Over the past few years, operational risk has gained much attention in the financial services industry. This is partially because many of the largest losses in the financial industry have their roots in the failure of operational risk. As the financial technology becomes more and more advanced, and the industry moves further towards globalization, the

# PRM Exam III

## Bond Duration and Convexity Simplified – Part 2 of 2

As we learnt in part 1, the duration, as measured by the slope of the curve, changes as yields change. The slope of the curve is steeper (and the duration is larger) at low yield levels, and becomes flatter (and the duration becomes smaller) at high yield levels. This property is called convexity. Convexity is

## Major Types of Return Measures

For the purpose of portfolio construction, the financial assets are primarily looked at from the perspective of risk and returns. Based on the analysis of risk and returns we analyse thousands of securities and portfolio combinations before making the right selection for our own portfolio. Therefore, it is important that we have a deeper understanding

## Mitigation of Market Risk in Fund Management

To control and have methods to offset market risk is tough and complex. Fund managers cannot always fully estimate the impact of the market risk on their portfolios. 9/11 was an event that no one had ever envisaged. Yet, it happened, forever changing the way risk was viewed. Tim East, the Director of Corporate Risk

## Market Risk Management in Fund Management

Several individuals have a higher appetite for risk and seek higher returns. Typically they entrust their funds with one kind of fund or the other. The funds that have lesser controls and are considered more risky are called hedge funds. These funds contrary to their name are considered more risky than most. The managers of

## What does the Market Risk Department Do?

Market risk is unavoidable but not unmanageable. Market risk tends to occur when an unpredictable turn of events such as fluctuation in exchange rates, fluctuations in the prices of traded assets and commodities lead to a change in the value of financial instruments held by a firm. Assessing market risk is not unlike predicting the

## Types of Operational Risk

The financial institutions encounter a variety of operational risks on a daily basis. It’s important that businesses are able to identify these risks and the losses incurred from them. The Basel Committee on Banking Supervision (BCBS) collected operational risk loss data and classified the losses in terms of eight business lines and seven loss event

## Impact of Volatility Clustering on Value at Risk

We have seen that volatility clustering is a common phenomenon observed in financial data. This has serious implications for how risk managers calculate VaR for their portfolios to be adequately covered. We know that financial markets are characterized by unexpected information and shocks. When a market shock happens, the volatility in prices of financial assets

## Models of Volatility Clustering: EWMA and GARCH(1,1)

Volatility clustering is one of the most important characteristics of financial data, and incorporating it in our models can produce a more realistic estimate of risk. Volatility clustering is evident from the fact that today’s volatility is positively correlated with yesterday’s volatility. So, if yesterday observed high volatility, today also we are likely to observe

## VaR Calculation: The Assumptions of Standard Distribution

While calculating VaR using one of the statistical models, we make many assumptions, one of them is that the asset returns are i.i.d. normally distributed. This means that just like a coin toss, each return is an independent draw from the normal distribution. However, in reality, there is empirical evidence that the financial data is