Continuous Uniform Distibutions urcomer an only be beeen and the probably ofan ourcome ousie the boundaries of eand Bisse Gai dent ection cf fr aim disribaien F(x)=0forx <2 F(x) = (xa)/(b~3) foracac F(s)=1ferx > Binomial Diswibution Outcome can either be “succes” ot “lure” fe tna Binomial Random Variable Pb= ‘Standardized Rasidom Variables A sandaricd render variables normed ‘other it has amean of ero and a standacd deviation ofl Zscore represents #of standard deviations 3 given observation i fom a population mes lbseration ~ po ion mean _x~se ‘tandard dei Cortelation Coefficient, - “The carlton enfiients bounded by 1 and 1. the coeation i 2, the variables xand “7 te uncorelied conlX¥) ae ‘Measures of Central Tendency Archaic mean: sum of al obervtion vies Jn samplelpopulaion divided by the number of observations Made value that cure mos frequently ina dace, Medien: widpine ofa dat set when dat it aucanged in an ascending or descending o1det ‘Variance and Standaed Deviation Variance: average of squared deviations from the DOG -aF population valance =, Standard deviston : sate roo of the variance. ‘Normal Distibution [Nouma dssibution is completely described by iss mean and vaiance. Lh + 6896 of observations fll thins 1 + 909 of ebeervations ill wihin = 1.65 o. ecration fall within # 1.96 6, *+ 9996 of observations ill within + 2.58. Skewness * Pasiely shed: mean > median > mode. 1 Negi sheved : mean < median < mode Kurosis * Leptourtic: ove peak than anormal Aiseibuton (Ft eal); exes kurtosis > 0. + Planar: Baer than & teal dstibudon eres ureois0. ‘Standasd Exror Standard enor of he sample mean i the standard deviation of the disbution of sample koown popain vases = 5 =F unknown population vr Confidence Intervals “The condense nvr gives the range of ales th mean value willbe beoween, with a certain probability (6g, 90% or 95%). With known ‘aiance, the forme fora confidence inerva is ays = 1.65 for 90% confdenesincerals (Gipniiance level 10%, 59 in each ea) toys = 1.96 for 95% confidence incervals (Gigniticance lve! 58, 2.586 in each il) ays =258 for 99% confidence intervals (Gpifcance lee! 195, 0.5% in each el) Hypothesis Testing Niall ypobeis(H) «hypothesis he researcher vant to reject: hypothesis chai acrually ested the basis for selection of the et sts. Alternative Ippo (H.) : what is conciuded if here issgnifiean evidence ro jet the ll hypothe One ald se: ress wheter vale is greater than or ess tha 0 Hy: w <0 vesus Hy: «>0 “Tosa tr tess wheter valve i diferent fiom zr. Hi: = 0 versus Hy: ae ‘pe Hero: ejection of nll hypochesis wien ic ie aeualy ue {pe I ever: Falla wo reject the ml hypothesis wen eis actualy fase, Simple Linear Regression General form of inca egession model Yomby thX te, pendent varable; estimated value of F, intercept; represents value of YIFX +b, «slope coefiient: measures change in Ffor s one-nit change in X 5 em(X¥) §- 2 “arance(X) Regresion Coefictents: Testing Significance Appropriate tet sracare Hy: =0 versus: #0 ay Tes, Decision rl reject Hy iF €> + jaa OF F< ep Coefficient of Determination, R® Tercentage of the total variation in Yexplained explained ‘alae a Risk (VAR)* Minima oust cnbagenpamhly WARRO) =e o> the square rot at time ta shange crontiporannal VAR VARIO) in = VARI) i To ic iat et nfl Ri Ase lle + Aaietcnelidod “PS + Somer relisoniip berveen an underyingfacon = and the detvaive value ae linear in nacre + Aline derivative’ value’ a fraction ~ of he hare ithe ae oh endeig ast ad is dependent he sate ofthe \uodeying ase. ie ——_ convenWAQUEA KCL Cons CFAR should beincorpoated nro Lcetcammnmaent ‘Portfalia VA re a Anthem ante SURYA AR ht otis om ana Invesoment in aposon.