Lecture 2_Market Risk and Liquidity Risk - Copy (2)

Market Risk

The risk of loss or profit as a result of changes in the market price of the positions held.

Liquidity Risk

The risk of an institution being unable to meet its financial obligations as they fall due without incurring unacceptable costs or losses.

Value at Risk (VaR)

A risk measurement that defines the loss level that will not be exceeded with a certain confidence level during a period of time.

Expected Shortfall (ES)

Also known as conditional value at risk (CVaR), it estimates the amount that the bank will lose if VaR is breached.

Funding Liquidity Risk

Inability of firms to raise cash (secured or unsecured) without paying unreasonable rates.

Asset Liquidity Risk

Inability to exit a position without accepting massive losses, reflected as wide bid-ask spreads.

Liquidity Coverage Ratio (LCR)

A Basel III post-crisis reform designed to ensure banks hold a sufficient reserve of high-quality liquid assets (HQLA) to survive liquidity stress.

Net Stable Funding Ratio (NSFR)

Aims to promote resilience over a longer time horizon by creating incentives for banks to fund activities with stable sources of funding.

Historical Approach (VaR)

Utilizes past actual data to compute VaR by re-organizing historical data in ascending or descending order.

Variance-Covariance Approach (VaR)

Assumes portfolio returns follow a normal distribution and is a parametric approach to compute VaR.

Market Risk Management Framework

A framework that includes market risk limits consistent with the institution’s risk appetite, profile, and capital strength.

Long Term Capital Management (LTCM)

A hedge fund that used high leverage to exploit pricing discrepancies, experiencing massive losses during a crisis in 1998.

Flight to Safety

A phenomenon wherein investors move their investments from risky assets to safer ones, often in response to market stress.

Standard Deviation Method

A method of measuring market risk volatility where all data points are treated with equal weight.

Exponentially Weighted Moving Average (EWMA)

A method that gives more weight to recent data points, enhancing the sensitivity of the measurement.

Market Making

The activity of quoting both a buy and a sell price for a financial instrument, facilitating trading.

Proprietary Trading

When a financial institution trades its own money, rather than on behalf of clients.

Agency Trading

A trading strategy where a firm acts on behalf of clients and facilitates their transactions.

Economic Value of Equity (EVE)

A measure of the market risk associated with changes in interest rates.

Regulatory Arbitrage

The practice of taking advantage of the differences in regulations in different markets.