Exam 2

Question 1

Operational Risk

Answer 1

The risk of loss resulting from inadequate or failed internal processes, people, systems or external events.

Question 2

Liquidity Risk

Answer 2

a financial institution cannot meet its financial obligations without incurring significant losses.

Question 3

Types of Liquidity Risk

Answer 3

1) Liquidity Trading Risk - the sale of assets in the market
2) Liquidity Funding Risk - meeting funding needs without adverse financial effects
- managed by maintaining reserves, borrowing capacity, and diversifying funding sources

Question 4

Cost of Liquidation

Answer 4

considers the potential impact of forced sales in stressed markets, where quick asset sales often lead to losses.

Question 5

Liquidity-Adjusted Value at Risk (LVaR)

Answer 5

adjusts VaR by factoring in these liquidation costs, providing a more accurate picture of potential losses under liquidity stress.

Question 6

Regular Liquidity Ratios

Answer 6

1) Liquidity Coverage Ratio - Requires sufficient high-quality assets to withstand a 30-day stress period

2) Net Stable Funding Ratio - Ensures that banks maintain stable funding over a one-year period, relative to their asset holdings

Question 7

Liquidity Black Holes

Answer 7

Market participants attempting to sell assets simultaneously, using market liquidity and amplifying price drops.

• Positive feedback mechanisms, such as stop-loss orders, can intensify these effects during crises.

Question 8

Managing Operational and Liquidity Risk

Answer 8

1) Operational Risk: Set strong internal controls, conduct regular risk assessments, and educate employees on risk management.

2) Liquidity Risk: Maintain liquid assets, diversify funding sources, and monitor regulatory liquidity ratios.