=o~~ cenit Vite ign VAR ed addin ne poalGnin 4 porto” ‘Componce Ai c anaun’ x pola VAR, oul ange fom desng poten ina porns : spony Weighed Moving Average Model ~ (ae Mase cee ero and ‘RukMeviat and GARCH models are both = capone smonthing weighing mecbods “GARCHRsimation Model: * lity sums rece me saatsrergelevel> + Sum of(a +) max bes te i he ie ws bp a Approaches for Eximating YAR + Hii bse: patter, donate au yb 2 lnpie-ai ted e daa. png modes - Sites Testing VAR tl the proeblin-fsrneding ag loss buch insporatethe pesibles = fount of os tat Ul from an Sine ‘She ering complenients VAR by providing ‘formation abou che magnitude of loses that may occur in extreme marker conditions lak Budgeting VAR Wi For. choice bemieen swe new posions fora portfolio, compare tke maygial VAR to make the selection: When decing whether ro inte ne exiting Position over another compe he f-t:VAR ratios and increas the potion in ne with the higher aio. - afr the Tete ows seed ie he lng rl een oe age age. perl’ eign ater fests eel aesatey eerily =” 4 ESS armen eet cameras dpi sratche iy Geo Relationship Among Coupon, YTM, and Price Iecoupon race> YTM, bone price willbe greater than par value: premion bond. [coupon rate Sye, borrow, buy spot lt forward today deliver ase, epay oan at end } FER < Se shore spor, vests buy forward todays collec loan, buy aset under cies contact deliv to caver short sale 1 4 Pants rise change eimai aig drain and conv [duration xy 100+ ((Pscooesirx(y) te ‘Macaulay and Modified Duration Mediied duraion : approximate pecencage pice change ina bond from a gives change in yee Macey duration weighed average term to vnanuity ofa bonds cash Rows Macaulay (1,2) rere ern + Yel increases (price decreates), duration pe Se + Key ate duration addzexes nonparalll shits in the yield curve by allowing fr changes in all rates 0 be determined by changes in key sates.“Hedging Strategies Using Furres Basis ik: difference berween spo pice of edge asec and futures price of contract used in a hedge (Optima minima variance) hedge rate fone : or Day Count Conventions + Atala. bonds + 39360. US. Corporate snd muicpal bonds 1 eual360. "ila eter money master Interest Rate Snaps Plain vil inne te ep ebanges fined fo owing at payments ove the ile ofthesmp ‘A inept, the vale of sap io ‘Air ncption she val fe rip ich Aifeens beeen the presenta of he rennin fed and Hoang Payments Von np Bion ~ Be Verse nste tet Bi ~Big po, + Changes in each hey rate will et the tes of che previous and subequent hey rts ina linea fshion Bonds With Embedded Options Callable bond: issuer has the cght w buy back the bond inche fare aa et price a yes al, bondi ikl obe elle: prices wile ata decreasing te — negeie conor, Pazble bond: bondholder has the righ co sll ‘ond back othe ser aca set pice. (MBS Prepayment Risk Facto that afer prepaymenss + Prealng morgage res + Spread of current vs. original morgage tes. + Morgage ate path (financing burn) + Level of morgige tes. + Undedying morgage charac. + Seasonal facies + General eonomicsevny Contraction rick occu ates fl prepayerens Fs, average if fal ‘Bxoion rik: outs 2 sts, prepayments fal low) average if ie. EMO Prepayment Risk PAC tranche: reeves ath Bows according a prederermined schedule, Support ache: cecves prepayments in exces (of PAC upper rat, diverts ath ro PAC wanche if repaymens ar slower than expected Cerzainy of PAC bond cath fow comes athe expense of increased rk othe suppor tances. Scripped MBSs Orig: receives principal payments sold ax discount from par: nceae in vale as repayment increase inves relationship with TO sri: receives ierestpeymenss investor, ‘wane prepayments be slows postive aon ihn, a= (Mina xe) tia x fsa +7 rocional + [nan Bren xe) Currency mp