Types of Risks in banks 1.Market risks 2.Liquidity risks 3.Credit risks 4.

Operational risks Market risk is the risk related to the uncertainty of a financial institution s earnings on its trading portfolio caused by changes in market conditions such as the price of an asset, interest rates, market volatility, and market liquidity In investment Assets are loans and liabilities are capital Reasons MRM is important 1. Management information: MRM gives senior managers information about risk exposures. 2. Setting limits: MRM helps set logical position limits 3. Resource allocation: Because it compares return-versusrisk across asset classes, helps allocate capital effectively. 4. Performance evaluation: Rather than pay traders merely for taking on more risk, considers the return-risk ratio, and therefore helps for more rational compensation scheme. The Monte Carlo Simulation Approach The Monte Carlo approach overcomes the problem of limited observations. A typical Monte Carlo simulation produces a large number of synthesized observations List the methods the Bank for International Settlement uses to regulate market risks 1.Foreign Exchange (Under BIS Standardized Framework) ? The standardized model or framework requires the bank to calculate its net exposure in each foreign currency and then convert this into dollars at the current spot exchange rate. FX RISK Explain the different types of foreign trading activities and the sources of most profits and losses on foreign exchange trading. Purchase/sale of foreign currencies 1.To allow customers to participate in international commercial trade transactions 2.To allow customers to take positions in foreign investments (real or financial assets) 3.For hedging purposes i.e., to offset currency exposure 4.For speculative purposes LO 19.6: Explain why diversification in multicurrency foreign asset-liability positions could reduce portfolio risk. To the degree that domestic and foreign interest rates (or stock returns) are not perfectly correlated, potential gains from asset-liability portfolio diversification can

offset risk of asset-liability currency mismatch Liquidity risk LO 20.1: Explain the interrelationship between funding liquidity risk and market liquidity risk 1.Funding liquidity risk Not enough balance sheet cash to fund ongoing operations.CFO resp 2.Market liquidity risk Deterioration in asset value: Cannot liquidate the position, and/or Cannot sufficiently hedge the position. market traders LO 20.2: Describe alternative methods for measuring liquidity risk. Liquidity gap = Liquid assets minus ( ) volatile liabilities Companies can take at least two steps to minimize liquidity risks: ? Diversify liquidity risks across sources ? Perform scenario analysis-based planning CREDIT RISK OPERATIONAL RISK