Bionic Turtle’s Week in Risk — Ending January 15th

David Harper CFA FRM

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Jan 18, 2017 · 8 min read

New FRM Practice Questions:

• P1.T1.702. Getting up to Speed on the Financial Crisis (Gorton) https://www.bionicturtle.com/forum/threads/p1-t1-702-getting-up-to-speed-on-the-financial-crisis-gorton.10092/
• P1.T1.703. Policy responses and real effects of global financial crisis (Gorton) https://www.bionicturtle.com/forum/threads/p1-t1-703-policy-responses-and-real-effects-of-global-financial-crisis-gorton.10099/

• P2.T6.702. Credit rating assignment methodologies (De Laurentis) https://www.bionicturtle.com/forum/threads/p2-t6-702-credit-rating-assignment-methodologies-de-laurentis.10097/
• P2.T6.703 Structural versus Reduced-form credit risk approaches (DeLaurentis) https://www.bionicturtle.com/forum/threads/p2-t6-703-structural-versus-reduced-form-credit-risk-approaches-delaurentis.10102/

In the forum this week

• Forum member, berrymucho, expertly answers the question, What is an optimal sample size for estimation of the Sharpe ratio? This is awesome! https://www.bionicturtle.com/forum/threads/issues-calculated-sharpe-ratio-information-ratio-beta-and-alpha.10070/page-2#post-47581
• Trying to explain Meissner’s example of the first correlation-related crisis in May 2005 (downgrade of General Motors and Ford) https://www.bionicturtle.com/forum/threads/meissners-correlation-related-crisis-chapter-1.10111/#post-47639
• Basis https://www.bionicturtle.com/forum/threads/basis-risk-strengthening-weaking.7623/#post-47640
• Forum member, Anuragh20, is looking for recommendations for Financial Modelling certification(s) https://www.bionicturtle.com/forum/threads/financial-modeling.9613/page-2#post-47611
• VaR mapping can be analytical (partial derivative) or estimated by regression https://www.bionicturtle.com/forum/threads/l2-t5-61-value-at-risk-var-mapping.3613/#post-47560
• Forum member, Yvanko, asks how relevant (to the exam) are Diebold’s difficult chapters on time series forecasting (reading 15) https://www.bionicturtle.com/forum/threads/is-r15-t1-important-for-the-exam-it-is-very-theoretical.10105/
• Trying to explain the specifics of Jorion’s VaR backtest and the implications of varying the cutoff https://www.bionicturtle.com/forum/threads/l2-t5-57-value-at-risk-var-backtest.3602/#post-47586

• In case you missed it, a mistake in the FRM handbook that gets caught pretty much ever year (Helman Bank and the total return swap) https://www.bionicturtle.com/forum/threads/total-return-swap-fall-in-asset-value.10107/

Bank and banking

• It’s Asset Managers’ Turn to Sweat https://www.bloomberg.com/gadfly/articles/2017-01-13/bank-earnings-wall-street-hands-off-struggles-to-asset-managers

• How banks avoid extinction https://www.finextra.com/blogposting/13554/how-banks-avoid-extinction
• Take on Payments (Retail Payments Risk Forum) The Year in Review http://takeonpayments.frbatlanta.org/2017/01/the-year-in-review.html
• You Don’t Want What Wells Fargo Is Selling. What Should It Do Now? https://www.nytimes.com/2017/01/13/your-money/you-dont-want-what-wells-fargo-is-selling-what-should-it-do-now.html

Political and regulatory risk, including systemic risk (including BIS)

• The Office of Financial Research (OFR) 2016 Annual Research Review https://www.dropbox.com/s/hesju1tbzlzosdt/ofr-2016-review.pdf

• What does FRTB or Fundamental Review of trading book really mean? http://iconvexity.com/what-does-frtb-or-fundamental-review-of-trading-book-really-mean/
• CECL — The new FASB accounting rule to capture expected credit losses http://iconvexity.com/cecl-the-new-fasb-accounting-rule-to-capture-expected-credit-losses/
• Do lenders of last resort actually make the financial system safer? https://ftalphaville.ft.com/2017/01/12/2182238/do-lenders-of-last-resort-actually-make-the-financial-system-safer/