exchanges payments in 0 diferent currencies; payments at be fixed or floating. fa swap ba postive valu to one counterpary, thar pony it exposed to cri sek. Tractors Acting an Options Price Tip | Ege | nc | Aacin il st eee nent [eeree ats ¥P- pe pe be T rte [- | ae eae Option Pricing Bounds ‘Upper bound Buropein/Amedcan ell ESS 5CS Sp "Upper bound BaropeaniAmesetn put psxe™ Pex Lovet epee neon den prs cana( 7) CS poring 3) p2ma(Xe ~: Rules for Exercising American Options "6 Tenover optimal ete an American eallonanon-dividenépeying nck before is capiation date + Azetcan pts can be optimally exec erly if they are slice inthemone. + An Arericn elon dividend: paying tock 1 maybe exerci eal the dividend exceeds ‘he amount of gone ince. Pas-Cal Pasty PHS =Cexe® Binomial Option Pricing ‘Sup ls Calesat option payo ar end in all ‘Suop 2: Calculate option vals sing risk-neutral probabilities sie af up move «Uae L sor of down nove =D = re 5—D | Sep 3 Discoun wo today using ssf ate Rona =1— Typ Black Scholes-Merton Option Pricing Model c= SN(é))-Xe™N(4,) p= Xe [1 -N(4,)]—S[1-N(4)] Volatility Smiles Gare opin: implied volt is lower for aeshemaney option than is for aay ome ‘hemoney options Zp orion: higher implied vlaliy for low ‘epic options Option Trading Strategies + Coered all. Lang tock pus shor cil * Prove pu Long stock pls log pat. Also ‘alle poli insurance. + Bul rad. Purchase cal opon with low exec pice, and subd the purchase with tle call option with higher exercise Price, ‘Beare. Shor ball spread. Purchases calli igh tke prize and shores eal with low sie price. Tnvestor keep diferencia rice ofthe option if sock pice fill. Bee spread with us involves buying put wich igh ere price and sling pu wth low orc pice ‘Bacay greed. The dierent options. Boy cone call wi low exerci pric, buy another With abigh exes rie and shor evo cals witha exercise price in becween. Bureciy buyer e being the tock price wil sty nest the price fhe weiten els Gulndir psd To options wth difrene expicons. Sella shore dated opion and buy ‘leogeaced option. Investor profi tock rice sayin a natow range. + Lov made. Bet on vlc. Buy all sda pt with the sume excise price and expitation date. Profi earned if tok price has age change in ithe recon. Serta Sells put and cll wich he ‘ame exis price and expration date. IF stock pce emsins unchanged lle keeps eprion premiums. Unimied potential lose Sirange Silt wo seal, cept purchased option i ourof she moneys ies cheaes to implement. Stock price has to move more 10 Soi and avaps. Adan aidonal pu (ip) or call (ap) to aad sate. Grecka Dalia estimates the change in vale for an option fora huni change in sock price. + Cal dela bowen O and + aceaes as stock ples ineee, + Call da cle 00 fr fr outa the-money cals get 1 for deep inche-money cll + Purdslts becneen =I and incest om 1 (00 as stock pce ncreses + Pur dele se 0 fo ar out-of the-money pus cloe ot for desp inate: money put ‘Thee ie decays mos negative when option lsacchemorey and clac oexpintion. Gamma rae of ange in dels a undeying stock pie changes ares when option is at themoney ‘aga: sense fan option pric to changes involaliglagetwhen option i athe-| Risk and Return of a Portfolic | Bip | 2, )= EE | if april whof + whed +20wap,20102 | The lower the correlation, the greater the benef | from dlvertcatin, Cpa Malet Theor ing ied ir ie ici Fer Mae Peo ' Security Market Line (SML) ts hoy nce a sk | iSew enutee aye | Soil gine orp systenatic ri. ‘Te equation ofthe SML ie moneys cose O when option i deep in- or ‘oucoFthe-money, ‘Bhp: sensi of options pice to changes in che rk-lie se larger for n-the-money options. Delee-Neutrl Hedging + To completly hedges long stock/shore ca position, purchase