Business Finance 2 Dersi 7. Ünite Sorularla Öğrenelim

e milestones are the 1988 regulation on capital adequacy by the Basel Committee, the release of RiskMetrics^TM Technical Document by JP Morgan in 1994, and the release of Basel-II by the Basel Committee in 2000.

The fascinating progress and development of risk management has been the meeting point of several disciplines, among which are statistics, computer science, and econometrics.

There is no uniform definition, but generally, it is defined as the probability of facing loss or unintended consequences. Here is the definition Cecchetti and Schoenholtz propose: Risk is a measure of uncertainty about the future payoff an investment, assessed over a particular time horizon and relative to a benchmark. To rephrase the definition, we can say that, from a financial perspective, risk is the degree of uncertainty about the return of future net cash flows generated from a particular investment.

Market risk can be defined as the risk related to a financial institution’s financial condition resulting from unexpected market movements in the price level of certain risk factors. These risk factors can be categorized into four main classes: equity prices, commodity prices, foreign exchange rates, and interest rates.

The first three series of banking regulations, namely, Basel I and Fisher Report were all set by the Basel Committee on Bank Supervision (BCBS), which provides recommendations on banking regulations in regard to credit risk and market risk. The purpose of the accords and following amendments is to ensure that financial institutions have enough capital on account to meet their obligations and absorb unexpected losses.

These are a market risk, credit risk, operational risk, and liquidity risk.

With the Basel documentations, the risks have been categorized into two main groups; banks’ activities have been separated into the trading book and the banking book; the former refers to market risk components, and the latter, to credit risk.

With the evolution of the Basel-II, a new set of risks, called operational risk, was added to the regulation.

According to the Basel Committee, market risk is defined as the risk of losses arising from movements in market prices.

To compare the definition of VaR and ES, we can say that the former asks the question ‘how bad can things get (with a pre-specified probability level on a single day)?’, while the latter answers the question ‘if things get worse, what is our expected loss?’.

Operational risk is simply any event that disrupts the normal ow of business processes and which generates financial loss or damage to the image of the bank (although the latter outcome has been explicitly excluded from the definition of the Basel Committee, still remains as a major concern).

In finance, it should be defined in statisticians’ terms: Mean value of returns. The expected return from this perspective is the weighted sum of expected returns with associated probabilities.

One of the widely used methods is to construct an efficient portfolio. However, we should always bear in mind that certain risks cannot be eliminated by diversifying.

VaR answers the question: how much can I lose with x % probability over a given time horizon.

Methods used for the calculation of VaR differ in their broad methodology and the assumptions they make. But most broadly used ones are, variance-covariance, historical simulation, Monte Carlo simulation, and extreme value theory.

The Group of irty’s (1993) excellent definition of financial derivatives is: “In the most general terms, a derivatives transaction is a bilateral contract or payments exchange agreement whose value derives, as its name implies, from the value of an underlying asset or underlying reference rate or index. Today, derivatives transactions cover a broad range of “underlying”—interest rates, exchange rates, commodities, equities, and other indices”.