Case Studies and Companies, including Strategic or Reputation risk

• F.B.I. Arrests Volkswagen Executive on Conspiracy Charge in Emissions Scandal http://www.nytimes.com/2017/01/09/business/volkswagen-diesel-emissions-investigation-settlement.html?ref=business&_r=0

Financial reporting, including Accounting and Audit

• SEC Guidance on “New GAAP” Transition Disclosures and Non-GAAP Measures https://corpgov.law.harvard.edu/2017/01/14/sec-guidance-on-new-gaap-transition-disclosures-and-non-gaap-measures/
• International Standards for the Professional Practice of Internal Auditing, Revised Standards effective January 1st, 2017 https://na.theiia.org/standards-guidance/mandatory-guidance/Pages/Standards.aspx

Technology, including FinTech and Cybersecurity

• Insurers tap cyber security ratings to limit liabilities (New breed of start-ups aims to assess strength of companies’ defences against hackers) https://www.ft.com/content/1cfd5d28-c26f-11e6-81c2-f57d90f6741a “A new generation of cyber security start-ups is trying to solve this problem of a widespread attack, helping insurers analyse the risk of writing cyber security policies for individual companies, how to price them and how to balance their portfolio so they do not accidentally insure the cyber equivalent of all the houses in Florida. With the market for cyber insurance predicted to grow to more than $20bn by 2025, according to forecasts by Allianz, insurers are looking for help to understand the fast-changing threat from hackers.”
• Cybersecurity risk: a definition https://www.bitsighttech.com/blog/cybersecurity-risk-thorough-definition “Risk is commonly defined as threat times vulnerability times consequence. This formula applies to anything that could be exposing you to danger, but when applied to cybersecurity — the unique risks individuals and businesses face as a result of using interconnected technological systems — it provides us with a great deal of insight on risk mitigation.”
• Coinbase and the IRS https://medium.com/@barmstrong/coinbase-and-the-irs-c4e2e386e0cf#.52fr7qv24
• The Regtech Revolution: Compliance and Wealth Management in 2017 https://blogs.cfainstitute.org/investor/2017/01/12/the-regtech-revolution-compliance-and-wealth-management-in-2017/
• Life Insurers Draw on Data, Not Blood (Life insurers are making it easier to get policies online, often waiving medical exam and instead relying on data)http://www.wsj.com/articles/the-latest-gamble-in-life-insurance-sell-it-online-1484217026

• Oscar is disrupting health care in hurricane https://backchannel.com/oscar-is-disrupting-health-care-in-a-hurricane-65480bfed940#.4i9npfioc

Natural Science, including Climate and Energy

• Second-Warmest Year in U.S. Weather History, and Among the Wettest https://www.wunderground.com/blog/JeffMasters/secondwarmest-year-in-us-weather-history-and-among-the-wettest

Exams, Financial Associations (GARP, FRM, CFA Institute) and Careers, including CRO Interviews

• CNN Money says Risk Management Director is the 2nd Best Job in America! http://money.cnn.com/gallery/pf/2017/01/05/best-jobs-2017/2.html “The job has evolved in recent years to be about more than just natural disasters. Directors are now also tasked with identifying, preventing, and planning for all the risks a company might face, from cybersecurity breaches to a stock market collapse.”
• Certified in Entity and Intangible Valuations™ (CEIV™) http://www.appraisers.org/credentials/ceiv-certification see: Financial Groups Roll Out New Valuation Standard http://blogs.wsj.com/cfo/2017/01/10/financial-groups-roll-out-new-valuation-standard/
• Seven Chief Risk Officer Priorities for 2017 https://www.finextra.com/blogposting/13543/7-chief-risk-officer-priorities-for-2017 I really like this list. “Cybersecurity was the conference future risk scenario of choice, but details of measuring it and bank mitigation were vague.”