shares of sock equl 0 ela» numberof options sod (Only appropriate for small changes in valuc ofthe undelying asset. + Gamina can caret hedging eror by protecting guint large movements in ater price. (Gamma-neutral positions are creard by satching pocfollo gana with an oferting option pasion. Exotic Options Compra option: option on another option, Chose option: owner chooses whether option ‘sa cal : purse initiation. Barviereption : payofF ad existence depend on price reaching certain baer lve, Binary option: pay either nating or 2 fxed Loakback epion: payoff depends on the ‘aximiam (cal) or minimum (pat) value ofthe underlying ase over the life ofthe option, Shout apuon: ovens receives wcsinsc vale of ‘option at shou dite or expiration, whicheve it grater ‘Aton option: payof depends on average ofthe underlying asset price over he life ofthe option; less vou chan stands option, 1 + Waly arbieage: postions ino the CAPM, which ea eturnlystemasc sk cquilbrium relaonship. CAPM: B(R))=Re+;[E(Rass)—Re] Forts of Maret Efciency Wea form : al pas paren are incorporated ico mae pies. Sem-srong form all public information's incorporated into mate pice Song form: al public and private information {is incorporated into market pies. Measures of Rsh- Adjusted Petformance 2(R,)=Rr ‘Feeynge ensure = » Sharpe meaiare (Rp)—Re )-Relée Tackng ero, Gy tthe standard deviion of the difference berween rears ofthe portlio and recurs ofthe benchrark ~[E(@0) [een=2es 2 Hedge Fund Siege + Langhdor equi: long an equity poxlio, and simuleaneously short other equity + Equisy markt neutrals long and short stock postions ofrelited companies. + Bau marke sing: scren stocks sing technical wading rule to find she profi opporcuniie + Shoresellng: socks aié borrowed and shea ‘old in the public marke * Canwerble arbinage :converble ecuiies ane purchased, anda percentage ofthe issuer's stock scold shor, + Bad income arbtage: the spread between Simla fixed-income secures and thee derivative is expla ed-income ecuiies hat hive mispried volaelty. + Capital uracurearbinage capitalize on discrepancies oberved berween debtand equity ecu + Eomni-driven: a parolo of undervalued or overvalued ccuiies with respect to company. specific evens + Merger arbirage: ongand shor posisions in companies that are partis to corporate + Disrend secre ong position in the financial secures of financially troubled company, + Reale Dong position tn privately plied savepetered scutisiased by publicly caded small company. + Glo mac: sed around expected change in plot capil make: prices. + Moneed furs eaablih longand hore | fares pesdone on commodities and nail | Hedge Fund Diversification Classifications + Returseshacer: high cca, high cova. | + Ri dee ow rer, low comeagon, © Teor: high ear, low corrton + Pare diver: low or negative recs, high equiv colton ‘edge Fund Inder Problems \ + Suri bis + Backing + Aver weighing + Sdccion bis. + Aucoin + Time peiod bie. Caavergence Fading i ‘Mean reenon sate Yong underaed asset shor overvalued ast wth anipation of sarowing yield spread. Forms of Leverage Balance hee leverage: wing credit to finance pesiions Insrament orig: cdines inherent in ahedge | fund’ invenmene Teanspareney i “Theres 2 wadeo with cransparency for hedge fund invesors. Investors wane enough information to manage thei risk however, {iselosing details about portfolio postion riding parinerimitators may impale the Fund abil waequle or liquidate positions Acuibutes of Transparency + Cantor: qualcy and relabiliy of dat, + Grularig: level of detail about dat, t + Bguency: timing and regularity of discloses, + Dedey: ei ng berveen period covered and Asclosure | Hedge Fand Style Drift * Change in rik actor exposures 8 the fond, * Change in overall sk ofthe fund (pvimaily through levers). “edge Fund Soye Dife Red Flags + Poors + Bxcese cash inflows + Beczat loses * Personnel change * Regulatory change. Lf REDITRS LS ss] CRI Contracualy Promised Gross Loan Reeoro drm) == Compensating balance: proportion ofthe loss that bocrowers must ep on deposit wich banks ses theefetive cost ofthe loan, lekels ONTWED ~prob of | (4) repayment, P J prot of defau a2 cumulative protbiy=C, =1~(61P2%.