Stress Testing

After completing this reading, you should be able to: Describe the rationale for the use of stress testing as a risk management tool. Identify key aspects of stress testing governance, including choice of scenarios, regulatory specifications, model building, stress-testing coverage,…

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Measures of Financial Risk

After completing this reading you should be able to: Describe the mean-variance framework and the efficient frontier. Explain the limitations of the mean-variance framework with respect to assumptions about return distributions. Compare the normal distribution with the typical distribution of…

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Pricing Conventions, Discounting, and Arbitrage

After completing this reading you should be able to: Define discount factor and use a discount function to compute present and future values. Define the “law of one price,” explain it using an arbitrage argument, and describe how it can…

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Options Markets

After completing this reading, you should be able to: Describe the types, positions variations, and typical underlying assets of options. Explain the specification of exchange-traded stock option contracts, including that of non-standard products. Explain how dividends and stock splits can…

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Bond Yields and Return Calculations

After completing this reading you should be able to: Distinguish between gross and net realized returns, and calculate the realized return for a bond over a holding period including reinvestments. Define and interpret the spread of a bond, and explain…

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Binomial Trees

After completing this reading you should be able to: Calculate the value of an American and a European call or put option using a one-step and two-step binomial model. Describe how volatility is captured in the binomial model. Describe how…

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Exchanges and OTC Markets

After completing this reading, you should be able to: Describe how exchanges can be used to alleviate counterparty risk. Explain the developments in clearing that reduce risk. Describe netting and describe a netting process. Describe the implementation of a margining…

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Foreign Exchange Risk

After completing this reading, you should be able to: Calculate a financial institution’s overall foreign exchange exposure. Explain how a financial institution could alter its net position exposure to reduce foreign exchange risk. Calculate a financial institution’s potential dollar gain…

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Credit Risk and Capital Modeling

After completing this reading, you should be able to: Evaluate a bank’s economic capital relative to its level of credit risk. Explain the distinctions between economic capital and regulatory capital and describe how economic capital is derived. Identify and describe…

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Observations on Development in Risk Appetite and IT Infrastructure

In this chapter, the concept of a Risk Appetite Framework (RAF) is described and its elements are identified. An explanation of a well-developed RAF’s benefits will also be given and the best practices for a firm’s Chief Risk Officer (CRO),…

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