In a previous article, we introduced the
CFA Institute Investment Foundation Program (Read
more here). It is a free program
designed for anyone who wants to enter or advance within the investment
management industry, including IT, operations, accounting, administration, and
marketing. Candidates who successfully
pass the online exam earn the CFA Institute Investment Foundations Certificate.
There are total of 20 Chapters in 7
modules, covering all the essential topics in finance, economics, ethics and
regulations. This series of articles
will highlight the core knowledge of each chapter.
Chapter 18 provides an overview of the risk
management. The learning outcome of chapter 18 is as follows:
·
Define
risk and identify types of risk;
·
Define
risk management;
·
Describe
a risk management process;
·
Describe
risk management functions;
·
Describe
benefits and costs of risk management;
·
Define
operational risk and explain how it is managed;
·
Define
compliance risk and explain how it is managed;
·
Define
investment risk and explain how it is managed;
·
Define
value at risk and describe its advantages and weaknesses.
Operational risk is the risk of losses
from inadequate or failed people, systems, and internal policies and
procedures, as well as from external events that are beyond the control of the
company but that affect its operations. The reduction of operational risk
requires companies to manage people to reduce human failures ranging from
unintentional errors to fraudulent activities; manage systems, particularly IT
and communication systems, and ensure compliance with internal policies and
procedures; and manage political, legal, and settlement risks.
One example of operational risk that has
a human component and that is more frequent in the financial services industry
than in any other industry is rogue trading. Rogue trading refers to situations
wherein traders bypass management controls and place unauthorised trades, at
times causing large losses for the companies they work for. Rogue trading may
involve fraudulent trading that is done for personal enrichment or to make up
losses. Exhibit 1 lists a number of rogue trading incidents that occurred in
the past.
Compliance risk is the risk that a
company fails to comply with all applicable rules, laws, and regulations. The
company may face sanctions and damage to its reputation as a result of
non-compliance. Examples of key compliance risks that have the potential to
inflict serious damage on investment firms and their employees include
corruption, inadequate tax reporting, insider trading, and money laundering.
Investment risks take different forms
depending on the company’s investments and operations. Investment firms
typically experience: market risk, caused by changes in market conditions
affecting prices; credit risk, caused by borrowers’ inability and/or
unwillingness to make timely payments of interest and principal; and liquidity
risk, caused by difficulties in buying or selling assets or securities quickly
without a significant concession in price.
Value at risk, which provides an
estimate of the minimum loss of value that can be expected for a given period
of time with a given probability, is a widely-used metric to measure risk. By
relying on historical data and making assumptions about the distribution of
returns, VaR suffers from weaknesses that are typical of all measures that rely
on models.
Although most companies in the
investment industry have dedicated risk management functions, it is important
to remember that risk is not just the responsibility of the risk management
team—everyone is a risk manager. So, even if you are not a risk management
specialist, you should still seek to understand risk management process,
systems, and tools and participate in risk management activities in your
organisation.
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