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Concentration Risk
CONCENTRATION RISK is a banking term denoting the overall spread of a bank's outstanding accounts over the number or variety of debtors to whom the bank has lent money. This risk is calculated using a "concentration ratio" which explains what percentage of the outstanding accounts each bank loan represents. For example, if a bank has 5 outstanding loans of equal value each loan would have a concentration ratio of .2; if it had 3, it would be .333. Various other factors enter into this equation in real world applications, where loans are not evenly distributed or are heavily concentrated in certain economic sectors . A bank with 10 loans, valued at 10 dollars a piece would have a concentration ratio of .10; but if 9 of the loans were for 1 dollar, and the last was for 50, the concentration risk would be considerably higher
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Bank Loan
In finance, a LOAN is the lending of money from one individual, organization or entity to another individual, organization or entity. A loan is a debt provided by an entity (organization or individual) to another entity at an interest rate , and evidenced by a promissory note which specifies, among other things, the principal amount of money borrowed, the interest rate the lender is charging, and date of repayment. A loan entails the reallocation of the subject asset (s) for a period of time, between the lender and the borrower. In a loan, the borrower initially receives or borrows an amount of money , called the principal, from the lender, and is obligated to pay back or repay an equal amount of money to the lender at a later time. The loan is generally provided at a cost, referred to as interest on the debt , which provides an incentive for the lender to engage in the loan
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Debtor
A DEBTOR is an entity that owes a debt to another entity. The entity may be an individual, a firm, a government, a company or other legal person . The counterparty is called a creditor . When the counterpart of this debt arrangement is a bank , the debtor is more often referred to as a borrower . If X borrowed money from his/her bank , X is the debtor and the bank is the creditor . If X puts money in the bank , X is the creditor and the bank is the debtor. It is not a crime to fail to pay a debt. Except in certain bankruptcy situations, debtors can choose to pay debts in any priority they choose. But if one fails to pay a debt, they have broken a contract or agreement between them and a creditor. Generally, most oral and written agreements for the repayment of consumer debt - debts for personal, family or household purposes secured primarily by a person's residence - are enforceable
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Economic Sector
One classical breakdown of economic activity distinguishes three sectors: * Primary : involves the retrieval and production of raw materials, such as corn, coal, wood and iron. (A coal miner, farmer or fisherman would be workers in the primary sector.) * Secondary : involves the transformation of raw or intermediate materials into goods e.g. manufacturing steel into cars, or textiles into clothing. (A builder and a dressmaker would be workers in the secondary sector.) * Tertiary : involves the supplying of services to consumers and businesses, such as baby-sitting, cinema and banking. (A shopkeeper and an accountant would be workers in the tertiary sector.)In the 20th century, economists began to suggest that traditional tertiary services could be further distinguished from "quaternary " and quinary service sectors
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Economic Downturn
In economics, a RECESSION is a business cycle contraction which results in a general slowdown in economic activity. Macroeconomic indicators such as GDP (gross domestic product), investment spending, capacity utilization , household income, business profits, and inflation fall, while bankruptcies and the unemployment rate rise. In the United Kingdom, it is defined as a negative economic growth for two consecutive quarters. Recessions generally occur when there is a widespread drop in spending (an adverse demand shock). This may be triggered by various events, such as a financial crisis , an external trade shock, an adverse supply shock or the bursting of an economic bubble . Governments usually respond to recessions by adopting expansionary macroeconomic policies , such as increasing money supply , increasing government spending and decreasing taxation
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Expected Return
The EXPECTED RETURN (or EXPECTED GAIN) on a financial investment is the expected value of its return (of the profit on the investment). It is a measure of the center of the distribution of the random variable that is the return. It is calculated by using the following formula: E = i = 1 n R i P i {displaystyle E=sum _{i=1}^{n}R_{i}P_{i}} where R i {displaystyle R_{i}} is the return in scenario i {displaystyle i} ; P i {displaystyle P_{i}} is the probability for the return R i {displaystyle R_{i}} in scenario i {displaystyle i} ; and n {displaystyle n} is the number of scenarios. Although this is what one expects the return to be, it only refers to the long-term average. In the short term, any of the various scenarios could occur
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Bank
A BANK is a financial institution that accepts deposits from the public and creates credit . Lending
Lending
activities can be performed either directly or indirectly through capital markets . Due to their importance in the financial stability of a country, banks are highly regulated in most countries. Most nations have institutionalized a system known as fractional reserve banking under which banks hold liquid assets equal to only a portion of their current liabilities. In addition to other regulations intended to ensure liquidity, banks are generally subject to minimum capital requirements based on an international set of capital standards, known as the Basel Accords . Banking
Banking
in its modern sense evolved in the 14th century in the prosperous cities of Renaissance Italy but in many ways was a continuation of ideas and concepts of credit and lending that had their roots in the ancient world
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Default (finance)
In finance , DEFAULT is failure to meet the legal obligations (or conditions) of a loan , for example when a home buyer fails to make a mortgage payment, or when a corporation or government fails to pay a bond which has reached maturity . A national or sovereign default is the failure or refusal of a government to repay its national debt. The biggest private default in history is Lehman Brothers
Lehman Brothers
with over $600,000,000,000 when it filed for bankruptcy in 2008 and the biggest sovereign default is Greece
Greece
with $138,000,000,000 in March 2012
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Margining Risk
