Pass 2016-FRR Exam Guide

Economic capital is a risk measure used by banks to determine the amount of capital they need to hold to remain solvent and cover potential losses:

Internal Risk Estimates: Unlike regulatory capital, which is determined by external regulatory requirements, economic capital is based on the bank's own risk assessment models and internal estimates of potential losses.

Risk Types: It considers a range of risks including credit risk, market risk, operational risk, and other financial risks that the bank might face.

Purpose: The goal is to ensure the bank has enough capital to absorb unexpected losses and to maintain confidence among depositors and investors.

Therefore, economic capital is a measure of the potential losses based on the bank's internal risk estimates.References: How Finance Works, detailed discussions on economic capital and risk management​​.

Value-at-Risk (VaR) can be calculated using either parametric or non-parametric methods. Parametric methods, such as the variance-covariance approach, typically assume that returns follow a normal distribution. This assumption simplifies the calculations but may not always accurately reflect the true distribution of returns, especially in the presence of skewness and kurtosis.

On the other hand, non-parametric methods, such as historical simulation or Monte Carlo simulation, do not make any assumptions about the distribution of returns. Instead, they rely on actual historical return data or simulated data to estimate the VaR, allowing for more flexibility and potentially more accurate risk assessments in cases where the return distributions deviate significantly from normality.

Option delta (Δ) is a measure used in finance to indicate the sensitivity of an option's price to the price of the underlying asset. Specifically, it represents the rate of change of the option's value with respect to changes in the price of the underlying instrument. It is a fundamental concept in options trading and risk management.

References:

Standard definition from options theory.

Activities typically used to develop an operational risk framework include planning, training, and auditing. Marketing is not typically used to develop an operational risk framework, as it is more relevant to the promotion of products and services rather than the establishment of risk management processes and structures.References:Operational risk framework development activities.