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The Fundamentals of Risk Measurement
1stPublisher: McGraw-HillFormat: Hardcover
TABLE OF CONTENTSChapter 1: The Basics of Risk Management This chapter introduces how banks work. It describes how they make money, how they often lose money, and how they try to manage their losses. It includes thirteen short case studies showing how banks have lost money.Chapter 2: Risk Measurement at the Corporate Level: Economic Capital and RAROC Chapter Two discusses the meaning of capital and how the risks that a bank faces are related to the amount of capital that the bank should hold. It then describes the two fundamental building blocks of integrated risk measurement: Economic Capital and Risk Adjusted Return on Capital (RAROC).Chapter 3: Review of Statistics Chapter Three is useful for those readers who do not have a recent working knowledge of statistics. It reviews the statistical relationships that are commonly used in risk measurement and provides reference material for the rest of the book. Examples are provided using financial loss data.MARKET RISK SECTIONChapter 4: Background on Traded Instruments This chapter gives an overview of the main types of traded instruments: bonds, equities and derivatives. It gives a qualitative description of the instrument, examples of calculating the instrument's value and the basic risk metrics such as duration and the Greeks. This chapter is useful for those readers who are new to the finance industry.Chapter 5: Market Risk Measurement This chapter describes the most common ways to measure market risks: Sensitivity analysis, Stress testing, Scenario testing, Sharpe Ratio and Value at Risk. It gives detailed examples of using each of the metrics.Chapter 6: The Three Common Approaches for Calculating Value at Risk Value at Risk (VaR) has become the standard approach for measuring market risk. This chapter is devoted to explaining the details of the three common approaches to calculating VaR: Parametric VaR, Historical VaR and Monte Carlo VaR. We work though increasingly complex examples and compare the strengths of each approach. (Note: many readers will be particularly interested in this chapter because the name “VaR” is well known and has a certain mystery)Chapter 7: Value at Risk Contribution The Value at Risk Contribution (VaRC) is a useful way of pinpointing the source of the portfolio's risk. VaRC can break down the risk by instrument, trading desk or market risk factor. Examples are given for several types of VaRC.Chapter 8: Testing VaR Results to Ensure Proper Risk Measurement This chapter discusses the procedures required by regulators to backtest VaR calculators to check that their predictions of losses are consistent with market events.Chapter 9: Calculating Capital for Market Risk VaR is used as the basis for calculating both Regulatory Capital and Economic Capital for Market Risks. In this chapter VaR also extended to measure the risk of Asset Management operations.Chapter 10: Overcoming VaR Limitations Although VaR is the best single metric for market risks, is has several limitations. The limitations and typical solutions are discussed in this chapter.Chapter 11: The Management of Market Risk This chapter concludes the market risk section by describing how the results of risk measurement are used by management to identify the sources of risk. It also describes the process of setting VaR Limits. (Note: readers should be particularly interested in VaR Limits because it is difficult and an important element in controlling a bank's risk).ASSET/LIABILITY MANGEMENT SECTIONChapter 12: Introduction to Asset Liability Management Asset Liability Management (ALM) is primarily concerned with the interest rate and liquidity risks that are created when commercial banks take in short term deposits from customers and give out long term loans. This chapter describes how those risks arise and the risk characteristics of different types of deposits and loans.Chapter 13: Measurement of Interest Rate Risk for ALM This chapter discussed the primary techniques used to measure interest rate risk: Gap reports, Rate shift scenarios and SimulationsChapter 14: Funding Liquidity Risk in ALM The measurement of liquidity risk is broken into three groups: expected, unusual and crisis events. Measurement techniques are given for each group.Chapter 15: Funds Transfer Pricing and the Management of ALM Risks A key use of asset/liability measurement is the calculation of the fair price at which funds should be lent from one department to another within a bank. This is one of the keys to integrated risk measurement and is a critical component in measuring risk-adjusted profitability and setting prices to customers. A typical balance sheet is used to illustrate how transfer pricing works in detail.CREDIT RISK SECTIONChapter 16: Introduction to Credit Risk This chapter discusses the sources of credit risk and how measurement is used to manage the risksChapter 17: Types of Credit Structure For readers who are unfamiliar with lending operations, we discuss the ways that credit exposures are structured in commercial and retail lending. It also describes the calculation of credit exposure for derivatives trading operations and gives an overview of credit derivatives.Chapter 18: Risk Measurement for a Single Facility This chapter shows how the Expected Loss and Unexpected Loss for a loan can be calculated from the Probability of Default, Loss In the Event of Default, Exposure at Default and the Grade Migration Matrix.Chapter 19: Estimating Parameter Values for Single Facilities One of the main difficulties in credit risk measurement is the estimation of values for Probability of Default, Loss Given Default and Exposure at Default. This chapter discusses estimation techniques such as Discriminant Analysis and the Merton Model. It also gives parameter values that can be used as the basis for the reader's own models. The parameter values are used in examples to demonstrate how the cr
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