Financial Risk and Regulation 2016-FRR Book

By selling off the lower risk portions of the portfolio credit risk, Delta Bank can increase its cash efficiency. This process generates cash which can be reinvested or used for other purposes, effectively improving the return on equity (ROE).

The overall risk exposure of the bank is reduced as the lower risk assets are sold off, leaving a more concentrated higher-risk portfolio, which still needs to be managed effectively.

References:

How Finance Works: "Securitization and selling lower risk assets can increase cash efficiency and return on equity by reducing the overall exposure to risk."

During the second quarter of 2009, transactions in foreign exchange derivative contracts comprised approximately 7% of all types of derivative transactions between financial institutions in the United States. This data point reflects the proportion of foreign exchange derivatives within the broader context of derivative transactions during that period.

Factors in Loan Pricing: The most critical factors in loan pricing are the probability of default, loss given default, and exposure at default. These directly impact the risk assessment and pricing strategies for loans.

Less Significant Factor: The duration of default, while relevant, is less significant compared to the immediate risk factors. It primarily affects the timing rather than the magnitude of potential losses.

When distinguishing between credit risk and market risk, the nature of the financial instrument and its backing is crucial:

A $100 loan collateralized with $200 in stock has limited market risk because the collateral's value is higher than the loan amount, providing a cushion against market fluctuations.

An uncollateralized obligation issued by a large bank linked to the performance of the Nikkei 225 Index has high market risk due to its dependency on the stock market’s performance and high credit risk due to the lack of collateral and reliance on the issuer's creditworthiness.