CiNii Books - Financial risk manager handbook

An essential guide to financial risk management as well as the only way to ace the GARP FRM Exam The Financial Risk Management Exam (FRM Exam) was developed by the Global Association of Risk Professionals (GARP) as a means of establishing an industry standard of minimum professional competence in the field. It is given annually in November for risk professionals who want to earn FRM certification. Authored by renowned financial risk management guru Phillipe Jorion, with the full support of the GARP, this is the definitive guide for those preparing to take the FRM Exam. With the help of questions (and solutions) taken from previous exams, Jorion coaches readers on quantitative methods, capital markets, and market, credit, operational, and risk management concepts and assessment techniques. In addition to being the indispensable guide for those aspiring to FRM certification, Financial Risk Manager Handbook also serves as a valued working reference for risk professionals. Phillipe Jorion, PhD (Irvine, CA), is a Professor of Finance at the Graduate School of Management at UC Irvine. He has also taught at Columbia University, Northwestern University, the University of Chicago, and the University of British Columbia.

Table of Contents

Preface
Introduction
Part I: Quantitative Analysis
Ch. 1: Bond Fundamentals
1.1 Discounting, Present, and Future Value
1.2 Price-Yield Relationship
1.2.1 Valuation
1.2.2 Taylor Expansion
1.2.3 Bond Price Derivatives
1.2.4 Interpreting Duration and Convexity
1.2.5 Portfolio Duration and Convexity
1.3 Answers to Chapter Examples
Ch. 2: Fundamentals of Probability
2.1 Characterizing Random Variables
2.1.1 Univariate Distribution Functions
2.1.2 Moments
2.2 Multivariate Distribution Functions
2.3 Functions of Random Variables
2.3.1 Linear Transformation of Random Variables
2.3.2 Sum of Random Variables
2.3.3 Portfolios of Random Variables
2.3.4 Product of Random Variables
2.3.5 Distributions of Transformations of Random Variables
2.4 Important Distribution Functions
2.4.1 Uniform Distribution
2.4.2 Normal Distribut ion
2.4.3 Lognormal Distribution
2.4.4 Student's Distribution
2.4.5 Binomial Distribution
2.5 Answers to Chapter Examples
Ch. 3: Fundamentals of Statistics
3.1 Real Data
3.1.1 Measuring Returns
3.1.2 Time Aggregation
3.1.3 Portfolio Aggregation
3.2 Parameter Estimation
3.3 Regression Analysis
3.3.1 Bivariate Regression
3.3.2 Autoregression
3.3.3 Multivariate Regression
3.3.4 Example
3.3.5 Pitfalls with Regressions
3.4 Answers to Chapter Examples
Ch. 4: Monte Carlo Methods
4.1 Simulations with One Random Variable
4.1.1 Simulating Markov Processes
4.1.2 The Geometric Brownian Motion
4.1.3 Simulating Yields
4.1.4 Binomial Trees
4.2 Implementing Simulations
4.2.1 Simulation for VAR
4.2.2 Simulation for Derivatives
4.2.3 Accuracy
4.3 Multiple Sources of Risk
4.3.1 The Cholesky Factorization
4.4 Answers to Chapter Examples
Part II: Capital Markets
Ch. 5: Introduction to Derivatives
5.1 Overview of Derivatives Markets
5.2 Forward Contracts
5.2.1 Definition
5.2.2 Valuing Forward Contracts
5.2.3 Valuing an Off-Market Forward Contract
5.2.4 Valuing Forward Contracts with Income Payments
5.3 Futures Contracts
5.3.1 Definitions of Futures
5.3.2 Valuing Futures Contracts
5.4 Swap Contracts
5.5 Answers to Chapter Examples
Ch. 6: Options
6.1 Option Payoffs
6.1.1 Basic Options
6.1.2 Put-Call Parity
6.1.3 Combination of Options
6.2 Valuing Options
6.2.1 Option Premiums
6.2.2 Early Exercise of Options
