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“Wall Street is a street that begins in a graveyard and ends in a river.”

“Wall Street is a street that begins in a graveyard and ends in a river.”. Anonymous. Interest Rate Risk. The impact of unanticipated changes in interest rates on the FI’s market value. Arises from mismatched maturities.

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“Wall Street is a street that begins in a graveyard and ends in a river.”

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  1. “Wall Street is a street that begins in a graveyard and ends in a river.” Anonymous Saunders & Cornett, Financial Institutions Management, 4th ed.

  2. Interest Rate Risk • The impact of unanticipated changes in interest rates on the FI’s market value. • Arises from mismatched maturities. • FIs typically issue longer term assets to finance funds deficit units and obtain shorter term liabilities to offer claims to funds surplus units. So: typically FIs face refinancing risk – the risk of rolling over borrowed funds over the longer life of the asset investment. Saunders & Cornett, Financial Institutions Management, 4th ed.

  3. Market Risk • The impact of unanticipated changes in exchange rates, securities prices and interest rates on the FIs’ market value. • Interest rate risk can be considered a subtopic under market risk. • Arises in both the trading book and the more stable banking book. Saunders & Cornett, Financial Institutions Management, 4th ed.

  4. Credit Risk • The impact of unanticipated changes in cash flows on the FIs’ market value. • McKinsey estimates that 60% of FIs’ risk emanates from credit risk exposure. • Loan charge-offs: deduction for lack of repayment of either principal or interest. Saunders & Cornett, Financial Institutions Management, 4th ed.

  5. Operational Risk • Risk of loss caused by failures in operational processes or the systems that support them, including those adversely affecting reputation, legal enforcement of contracts and claims. • Includes strategic and business risks. Not limited to technology/backoffice failures. • Example: Arthur Andersen’s shredding of Enron documents. Catastrophic operational risk can end life of firm. Saunders & Cornett, Financial Institutions Management, 4th ed.

  6. Off-Balance Sheet Risk • The impact of unanticipated shocks resulting from contingent assets & liabilities • May be due to credit risk – ex. Default triggers letter of credit guarantee or perfomance bond. • May be due to market risk – ex. Exchange rate or interest rate swap payments. • May be due to operational risk – ex. Cat options. Saunders & Cornett, Financial Institutions Management, 4th ed.

  7. Other Risks • Country or Sovereign Risk: repayments from foreign borrowers and access to foreign assets may be blocked by foreign governments. (ex. Argentina’s 2001 default) • Liquidity Risk: Sudden surges in liability withdrawals may require losses as FI liquidates illiquid assets at firesale prices. • Insolvency Risk: Capital may be insufficient to absorb losses due to other risk events. • Interaction across Risks Saunders & Cornett, Financial Institutions Management, 4th ed.

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