Learning objectives: Describe the changes to the Basel framework for calculating market risk capital under the Fundamental Review of the Trading Book (FRTB) and the motivations for these changes. Compare the various liquidity horizons proposed by the FRTB for different asset classes and explain how a bank can calculate its expected shortfall using the various horizons. Explain the FRTB revisions to Basel regulations in the following areas: Classification of positions in the trading book compared to the banking book; Backtesting, profit and loss attribution, credit risk, and securitizations.
Questions:
23.8.1. In 2009, the Basel Committee on Banking Supervision (BCBS) reacted quickly to the global financial crisis (GFC) with revisions to Basel's market risk framework, aka Basel 2.5. However, these were known to be temporary measures that would await the holistic changes contained in the Fundamental Review of the Trading Book (FRTB). Development of the FRTB occupied several years, and implementation continues a full decade after the original consultation was published in 2012. Both Basel 2.5 and the FRTB give firms two approaches in their calculation of market risk capital: a standardized approach (SA) and an internal model approach (IMA).
Each of the following statements is true about the FRTB, except which is FALSE?
a. Under the SA, the FRTB's capital requirement is the sum of three components: a sensitivities-based (e.g., delta, vega) charge; the default risk capital (DRC) requirement; and the residual risk add-on (RRAO)
b. Under the IMA, Basel 2.5's 10-day liquidity horizon was replaced with FRTB's various asset-class specific liquidity horizons up to 120 days
c. Under the IMA, Basel 2.5's estimate of a 99.0% (normal and stressed) value at risk (VaR) was replaced by the FRTB's 97.5% stressed expected shortfall (ES)
d. Under neither the SA nor the IMA does FRTB require charges for any credit-related risk exposures, including credit spread risk or jump-to-default risk, because instead, those exposures must be charged under the capital requirements for credit risk, aka CRE20 to CRE99
23.8.2. In order to determine which exposures are subject to credit or market risk capital requirements, Acme Bank has classified its instruments into either the trading book or the banking book. Below are classifications of eight instruments (or positions):
Trading book
a. All eight are clearly wrongly classified
b. Two are probably wrong, but the other six are correctly classified
c. Three are probably correct, but the other five are wrongly classified
d. All eight are probably classified correctly
23.8.3. Consider an exposure with a value of $30.0 million. In L(+)/P(-) format, its expected loss is 4.0% with volatility of 15.0%; i.e., μ(L/P) = +4.0%, σ = 15.0%. Conveniently, the exposure happens to have a normal distribution. Which is nearest to the single-period 97.5% expected shortfall (ES)?
a. 6.60 million
b. 9.38 million
c. 11.72 million
d. 14.50 million
Answers here:
Questions:
23.8.1. In 2009, the Basel Committee on Banking Supervision (BCBS) reacted quickly to the global financial crisis (GFC) with revisions to Basel's market risk framework, aka Basel 2.5. However, these were known to be temporary measures that would await the holistic changes contained in the Fundamental Review of the Trading Book (FRTB). Development of the FRTB occupied several years, and implementation continues a full decade after the original consultation was published in 2012. Both Basel 2.5 and the FRTB give firms two approaches in their calculation of market risk capital: a standardized approach (SA) and an internal model approach (IMA).
Each of the following statements is true about the FRTB, except which is FALSE?
a. Under the SA, the FRTB's capital requirement is the sum of three components: a sensitivities-based (e.g., delta, vega) charge; the default risk capital (DRC) requirement; and the residual risk add-on (RRAO)
b. Under the IMA, Basel 2.5's 10-day liquidity horizon was replaced with FRTB's various asset-class specific liquidity horizons up to 120 days
c. Under the IMA, Basel 2.5's estimate of a 99.0% (normal and stressed) value at risk (VaR) was replaced by the FRTB's 97.5% stressed expected shortfall (ES)
d. Under neither the SA nor the IMA does FRTB require charges for any credit-related risk exposures, including credit spread risk or jump-to-default risk, because instead, those exposures must be charged under the capital requirements for credit risk, aka CRE20 to CRE99
23.8.2. In order to determine which exposures are subject to credit or market risk capital requirements, Acme Bank has classified its instruments into either the trading book or the banking book. Below are classifications of eight instruments (or positions):
Trading book
- Listed equities
- Hedge funds
- Crude oil option contracts with 30-day maturity
- Instruments in a correlation trading portfolio
- Unlisted equities
- Real estate holdings
- Mortgage loans extended to customers of the bank
- Instruments resulting from market-marketing activities
a. All eight are clearly wrongly classified
b. Two are probably wrong, but the other six are correctly classified
c. Three are probably correct, but the other five are wrongly classified
d. All eight are probably classified correctly
23.8.3. Consider an exposure with a value of $30.0 million. In L(+)/P(-) format, its expected loss is 4.0% with volatility of 15.0%; i.e., μ(L/P) = +4.0%, σ = 15.0%. Conveniently, the exposure happens to have a normal distribution. Which is nearest to the single-period 97.5% expected shortfall (ES)?
a. 6.60 million
b. 9.38 million
c. 11.72 million
d. 14.50 million
Answers here:
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