A primer on financial risk management for novice on banking & finance.

1. Management BOI Domain Training Date: 11 Jan 2010

2. What is risk management? RISK: Uncertainty regarding the value of the underlying asset RISK MANAGEMENT: The process of identification, analysis and either acceptance or mitigation of uncertainty in investment decision-making.

4. determining what risks exist in an investment and

5. handling those risks in a way best-suited to your investment objectives.

6. Risk management occurs everywhere in the financial world:

8. Risk Management Process 1 4 2 3

9. Risk Assessment The process of determining the likelihood that a specified negative event will occur. Investors and business managers use risk assessments to determine things like whether to undertake a particular venture, what rate of return they require to make a particular investment how to mitigate an activity’s potential losses.

10. Risk Assessment Examples of formal risk assessment techniques and measurements include conditional value at risk- cVaR(used by portfolio managers to reduce the likelihood of incurring large losses); loan-to-value ratios (used by mortgage lenders to evaluate the risk of lending funds to purchase a particular property); and credit analysis (used by lenders to analyze a potential client’s financial data to determine whether to lend money and if so, how much and at what interest rate).

11. Systematic Risk The risk inherent to the entire market or entire market segment. Also known as "un-diversifiable risk" or "market risk” Interest rates, recession and wars all represent sources of systematic risk because they affect the entire market and cannot be avoided through diversification.

14. SYSTEM DEFECTS / SYSTEM FAILURE

15. LAXITY IN INTERNAL RULES

18. INTEREST RATE RISK

19. FOREX RISK

21. Diversification A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio. Diversification strives to smooth out unsystematic risk events in a portfolio so that the positive performance of some investments will neutralize the negative performance of others.

22. Hedging “Hedge”: Take a position that offsets a risk By hedging, one changes the risk inherent in owning the underlying asset. The return distribution of the underlying asset is not changed It’s a type of transaction that limits investment risk with the use of derivatives, such as options and futures contracts. Hedging transactions purchase opposite positions in the market in order to ensure a certain amount of gain or loss on a trade. They are employed by portfolio managers to reduce portfolio risk and volatility or lock in profits.

23. VaR VaR is defined as the predicted worst-case loss at a specific confidence level (e.g. 99%) over a certain period of time. Value at Risk (VaR) is the most probable loss that we may incur in normal market conditions over a given period due to the volatility of a factor, exchange rates, interest rates or commodity prices. The probability of loss is expressed as a percentage – VaR at 95% confidence level, implies a 5% probability of incurring the loss; at 99% confidence level the VaR implies 1% probability of the stated loss. The loss is generally stated in absolute amounts for a given transaction value (or value of a investment portfolio).

25. Reports to G10 Governors/Heads of Supervision

26. Members are senior bank supervisors from G10, Luxembourg and Spain

27. Work undertaken through several working groups

28. Aims of Basel II:

29. To deliver a prudent amount of capital in relation to risk

30. To provide the right incentives for sound risk management

32. Operational risk

33. Market risk

34. Bank’s own capital strategy

35. Supervisor’s review

36. Enhanced disclosure All three pillars together are intended to achieve a level of capital commensurate with a bank’s overall risk profile

37. Thank You