6.2.3 Black-Scholes Valuation
6.2.4 Market vs. Model Prices
6.3 Other Option Contracts
6.4 Valuing Options by Numerical Methods
6.5 Answers to Chapter Examples
Ch. 7: Fixed-Income Securities
7.1 Overview of Debt Markets
7.2 Fixed-Income Securities
7.2.1 Instrument Types
7.2.2 Methods of Quotation
7.3 Analysis of Fixed-Income Securities
7.3.1 The NPV Approach
7.3.2 Duration
7.4 Spot and Forward Rates
7.5 Mortgage-Backed Securities
7.5.1 Description
7.5.2 Prepayment Risk
7.5.3 Financial Engineering and CMOs
7.6 Answers to Chapter Examples
Ch. 8: Fixed-Income Derivatives
8.1 Forward Contracts
8.2 Futures
8.2.1 Eurodollar Futures
8.2.2 T-bond Futures
8.3 Swaps
8.3.1 Definitions
8.3.2 Quotations
8.3.3 Pricing
8.4 Options
8.4.1 Caps and Floors
8.4.2 Swaptions
8.4.3 Exchange-Traded Options
8.5 Answers to Chapter Examples
Ch. 9: Equity Markets
9.1 Equities
9.1.1 Overview
9.1.2 Valuation
9.1.3 Equity Indices
9.2 Convertible Bonds and Warrants
9.2.1 Definitions
9.2.2 Valuation
9.3 Equity Derivatives
9.3.1 Stock Index Futures
9.3.2 Single Stock Futures
9.3.3 Equity Options
9.3.4 Equity Swaps
9.4 Answers to Chapter Examples
Ch. 10: Currencies and Commodities Markets
10.1 Currency Markets
10.2 Currency Swaps
10.2.1 Definitions
10.2.2 Pricing
10.3 Commodities
10.3.1 Products
10.3.2 Pricing of Futures
10.3.3 Futures and Expected Spot Prices
10.4 Answers to Chapter Examples
Part III: Market Risk Management
Ch. 11: Introduction to Market Risk Measurement
11.1 Introduction to Financial Market Risks
11.2 VAR as Downside Risk
11.2.1 VAR: Definition
11.2.2 VAR: Caveats
11.2.3 Alternative Measures of Risk
11.3 VAR: Parameters
11.3.1 Confidence Level
11.3.2 Horizon
11.3.3 Application: The Basel Rules
11.4 Elements of VAR Systems
11.4.1 Portfolio Positions
11.4.2 Risk Factors
11.4.3 VAR Methods
11.5 Stress-Testing
11.6 Cash Flow at Risk
11.7 Answers to Chapter Examples
Ch. 12: Identification of Risk Factors
12.1 Market Risks
12.1.1 Absolute and Relative Risk
12.1.2 Directional and Nondirectional Risk
12.1.3 Market vs. Credit Risk
12.1.4 Risk Interaction
12.2 Sources of Loss: A Decomposition
12.2.1 Exposure and Uncertainty
12.2.2 Specific Risk
12.3 Discontinuity and Event Risk
12.3.1 Continuous Processes
12.3.2 Jump Process
12.3.3 Event Risk
12.4 Liquidity Risk
12.5 Answers to Chapter Examples
Ch. 13: Sources of Risk
13.1 Currency Risk
13.1.1 Currency Volatility
13.1.2 Correlations
13.1.3 Devaluation Risk
13.1.4 Cross-Rate Volatility
13.2 Fixed-Income Risk
13.2.1 Factors Affecting Yields
13.2.2 Bond Price and Yield Volatility
13.2.3 Correlations
13.2.4 Global Interest Rate Risk
13.2.5 Real Yield Risk
13.2.6 Credit Spread Risk
13.2.7 Prepayment Risk
13.3 Equity Risk
13.3.1 Stock Market Volatility
13.3.2 Forwards and Futures
13.4 Commodity Risk
13.4.1 Commodity Volatility Risk
13.4.2 Forwards and Futures
13.4.3 Delivery and Liquidity Risk
13.5 Risk Simplification
13.5.1 Diagonal Model
13.5.2 Factor Models
13.5.3 Fixed-Income Portfolio Risk
13.6 Answers to Chapter Examples
Ch. 14: Hedging Linear Risk
14.1 Introduction to Futures Hedging
14.1.1 Unitary Hedging
14.1.2 Basis Risk
14.2 Optimal Hedging
14.2.1 The Optimal Hedge Ratio
14.2.2 The Hedge Ratio as Regression Coefficient
14.2.3 Example
14.2.4 Liquidity Issues
14.3 Applications of Optimal Hedging
14.3.1 Duration Hedging
14.3.2 Beta Hedging
14.4 Answers to Chapter Examples
Ch. 15: Nonlinear Risk: Options
15.1 Evaluating Options
15.1.1 Definitions
15.1.2 Taylor Expansion
15.1.3 Option Pricing
15.2 Option "Greeks"
15.2.1 Option Sensitivities: Delta and Gamma