%P,) fd . Concension Lis Conenaon in nc peri Jean amount any indi Berover 04 freneaee = loss a a percent of capital concentration, limie Los Sale Terminology ‘Witour neo loan emoved from bank's balance shes purcharer bears eed ik We ec: purchases ase igh sel ous back 0 iginating bank lon is kept. on banks alace shee ar consngen edie libil. Fariipavion basis: buyer buy portion of (parcipats in lge lun erene beveen loan slr and bosower remains in place—buyer ‘es hited con over borrower Asignment bas: buyer bas det claim 02 bocower or 90% of oan sles in U.S are done onan assignment bass Seeuriczation : “The proces of isuing secures guinea mse pool Involessome fata ofthe flowing paripants orginso, sponsor, set purchase, ‘ous custodian, sence suctrig age, undersea aw ms, egalatory agencies, ad isk nance counterpart, Derivative Exposure + Curent expe: cox of placing contract vende ire marke: conditon. Pornialexpecie amoune based on Fate + Pack expire: replacement cost under wor case scenaio (Genk) + igh wey poe: pose comelaed with councerpareys cred quality: educes expected cede loses + Wrong ey expr: negate coed with eounerparys cede qual increases expend eeiloues Mean Loss Rates ‘Mean a ate: expected Js on sky bond duet defer sean lis nte= PDI teeing me) irene moon rats whe inves acta ifthey ae renewal because the rte Includes a arial hgh mean las a hat reflects ais premia for scepting te higher defer hey inp for reli isk pring appleions. Suboptimal Loun Recovery Raves Four factors ihalea wo suboptimal behvir by fems wth espe thet booing incl: + Debrarute + Baruning power of the deo: + Excmsv rigs oF conzol by senior deboldre + Presence of oa or more houte Banks ‘The Merton Model Paynencodebholdrs: Dye~mx(Dy~ Ys 0) Payment hacholdens rmax(Yx Dy 0) ‘em Capital Structure in Comess of Option Pricing + Equi issimlare along al option onthe valu of Fi asc where evalu of debt is he ste pce of he option + Debris to kfc Bond and shor [putoption ofthe vale of imi ses whee ice value of eb isthe srk price of the option Credit Scoring Modes 1 Linear disriminant analy: seqrgues 2 large rp inc subgroup, + Parana dicrimincion: we seote function. 1 Kena mighbor:eegoies new ean by how closely it resembles ota ims. Suppor wetr machine :crexes 20 euation that divider age group ita So subgroups Credit Analysis Decision Rules 1 Minima eror: wes Baye? theorem. 4+ Minima rik: minis te probabiy of nissan, + Neymar: Peron weave wii eoncegt of pel and Typed ero. + Mining: misinies the motimur eo of wk Vulnerable Options Option wih defuse recrives promised payment only seller ofthe opcon i sbleto make he payment. ‘alu of vlaetable option = (1-p)e+ pe (Credic Rsk Portfolio Models GrdicMeri: computes the probabily of Aefzle, los given defauls, and correlations SMV’ Paras Manager maltvaie normal Aistbuion fas only one ierorand only ‘computes default lose. Forfolio Rik Tracker: dynamic analysis (eg, Je simulate rifts for pesods within the chosen hasan) Grd ParfoioView :econometic mod the defaul res oF indus sectors Creche: scuail approach predic che proporcon of bligors cat will defi in 2 prtiular sector and inthe porto of inssest. Portfolio Risk Indicators + Expected ay: based on probability, exposure, tnd