which it will be on the books) or the period over which mitigating action can be taken (the period until the emergence of the risk can be detected and suitable action taken – hedging, reinsuring or raising capital).