MARGINING RISK is a financial risk that future cash flows are smaller than expected due to the payment of margins , i.e. a collateral as deposit from a counterparty to cover some (or all) of its credit risk . It can be seen as a short-term liquidity risk , a quantity called MaR can be used to measure it. METHODOLOGYIn order to decrease the risk of a counter party to default , a technique called portfolio margining is applied, which simply means that the assets within a portfolio are clustered and sorted by the descending projected net loss, e.g. calculated by a pricing model. One can then determine for which cluster(s) one wants to perform margin calls . REFERENCES * ^ Reucroft, Miles. "Portfolio Margining Risk vs. Reward". TABB Forum. Retrieved 14 December 2015. * ^ "Portfolio Margining Risk Disclosure Statement" (PDF). optionsexpress.com. Charles Schwab. Retrieved 18 December 2015
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Operational Risk Management
The term OPERATIONAL RISK MANAGEMENT (ORM) is defined as a continual cyclic process which includes risk assessment, risk decision making, and implementation of risk controls, which results in acceptance, mitigation, or avoidance of risk. ORM is the oversight of operational risk , including the risk of loss resulting from inadequate or failed internal processes and systems; human factors ; or external events. CONTENTS * 1 Four principles of ORM * 2 Three levels of ORM * 3 ORM process * 3.1 In depth * 3.2 Deliberate * 3.3 Time critical * 4 Benefits of ORM * 5 Chief Operational Risk Officer * 6 ORM software * 7 See also * 8 References * 8.1 General * 8.2 Cited * 9 External links FOUR PRINCIPLES OF ORMThe U.S
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Financial Risk Modeling
FINANCIAL RISK MODELING refers to the use of formal econometric techniques to determine the aggregate risk in a financial portfolio . Risk modeling is one of many subtasks within the broader area of financial modeling . Risk modeling uses a variety of techniques including market risk , value at risk (VaR), historical simulation (HS), or extreme value theory (EVT) in order to analyze a portfolio and make forecasts of the likely losses that would be incurred for a variety of risks. Such risks are typically grouped into credit risk , liquidity risk , market risk , and operational risk categories. Many large financial intermediary firms use risk modeling to help portfolio managers assess the amount of capital reserves to maintain, and to help guide their purchases and sales of various classes of financial assets
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Market Portfolio
MARKET PORTFOLIO is a portfolio consisting of a weighted sum of every asset in the market, with weights in the proportions that they exist in the market, with the necessary assumption that these assets are infinitely divisible . Richard Roll 's critique (1977) states that this is only a theoretical concept, as to create a market portfolio for investment purposes in practice would necessarily include every single possible available asset, including real estate, precious metals, stamp collections, jewelry, and anything with any worth, as the theoretical market being referred to would be the world market. There is some question of whether what is used for the market portfolio really matters. Some authors say that it does not make a big difference; you can use any old index and get similar results. Roll gave an example where different indexes produce much different results, and that by choosing the index you can get any ranking you want
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Price Area Risk
An ELECTRICITY PRICE AREA is a zone throughout which the electricity is traded at the same spot price on a power exchange . An electricity price area are decided by transmission system operator and can be a whole country, or parts of it. EPADS AND PRICE AREA RISKThe electricity price usually differs from the system price from one price area to another, e.g. when there are constraints in the transmission grid. A special contract for difference called ELECTRICITY PRICE AREA DIFFERENTIALS or EPAD allows members on the power exchange to hedge against this market risk called AREA PRICE RISK. SEE ALSO * Nord Pool Spot * Nordic energy market * Electricity sector in Sweden * Electricity sector in Norway REFERENCES * ^ "Bidding areas". Nordpool Spot. Retrieved 15 December 2015. * ^ "Electricity Price Area Differentials". Nasdaq. Retrieved 15 December 2015
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Holding Period Risk
HOLDING PERIOD RISK is a financial risk that a firm's sales quote giving a potential retail client a certain time to sign the offer for a commodity , will actually be a financial disadvantage for the offering firm since the market price 's on the wholesale market has changed. The risk is usually reduced by a risk premium being added onto the wholesale price of a commodity by the offering firm. An alternative and less general definition is: Holding period risk is the risk, while holding a bond , that a better opportunity will present itself that you may be unable to act upon. REFERENCES * ^ "Glossary: Holding period risk". Interactive Brokers LLC. Retrieved 2015-12-14. * v * t * e Financial risk and financial risk management CATEGORIES CREDIT RISK * Concentration risk * Consumer credit risk * Credit derivative * Securitization MARKET RISK * Commodity risk (e.g
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Volume Risk
VOLUME RISK is a commodity risk which refers to the fact that a player in the commodity market has uncertain quantities of consumption or sourcing, i.e. production of the respective commodity. Examples of other circumstances which can cause large deviations from a volume forecast are weather (e.g. temperature-changes for gas consumption), the plant-availability, the collective customer outrage, but also regulatory interventions. EXAMPLEA electricity retailer cannot accurately predict the demand of all house holds for a given time which is why the producer cannot forecast the precise time that a power plant will provide more electricity that consumed, even if the plant always delivers the same output of energy . REFERENCES * ^ Kandl, Peter; Studer, Gerold (January 2001). "Factoring in volume risk". Risk magazine: 84f. Retrieved 23 October 2015
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Basis Risk
BASIS RISK in finance is the risk associated with imperfect hedging . It arises because of the difference between the price of the asset to be hedged and the price of the asset serving as the hedge, or because of a mismatch between the expiration date of the hedge asset and the actual selling date of the asset (calendar basis risk), or—as in energy—due to the difference in the location of the asset to be hedged and the asset serving as the hedge (locational basis risk). CONTENTS * 1 Definition * 2 Examples * 3 References * 3.1 Notes * 3.2 See also * 3.3 External links DEFINITIONUnder these conditions, the spot price of the asset, and the futures price, do not converge on the expiration date of the future. The amount by which the two quantities differ measures the value of the basis risk. That is, Basis = Futures price of contract - Spot price of hedged asset
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