Personal finance

• America’s Fastest-Growing Loan Category [PACE loans] Has Eerie Echoes of Subprime Crisis (Lenders offering energy-conscious loans care little about borrowers’ creditworthiness, contractors function as loan brokers — and investors can’t get enough) http://www.wsj.com/articles/americas-fastest-growing-loan-category-has-eerie-echoes-of-subprime-crisis-1484060984 “Creditworthiness matters little to lenders, because loans are based on the value of a homeowner’s property. PACE loans typically require no down payment, and the debt is added to property-tax bills as an assessment.” More about PACE here at https://energy.gov/eere/slsc/property-assessed-clean-energy-programs

Other

• Latest memo from Howard Marks: Expert Opinion https://www.oaktreecapital.com/insights/howard-marks-memos The summary by Barry Ritholtz https://www.bloomberg.com/view/articles/2017-01-13/pundits-facts-and-the-future

Risk Foundations(FRM P1.T1)

• The World Economic Forum’s [aka, Davos] Global Risks Report 2017 https://www.weforum.org/reports/the-global-risks-report-2017 But yikes they missed some big ones last year! https://ftalphaville.ft.com/2017/01/11/2182215/on-the-efficacy-of-wef-risk-reports/
• Allianz Risk Barometer 2017 http://www.agcs.allianz.com/insights/white-papers-and-case-studies/allianz-risk-barometer-2017/

• Here’s what really caused the housing crisis http://www.cbsnews.com/news/heres-what-really-caused-housing-crisis/

Financial Markets and Products, including Interest Rates, Commodity Risk, and Foreign Exchange (FX)(FRM P1.T3)

• Bond investors rebel against weaker deal terms (Covenant clause that could hit bondholders has appeared in at least a dozen sales) https://www.ft.com/content/f79ac888-d7bb-11e6-944b-e7eb37a6aa8e “Bondholders typically reap a premium if a company decides to pay off its debts before they are due. So-called make-whole redemptions compensate investors for missed earnings when a bond is retired earlier than promised, and the value is often spelt out explicitly in prospectuses. The make-whole claims extend to breaches of covenants, which can occur if a group’s debt surpasses certain levels or if a dividend is paid in excess of the bond document’s stipulations, triggering a technical default.”

• Understanding Futures Transaction Flow — Basic Introduction https://www.finextra.com/blogposting/13551/understanding-futures-transaction-flow—basic-introduction

• Bond Covenants and Skeptic Skepticism https://www.bloomberg.com/view/articles/2017-01-12/bond-covenants-and-skeptic-skepticism

Market risk, including Equity Risk (FRM P1.T5)

• Ten Things You Can’t Learn From a Backtest http://awealthofcommonsense.com/2017/01/10-things-you-cant-learn-from-a-backtest/

Credit risk (FRM P1.T6)

• Justice Department and State Partners Secure Nearly $864 Million Settlement With Moody’s Arising From Conduct in the Lead up to the Financial Crisis https://www.justice.gov/opa/pr/justice-department-and-state-partners-secure-nearly-864-million-settlement-moody-s-arising Here is the statement of facts https://www.dropbox.com/s/3b5qriv3uo6dddj/moodys_statement_of_facts.pdf
• Trends in Arbitrage-Based Measures of Bond Liquidity http://libertystreeteconomics.newyorkfed.org/2017/01/trends-in-arbitrage-based-measures-of-bond-liquidity.html “The CDS-bond basis is the difference between the CDS spread and the implied spread on the bond. Arbitrage refers to the fact that the spread of the bond should equal the CDS spread for the same firm if they represent only the firm’s default risk. In practice, the basis is generally not zero. One interpretation of this basis is that it measures the liquidity of the cash bond market relative to the CDS market; when one market is more liquid than the other, investors will accept a lower spread as compensation for the greater liquidity.”
• Credit Market Arbitrage and Regulatory Leverage http://libertystreeteconomics.newyorkfed.org/2017/01/credit-market-arbitrage-and-regulatory-leverage.html “The SLR [supplementary leverage ratio of 3.0%] increases the costs to a dealer of a negative CDS-cash basis trade because it modifies how off-balance-sheet items, including credit derivatives and repo transactions, are accounted for in the denominator of the ratio.”

Investment risk, including Pensions (FRM P1.T8)

• It’s 2017: Do You Know Where Your Risk Is? https://blog.thinknewfound.com/2017/01/2017-know-risk/ “To create a portfolio risk decomposition, we take the index returns (excess of the risk-free rate) of our target portfolio and regress them on a number of common risk factors, including: Global equity returns, Yield curve level changes, Yield curve slope changes, Credit spread changes, and Dollar index returns. This regression tells us the beta that our index has to each of these factors, as well as any return that is unexplained by them.”

Current issues (FRM P2.T9)

• Report on sterling “flash event” released by the Markets Committee http://www.bis.org/press/p170113.htm