Review of the Major Risk Types Market Risk –Sensitivity to the parameters of our pricing functions Credit Risk –Probability that the other side fails to live up to a contract Liquidity Risk –Not enough funds on hand to manage daily cash management needs Operational Risk –System failures, human mistakes Reputation Risk –Are we doing the right thing? Ethics matter. Fraud –Sometimes people do bad things

Questions a Risk Manager May Ask… How sensitive am I to interest rate changes? –Fed action Fed tightening/easing FOMC desk “Quantitative Easing” –Supply and demand –The market’s view : “implied” future interest rate environment How exposed am I to a particular Issuer? –They may request a bank loan and we want to know how much debt they have outstanding How is my risk distributed in my trading book? –By rating, by maturity bucket, by issuer What does history tell us about what to expect in the future? –VaR :“Value a Risk” How much capital should I have on hand for a rainy day (VaR is an input) What extreme moves should I test for (that may not have already happened)? –Stress testing vs. “expected” moves How do I know I have just the right amount of capital (not too much)?

Questions a Risk Manager May Ask (cont.) Are we net long or short, and where in the term structure? How did my risk profile change during the day, from yesterday, last week, last month? –“Position” Pnl –“New business” (trading activity from beginning of day to close of day) –Risk of new portfolio - where did risk change come from? Which position(s)? How much PnL did I realize? –Realized vs.. unrealized PnL –Mark to Market Does the desk have a view?

Historical VaR & Stress Testing -What does this mean: “95% 1 day VaR is $1mm” -What is VaR primarily used for? -Limitations of VaR -Run pricing scenarios on total book and calculate total risk: -All yields by +10, +50, +100, +150, +200 basis points -All yields by -10, -50, -100, -150, -200 basis -Tilt up and down (flattener/steepener) -Need historical data to calculate day over day P&L changes -We will treat these as pricing scenarios applied to our trading book today -Full re-val VaR vs stored sensitivity approximation