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. Describe the relationship between stress testing and other risk measures, particularly in enterprise-wide stress testing. Describe stressed…
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…
Options Markets
After completing this reading, you should be able to: Describe the various types and uses of options, define moneyness. Explain the payoff function and calculate the profit and loss from an options position. Explain how dividends and stock splits can…
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…
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…
Measuring Credit Risk
After completing this reading, you should be able to: Explain the distinctions between economic capital and regulatory capital and describe how economic capital is derived. Describe the degree of dependence typically observed among the loan defaults in a bank’s loan…
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),…
The Black-Scholes-Merton Model
After completing this reading you should be able to: Explain the lognormal property of stock prices, the distribution of rates of return, and the calculation of expected return. Compute the realized return and historical volatility of a stock. Describe the…
Modeling and Hedging Non-Parallel Term Structure Shifts
After completing this reading you should be able to: Describe principal components analysis and explain its use in understanding term structure movements. Describe key rate shift analysis and define key rate 01 (KR01). Calculate the KR01s of a portfolio given…
Portfolio Credit Risk
After completing this reading, you should be able to: Define and calculate default correlation for credit portfolios. Identify drawbacks in using the correlation-based credit portfolio framework. Assess the impact of correlation on a credit portfolio and its Credit VaR….