15.2.2 Option Sensitivities: Vega
15.2.3 Option Sensitivities: Rho
15.2.4 Option Sensitivities: Theta
15.2.5 Option Pricing and the "Greeks"
15.2.6 Option Sensitivities: Summary
15.3 Dynamic Hedging
15.3.1 Delta and Dynamic Hedging
15.3.2 Implications
15.3.3 Distribution of Option Payoffs
15.4 Answers to Chapter Examples
Ch. 16: Modeling Risk Factors
16.1 The Normal Distribution
16.1.1 Why the Normal?
16.1.2 Computing Returns
16.1.3 Time Aggregation
16.2 Fat Tails
16.3 Time-Variation in Risk
16.3.1 GARCH
16.3.2 EWMA
16.3.3 Option Data
16.3.4 Implied Distributions
16.4 Answers to Chapter Examples
Ch. 17: VAR Methods
17.1 VAR: Local vs. Full Valuation
17.1.1 Local Valuation
17.1.2 Full Valuation
17.1.3 Delta-Gamma Method
17.2 VAR Methods: Overview
17.2.1 Mapping
17.2.2 Delta-Normal Method
17.2.3 Historical Simulation Method
17.2.4 Monte Carlo Simulation Method
17.2.5 Comparison of Methods
17.3 Example
17.3.1 Mark-to-Market
17.3.2 Risk Factors
17.3.3 VAR: Historical Simulation
17.3.4 VAR: Delta-Normal Method
17.4 Risk Budgeting
17.5 Answers to Chapter Examples
Part IV: Credit Risk Management
Ch. 18: Introduction to Credit Risk
18.1 Settlement Risk
18.1.1 Presettlement vs. Settlement Risk
18.1.2 Handling Settlement Risk
18.2 Overview of Credit Risk
18.2.1 Drivers of Credit Risk
18.2.2 Measurement of Credit Risk
18.2.3 Credit Risk vs. Market Risk
18.3 Measuring Credit Risk
18.3.1 Credit Losses
18.3.2 Joint Events
18.3.3 An Example
18.4 Credit Risk Diversification
18.5 Answers to Chapter Examples
Ch. 19: Measuring Actuarial Default Risk
19.1 Credit Event... 412
19.2 Default Rates
19.2.1 Credit Ratings
19.2.2 Historical Default Rates
19.2.3 Cumulative and Marginal Default Rates
19.2.4 Transition Probabilities
19.2.5 Predicting Default Probabilities
19.3 Recovery Rates
19.3.1 The Bankruptcy Process
19.3.2 Estimates of Recovery Rates
19.4 Application to Portfolio Rating
19.5 Assessing Corporate and Sovereign Rating
19.5.1 Corporate Default
19.5.2 Sovereign Default
19.6 Answers to Chapter Examples
Ch. 20: Measuring Default Risk from Market Prices
20.1 Corporate Bond Prices
20.1.1 Spreads and Default Risk
20.1.2 Risk Premium
20.1.3 The Cross-Section of Yield Spreads
20.1.4 The Time-Series of Yield Spreads
20.2 Equity Prices
20.2.1 The Merton Model
20.2.2 Pricing Equity and Debt
20.2.3 Applying the Merton Model
20.2.4 Example
20.3 Answers to Chapter Examples
Ch. 21: Credit Exposure
21.1 Credit Exposure by Instrument
21.2 Distribution of Credit Exposure
21.2.1 Expected and Worst Exposure
21.2.2 Time Profile
21.2.3 Exposure Profile for Interest-Rate Swaps
21.2.4 Exposure Profile for Currency Swaps
21.2.5 Exposure Profile for Different Coupons
21.3 Exposure Modifiers
21.3.1 Marking to Market
21.3.2 Exposure Limits
21.3.3 Recouponing
21.3.4 Netting Arrangements
21.4 Credit Risk Modifiers
21.4.1 Credit Triggers
21.4.2 Time Puts
21.5 Answers to Chapter Examples
Ch. 22: Credit Derivatives
22.1 Introduction
22.2 Types of Credit Derivatives
22.2.1 Credit Default Swaps
22.2.2 Total Return Swaps
22.2.3 Credit Spread Forward and Options
22.2.4 Credit-Linked Notes
22.3 Pricing and Hedging Credit Derivatives
22.3.1 Methods
22.3.2 Example: Credit Default Swap
22.4 Pros and Cons of Credit Derivatives
22.5 Answers to Chapter Examples
Ch. 23: Managing Credit Risk
23.1 Measuring the Distribution of Credit Losses
23.2 Measuring Expected Credit Loss
23.2.1 Expected Loss over a Target Horizon
23.2.2 The Time Profile of Expected Loss
23.3 Measuring Credit VAR
23.4 Portfolio Credit Risk Models