oes given default B(L;) = EAD, XPD, x60, + Unexpected io: standard deviation ofthe Ira ge pod Wea us MN EST 3S Defaton of Operon Risk “Teri of le duet inadequate o fled proces eras and tes the cannot prow ‘frm fom ouside vent” “The BS dfition focuses onthe impact of operation loss, bu it excludes ered nd marker sks. Chassifications of Operational Risk : Highfregueny lowseeris ELS) rks occur equ br ele in Sal oss Lofigueny,hghsceriy (LEH) sks ae the reste ae of concern for operational ik ‘manages. Because they aerate, dere slide avaiable data wo anaiee such sks, and thes con ‘0 heim could be eaasophic. ‘Top-Down and Bowom-Up Models Topdown model: examines aggregate impact of ‘operaonal falues, macro view, lies 8 historical dit, + Advnages simple us, noe dasincensive + Disadvantages: doesnot distinguish beeween LHELS evens and LFF evens cannot diagnose {pecife ares of wanes baclvard ooking. Bouonexp model: analyzes ik in individu, process + Advantages: dininguishes beween HELS evens + VAR: value oflos, exceaded only 2 certain perce of he tne + Eeonomic capita: amount of capital needed as a bufer o avoid insolvency, + Bypced shorflls expected value ofthe loss given that loss> VAR Ceedit Desivatves Cre dele swap ke insurance; parry sling ‘he proection rexives a fee, pays bazed on swaps notional amount in ce as of dfs Fir defends ya sedres cred es ona basker of loans only firs loan in the basket 10 default wiggrs payment if more chan one oun defals swap only pays on frst default Taal esa swap: otal return on an asset (bond) isexchanged fora fxd lor vaio payments toca ruin teciver ges any appreciation (capital ‘mins and cash flow), pays any deprecation; ‘aymens take place whether or no credit event Buyer of credie derivative exchanges ced rk ‘of isser defaulting forthe combined ssk of the issuer and the derivative counterpary. Credit Spread Options par gayofl,= NP xdurationxmasferedin spread, ~scke spread.0) call payoff, = NPxduration xman(suke spread ~ credit spread,0) Credit a Risk (CAR) “Measures the pores loss in «bond invesiment fiom a change inthe asers credit quality: = NPxox2% VEand LFHS evens can dlagnose weakness in procedures and suggest corrections; forward looking + Disadvascages: complex and das intensive, ‘Methods for Hedging Operational Rsk + Tasurance, + Selfinsurance, + Devatve scares, Catastrophe Options and Bonds Car optons; Publi eradds pyof inked co index (Le, undermiting loses in che insurance ‘industry; spread opson that has imied upside. (Cat bonds: Bond conuacts wick embedded ‘options tac canbe wiggced by internal erent, excernal events, o che value ofan index Economies of Scale and Scope Economie: of ole: average costs of production decline 2s an instication grows. Economie of cope: synergy of producing «wo predict Join rather than each one Independendy: she cost of producing sw0 or mote producs together is es than the sum of the cos of producing each product individually. Daylight Overdraft Risk Dring the day banks are allowed to have ruepive intaday balances on their required reserve accounts witht Fe Ifa bank fllre cocoate while the bak has © Economic Capita) Digna to provide a eason aginst anageaad danse asec confidence lel, Noe tat economic exit > eegulatory pial Risk Adjusted Return on Capital Defined ead ned ern leaded pial expec sven [Fees recurmon } tanfer * (economic cape) price economic piel RAROC “The ARAROC approach addvesses RAROC law of assuming the probability of defuulei Allocating Bconomie Capita * Sedalone mecha eternal ain ae based approsch + Sealing medi incernl data n'a RAROC sppreach * Tnenal eae mead oscnl nd excel dain a busies-unit reurn-ased approach + Marginal eiital method: inceanl