def. Risk is related to the uncertainty in payment back when giving a loan.
- Example of a riskless investment is investing into the bank upto the federal deposit insurance (~$100K)
- Types of risk include:
- Credit Risk (=counterparty risk): the counterparty can fail to make the payment
- Interest Risk: the market interest rate might change
- Inflation Risk: the inflation is high so the money isn’t worth much
- Increased cash flow frequency usually means less risk.
def. Risk in finance is equivalent to Standard Deviation in mathematics.
- Risk is proportional to the duration of investment (See bond yield curve).
Banks broadly have teams to manage:
- Market Risk. How market changes will affect the bank’s positions
- Credit Risk.