23.4.1 Approaches to Portfolio Credit Risk Models
23.4.2 CreditMetrics
23.4.3 CreditRisk+
23.4.4 Moody's KMV
23.4.5 Credit Portfolio View
23.4.6 Comparison
23.5 Answers to Chapter Examples
Part V: Operational and Integrated Risk Management
Ch. 24: Operational Risk
24.1 The Importance of Operational Risk
24.1.1 Case Histories
24.1.2 Business Lines
24.2 Identifying Operational Risk
24.3 Assessing Operational Risk
24.3.1 Comparison of Approaches
24.3.2 Acturial Models
24.4 Managing Operational Risk
24.4.1 Capital Allocation and Insurance
24.4.2 Mitigating Operational Risk
24.5 Conceptual Issues
24.6 Answers to Chapter Examples
Ch. 25: Risk Capital and RAROC
25.1 RAROC
25.1.1 Risk Capital
25.1.2 RAROC Methodology
25.1.3 Application to Compensation
25.2 Performance Evaluation and Pricing
25.3 Answers to Chapter Examples
Ch. 26: Best Practices Reports
26.1 The G-30 Report
26.2 The Bank of England Report on Barings
26.3 The CRMPG Report on LTCM
26.4 Answers to Chapter Examples
Ch. 27: Firmwide Risk Management
27.1 Types of Risk
27.2 Three-Pillar Framework
27.2.1 Best-Practice Policies
27.2.2 Best-Practice Methodologies
27.2.3 Best-Practice Infrastructure
27.3 Organizational Structure
27.4 Controlling Traders
27.4.1 Trader Compensation
27.4.2 Trader Limits
27.5 Answers to Chapter Examples
Part VI: Legal, Accounting, and Tax Risk Management
Ch. 28: Legal Issues
28.1 Legal Risks with Derivatives
28.2 Netting
28.2.1 G-30 Recommendations
28.2.2 Netting under the Basel Accord
28.2.3 Walk-Away Clauses
28.2.4 Netting and Exchange Margins
28.3 ISDA Master Netting Agreement
28.4 The 2002 Sarbanes-Oxley Act
28.5 Glossary
28.5.1 General Legal Terms
28.5.2 Bankruptcy Terms
28.5.3 Contract Terms
28.6 Answers to Chapter Examples
Ch. 29: Accounting and Tax Issues
29.1 Internal Reporting
29.1.1 Purpose of Internal Reporting
29.1.2 Comparison of Methods
29.1.3 Historical Cost versus Marking-to-Market
29.2 External Reporting: FASB
29.2.1 FAS 133
29.2.2 Definition of Derivative
29.2.3 Embedded Derivative
29.2.4 Disclosure Rules
29.2.5 Hedge Effectiveness
29.2.6 General Evaluation of FAS 133
29.2.7 Accounting Treatment of SPEs
29.3 External Reporting: IASB
29.3.1 IAS 37
29.3.2 IAS 39
29.4 Tax Considerations
29.5 Answers to Chapter Examples
Part VII: Regulation and Compliance
Ch. 30: Regulation of Financial Institutions
30.1 Definition of Financial Institutions
30.2 Systemic Risk
30.3 Regulation of Commercial Banks
30.4 Regulation of Securities Houses
30.5 Tools and Objectives of Regulation
30.6 Answers to Chapter Examples
Ch. 31: The Basel Accord
31.1 Steps in The Basel Accord
31.1.1 The 1988 Accord
31.1.2 The 1996 Amendment
31.1.3 The New Basel Accord
31.2 The 1988 Basel Accord
31.2.1 Risk Capital
31.2.2 On-Balance-Sheet Risk Charges
31.2.3 Off-Balance-Sheet Risk Charges
31.2.4 Total Risk Charge
31.3 Illustration
31.4 The New Basel Accord
31.4.1 Issues with the 1988 Basel Accord
31.4.2 The New Basel Accord: Credit Risk Charges
31.4.3 Securitization and Credit Risk Mitigation
31.4.4 The Basel Operational Risk Charge
31.5 Answers to Chapter Examples
31.6 Further Information
Ch. 32: The Basel Market Risk Charges
32.1 The Standardized Method
32.2 The Internal Models Approach
32.2.1 Qualitative Requirements
32.2.2 The Market Risk Charge
32.2.3 Combination of Approaches
32.3 Stress-Testing
32.4 Backtesting
32.4.1 Measuring Exceptions
32.4.2 Statistical Decision Rules
32.4.3 The Penalty Zones
32.5 Answers to Chapter Examples
Index

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