data ina ed must absorb the overdraf, which could cause negative ees throughou the financial sycem, Less Data (Operational ik oss data can be cassified into one of five aregories: 1. Bereral out of the disc control ofthe organization 2, Pile. Los ae the direct esl of human 3, Proc Loss fom execution, transition, rocesing, or producing 2 good or sve 4, Relacothip, Risk ead 0 flttonships wich internal groups or exeralreaonships 5. Tebnalgy Loses slated to technology issues. Model Risk “The rise aociated with sing Finacial models to simulate complex celaionships. Souress of ‘model ek includeinconeet model spplicxion, implementation re, calbration eros, programming evors and data problems. Case Seis ‘Mellel shoce-seem furtes contracts used co hedge long-te™ expsare in che perroleum maskets; ack-and-rol edging ftrategy macking ro market on Fature caused huge ath ow problems Suomitoma wader attempted ro comer the copper ‘market by buying large quantities of physical copper and long fatures positions, copper prices plunged, causing huge lose: leon i the lace oF operational andes contol tha allowed thie shee ta gp undetected brsines-unic veluebased approach, + APT meted : exeroal daa is busines-vnie, value-based approach. + Fuiroale etod:nernal and excl da in abusiness-unt, reutn-based approach, Jurieasions fo Banking Regulation * Protect bak deposi rom sin banker. + Provide bly for eanscons. + Avoid domino eft onthe barking system. + Malocain sbi nthe economy Basel I 3 Pils 1. Minimum cpt regiments 2 Supervisory review proces 23. Mite dpi Basel JE Forms of Capita Ther 1 sachs oquy,rsned eas nonredeemabl noacumulativeprefened sock, Tier 2: cumulative prefered stock, pins on LT invesment lon oe eserves Ter3: shorter subordinated deb, an only be ued wo ober market. Borel U: Capital Requirements Sender appoad: Yaaro eel edit ting sessment Anal ring bed (1B) approche: + Foundation: bank eximatesPD. * Advanced: bankeimtes®D, LGD, AD, and M. Long: Teo Capital Management: hedge fund ehac wed relative value strzegiee wth enormous amounts of leverage; when Russia defaulted on its debe in 1998, the increase in eld spreads caused huge losis and ‘norms cashflow probleme frm realuing marking to-marke loses lessons include ele of diversification, mode! risk, leverage. and funding and wading liquidity Beriog): rogue cadet, Nick Leeson, 00k specultive decivaive postions (Nilket 225 supervising selemene operations, allowing him te hide cading loses; lescons include separation of duces and management over Amaranth Adviars lost shout otis of ts value Trades in natural gas futures and opsions appear tobe the most likely cae, The larger than expected los was probably used by liquidity problems. The cate pots out how tisk measures should include iquidiy ris, Enterprise Rsk Management “he framework of ERM isa 4-sep process: Susp 1 Dereemine the fms sk appetice Sup 2:Bsimate che amount of eapital needed to suppor the desiced level of isk ‘Sup 3: Determine the optimal combination of capital and rs hat achieves che eazgee cred cating Sip & Decenaliae the oanagerent of isk, Basel Ht Operstional Risk * Basic indizatr approach: capital charge sessed on a frmvide base, + Standardized approach: banks divide activites arnong busines lines capital eharge~ sum for exch business ie + Advenced meazarament approach: banks ise cei own meshodologles for assessing operational rk Capital Management “Tae problem of capital adequacy for financial conglomerates ca be resolved by determining + Ponflasngle-facror risk + The bisines unl croseis facto, Rik fecoreacoss che busines une at che holding corapan level ISBN 1-60373.013-3 wm) Us. $29.00, (©2007 Schweser Study Prograra. [ARights Reserved.