FRM Project

The Project is divided into four sections. Each section is dealing with one type of risk. You are required to
do all of the tasks listed.

Project is divided into the following sections:

Section A: Market Risk

Section B: Credit Risk

Section C: Liquidity Risk

Section D: Risk review

Section E: Operations risk (to be selectively released as makeup assignment if time left and is required)

You are reminded that you will end up with an F grade if you cheat or plagiarize or pay for your
assignment. DO not even give the impression of cheating. Do the assignment individually. You may
discuss issues only with fellow students. Students who have been cheating in the quizzes or have a
history of doing so will be taken to disciplinary committee in addition to the F grade.
 Section C: Liquidity Risk
The project is divided into two sections. The first section requires liquidity risk related calculations,
which will essentially teach you how liquidity risk models are made.

Firstly, open an excel file and save your file with your Liquidity_Market_Risk <space> Name <space> ERP
ID <space> Subject Initials

Task 1 – LCR

Calculating LCR is part of routine activity in order to see if incoming cash flows are sufficient for expected
outflows. Banks list expected inflows and outflows according to expected time in days (see table 1.0 as
an example). This is then used to calculate liquidity needs and availability of the next 30 days based on
certain assumptions (i.e what percent of inflows can be assumed).

Banks also need to calculate stock of high quality liquidity assets (see table 2.0 as an example). This is
done by categorizing assets into various types based on predefined criteria. For your ease, the
categorization has already been done and limited to just two types (i.e high and low). Banks then sort
out high quality assets for use in LCR.

Q1 ) Using the liquidity risk file -sheet LCR and data in table 1.0 and 2.0, calculate the LCR ratio. Assume
max (i)74% (ii)51% and (iii) 24% of inflows to calculate your LCR ratio. Based on your calculations
comment on the liquidity of the institution.

Task 2 – Bank runs

Bank runs can shut banks down. Analyzing stress situations such as bank runs is critical. Various stress
models are built to see if the bank can survive in such a situation

In the liquidity risk file, sheet Bank Run Mini, Table 1.0 shows the balance sheet of a hypothetical bank.
In order to analyse, we map the balance sheet on to Table 2.0., using asset characteristics to divide them
into:

● Cash Assets
● Cash equivalents
● Saleable loans
● Non-saleable loans

The above is just a suggestion and is highly simplified. The purpose of mapping is to see how much
money can be recovered from the liquidation of such assets in a fire sale (a separate exercise is done for
normal sales). Each of the above categories is given a liquidity conversion factor (LCF) based on historical
evidence or market data. Complex models will have more categories/sub categories and will analyze
variations, days to convert and other options.
The conversion factor is multiplied with asset amounts to calculate cash availability (see table 2.0) which
is then used to ascertain post crisis cash. The amounts are then used to see ability to sustain bank runs.

Q2) Using table 1.0 & 2.0, calculate liquidity losses, equity values and remaining asset value. Also
comment if the bank is bankrupt, assuming the following amount of deposits are withdrawn:
1) 105 m (already solved below as an example)
2) 295 m
3) 695 m
4) 850 m
5) 1100 m
For e.g. in (1) losses = 0 (no losses as cash has LCF of 1), equity value = 60(no losses so no changes) ,
remaining asset value = 1380-105= 1275 and bankruptcy- no not yet

Q3) what if the LCF are as following,

Liquidity conversion factor -Fire Sale Liquidity categories

0.95 Cash Assets
0.80 Cash equivalents
0.65 saleable loans
0 Non-saleable loans
Calculate liquidity losses, equity values and remaining asset value. Also comment if the bank is bankrupt,
assuming the following amount of deposits are withdrawn:
1) 100 m
2) 300 m
3) 700 m
4) 1000 m

Since deposits and assets (most of balance sheet) are readily changing the exercise is done on a frequent
basis. Alternatively, percentages are also used for calculations.

Q4) Assuming original data, what percentage of deposit withdrawal will cause a bank run?

Q5) Based on ranges, calculate the relationship between deposit withdrawal percentage and equity loss
percentage?

For e.g.

for 0-95m or 0% to 10% deposit withdrawal (out of total deposits) equity losses are 0m or 0%

For 95-310.6 m or 10% to 32.7% deposit withdrawal (out of total deposits) equity losses are
4.4m or 4.4/55 = 8%
Task 3 GAP analysis

Banks perform a similar exercise for liquidity risk as market risk. This time the idea is to see where
liquidity problems can occur.

Banks sort out asset and liabilities according to buckets and then take out MAGAPs to see liquidity
position for each bucket

Q6) Perform a similar exercise for the following buckets and comment of liquidity position for each

● 1 month
● 2 month
● 3 month
● 3+ to 6 months
● 6+to12 months
● 12+ to 36 months
● 36+ to 120 months
● 120+ to 240 months
● 240+ to 360 months