RAROC, Liquidity Risk & Case Studies

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Hi David,
Troubling you again with confusion in few readings.

§ Crouhy reading "Capital Allocation" & RAROC

§ Culp reading "Liquidity Risk"
what kind of questions are expected in these readings...more precisely how these will be tested?
I dint find Core readings for both neither convincing nor understanding!
Specially I dint understand rationale of Liquidity risk.

§ Reto Gallati - Case Studies
How these "old" case studies will be tested?
Is there any chance questions coming related to Bear Sterns or Lehman Brothers / Merill Lynch!

No screencast/brief tutorial related to OPER RISK so far!!

Thanks!
~Anil

 

[David Harper CFA FRM]

Hi Anil,

In regard to Crouhy, this is dense but mostly (IMO) worth a careful read. The most likely test questions are (i) the RAROC and (ii) the adjusted RAROC. Know both RAROC formulas and, in broad strokes, why the adjusted RAROC solves for the problem of 1st gen RAROC; i.e., the 1st gen RAROC is senstive to (baised by) risky projects and correlation with market. You do not need to explore the methodology (at the end) around the 2nd generation RAROC, just understand the headline. But, in the middle of Crouhy, is basically an approach to calculating (internal) economic capital (i.e., vs regulatory capital). Esp. in regard to market & credit risk, that is testable

In regard to Culp, I do expect this to be tested given the role of liquidity risk in the current credit debacle (e.g., I fully expect the 2009 FRM to expand the liquidity risk topic). I'd say any of the Culp liquidity could be tested. If it helps, you may think of liquidity as a function of time (funding liquidity: "If we had more time, we could collect our receivables and fund our liabilities; market liquidity: "if we had more time, we could sell this instrument at its fair price."). Previously testable items here include:

* definition and interrelationship btwn funding (CFO perspective) and market liquidity (trader)
* liquidity risk metrics
* definitely LVAR (add one half spread)

In regard to case studies, IMO, you can reduce each to (i) the headline root causes and (ii) the prevantative measures that can be taken. A typical question would be, was fraud involved? I don't know of shortcuts thru the cases. Metallgesellshchaft and LTCM are highly testable; do understand the mechanics and flaw in their stack and roll hedge.

Re Bear/Lehman/ML: the 2008 FRM should not test on these current events. They are not "assigned." Further, it would be unlike GARP to try and make instantaneous sense of the events. GARP does solicit test questions (e.g., I will submit the max myself) - so I'd predict the submissions will be influenced but they must still be according to the syllabus. Given events, I would fully expect questions on:

* The subprime securitization reading
* Model risk (Dowd)
* Liquidity risk
* Credit derivatives - CDS, etc
* Hedge funds

In summary (IMO), the current events should not impact your preparation strategy except to remind you that many of the issues are already in the cirriculum. Rather, they will impact 2009 FRM syllabus.

(I will do some brief OpRisk for sure! Thanks for noticing...)

David