P1 T1 foundation of risk (Crouhy)

[Hesham_87]

Hello,
i have several questions concerning first 3 chapters (Crouhy) in foundation of risk (P1 T1).

first 3 chapters deals with a lot of theoretical parts. would please tell me the best way to study such theoretical material? should i memorize all the mentioned points for example?

Moreover, in study notes page 28 highlights risk limit concept. would you please tell me the difference between risk capacity and risk limit and risk tolerance? because i am confused between all of them

i know my questions sound silly. i have just began to prepare for FRM exam. (beginner)

 

[David Harper CFA FRM]

HI @Hesham_87 Welcome! I happen to wholeheartedly agree that Crouhy's first chapters are (too) theoretical; my view is that GARP has somewhat struggled with effective initial readings. I'm not convinced they've ever improved on Jorion's first chapter (here at https://forum.bionicturtle.com/resources/jorion-value-at-risk-var-3rd-edition.13/ ) which prevailed until ~ 2012 as the initial reading. Based on post-exam feedback so far, it does not seem as if these chapters are highly testable (either low or moderate at best). Actually, I think Chapter 3 is almost more useful than 1, 2, and 4. My personal bias (others can disagree) is that you can always come back to these introductions at the end, when the context (especially of the typology) might make sense.

With respect to risk capacity vs tolerance (vs appetite vs. limits), we collected the summary below in 2013 (@Nicole Seaman : if I wanted to start a universal Glossary, where do you think we should put that? maybe in Resources > Foundations?). This was posted at https://forum.bionicturtle.com/threads/risk-appetite.7261/#post-25964 I hope that's helpful!

Risk limits, best found reference at http://value-at-risk.net/risk-limit/

• "Risk limits are a device for authorizing specific forms of risk taking. A pension fund hires an outside investment manager to invest some of its assets in intermediate corporate bonds. The fund wants the manager to take risk on its behalf, but it has a specific form of risk in mind. It doesn’t want the manager investing in equities, precious metals, or cocoa futures. It communicates its intentions with contractually binding investment guidelines. These specify acceptable investments. They also specify risk limits, such as requirements that: the portfolio’s duration always be less than 7 years; all bonds have a credit rating of BBB or better.
  
  The first is an example of a market risk limit; the second of a credit risk limit. When an organization authorizes a risk limit for risk-taking activities, it must specify three things: a risk metric, a risk measure that supports the risk metric, and the limit—a value for the risk metric that is not to be breached."

Risk appetite, various (inconclusive)

• IFC (FRM 2103 assigned): "Risk appetite: The amount of risk an organization is willing to seek or accept in pursuit of its long term objectives."
• Nocco & Stulz (previously assigned in FRM): Essentially, it an articulated probability of maintaining a threshold credit rating; e.g., 98% probability of maintaining at least BBB. "The risk implied by achieving an OPTIMAL credit rating (status), including a minimum probability of maintaining the rating and a maximum probability of default ... "When credit ratings are used as the primary indicator of financial risk, the firm determines an optimal or target rating based on its risk appetite and the cost of reducing its probability of financial distress."
• PWC: "Risk appetite: the quantum of risk that the firm is willing to accept within its overall capacity ... "Defined well, risk appetite translates risk metrics and methods into business decisions, reporting and day-to-day business discussions. It sets the boundaries which form a dynamic link between strategy, target setting and risk management." (source: http://www.pwc.com/en_GX/gx/banking-capital-markets/pdf/risk_appetite.pdf, page 2)
• IRM: "there is very little by way of formal guidance on the definition of risk appetite ... Given the lack of conformity about the meaning of [risk appetite] ... Interestingly ISO31000, the international standard, is silent on the subject of risk appetite (focusing instead on ‘risk attitude’ and ‘risk criteria’), although Guide 73 (ISO, 2002) defines risk appetite as the “amount and type of risk that an organization is willing to pursue or retain." (source:http://www.theirm.org/publications/documents/IRM_Risk_Appetite_Consultation_Paper_Final_Web.pdf, page 14)
• IRM on ISO 31000 / Guide 73 BS31100: "Amount and type of risk that an organization is willing to pursue or retain." BS31100: Amount and type of risk that an is Is prepared to seek, accept or tolerate"

Risk tolerance

• IFC (FRM 2013 assigned): The boundaries of risk taking outside of which the organization is not prepared to venture in the pursuit of long-term objectives. Risk tolerance can be stated in absolutes, for example: “We will not deal with a certain type of customer” or “We will not expose more that X percent of our capital to losses in a certain line of business.”
• IRM: "It is worth noting that in the eyes of some commentators, risk tolerance is the more important concept. While risk appetite is about the pursuit of risk, risk tolerance is about what you can bear."

Risk capacity, my current view is that "capacity" is suggestive of an INDIVIDUAL rather a firm; e.g., it has meaning in CFP. Unclear if distinction between capacity vs. tolerance w.r.t. firm/institutional ERM

• PWC: Risk capacity: the maximum risk that the firm can bear which is linked to capital, liquid assets, borrowing capacity etc

 

[Nicole Seaman]

HI @Hesham_87 Welcome! I happen to wholeheartedly agree that Crouhy's first chapters are (too) theoretical; my view is that GARP has somewhat struggled with effective initial readings. I'm not convinced they've ever improved on Jorion's first chapter (here at https://forum.bionicturtle.com/resources/jorion-value-at-risk-var-3rd-edition.13/ ) which prevailed until ~ 2012 as the initial reading. Based on post-feedback, it does not seem as if these chapters are highly testable (either low or moderate at best). Actually, I think Chapter 3 is almost more useful than 1, 2, and 4. My personal bias (others can disagree) is that you can always come back to these introductions at the end, when the context (especially of the typology) might make sense.

With respect to risk capacity vs tolerance (vs appetite vs. limits), we collected the summary below in 2013 (@Nicole Seaman : if I wanted to start a universal Glossary, where do you think we should put that? maybe in Resources > Foundations?). This was posted at https://forum.bionicturtle.com/threads/risk-appetite.7261/#post-25964 I hope that's helpful!

@David Harper CFA FRM, Yes, I think the forum resources would be a good place to start a glossary within the different sections that we've created (i.e. Foundations, Quant, etc.)

 

[Hesham_87]

Thank you so much