financial risk management discussion
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Those are discussion for financial risk management. See attachments for articles needed for discussion 9 and 10. Each discussion need about 150-200 words. No format needed.
Credit risk mitigation always comes at a cost. Deciding whether a credit risk mitigation strategy is cost-effective requires determining if the reduction in revenue caused by the cost of credit risk mitigation in a contract, commitment, financial instrument or portfolio is justified by the reduction in credit risk exposure achieved by the mitigation strategy. Following an example provided by the instructor, you will be asked to provide two examples, one of a credit risk mitigation strategy which is cost-effective and one that is not. You will also be asked to comment on the examples submitted by your fellow students.
Example: A bank holds a $100 million 5-year corporate loan outstanding to a firm that has an external credit rating of “A+”. The loan is partially secured by marketable securities with a current value of approximately $50 million. The firm’s risk manager is considering executing a 5 year Credit Default Swap for $100 million notional that will cost approximately $1 million per year in premium payments. This is an example of a non-cost effective hedge because; a) the probability of default for an “A+” rated firm is typically very low (e.g. < 0.25%) and b) the loan is already 50% secured by collateral so executing a CDS on the full $100 million value of the loan doesn’t appear reasonable. As such, the firm would likely be paying $5 millions of total CDS premium to insure a loan position that will be paid in full with a very high degree of certainty based on historical default rates. While still probably not necessary, a more cost effective hedge would be to do buy CDS protection on a much smaller amount (say $25-$50 million) to cover the unsecured portion.
Using the Northern Rock event discussed in Wednesday’s class, please provide an example(s) of a concept we discussed during the lecture that is illustrated by the Northern Rock saga and how this example contributed to the bank’s liquidity problems or could have been avoided by management taking a different action. If you read the article very carefully there are numerous such examples.
Why are Liquidity stress tests critical for financial firms? Following an example of Deutsche Bank Risk Reports (Page 77 – 80) which I’ll provide, you will be asked to state your opinion, explain your reasoning and give an example that supports it.