In this episode of FinPod, we discuss the recently released Market Risk Fundamentals course with insights from the Vice President of Content at CFI. We provide an in-depth look at key processes, such as measuring market risk through the standard deviation of returns and calculating value at risk (VAR). Listeners will learn how these concepts are put to practice in the real world, with examples from major banks and their daily operations to manage market risk exposure.

We also preface the history of VAR, tracing its origins from the late 1980s with Risk Metrics and its adoption by industry giants like JP Morgan. We explore why the financial industry and regulators transitioned from traditional volatility measures to VAR, highlighting its robustness and effectiveness in quantifying market risk.

Additionally, the episode previews the upcoming specialization in Risk Management at CFI, designed to equip finance professionals with the skills needed to excel in the field. Tune in to learn more about market risk and the exciting career opportunities it presents.

Transcript

Asim (00:13)
Hello and welcome to the What’s New at CFI podcast. I’m Asim Khan and I’m joined today by my colleague Ryan Spendelow, who’s the vice president of curriculum at CFI. Ryan, welcome to the podcast.

Ryan Spendeow (00:23)
Alright, it’s been nice to see you. It’s a pleasure to be here.

Asim (00:27)
Great to have you. So recently you published a course on market risk.

Ryan Spendeow (00:33)
That’s right. Very exciting.

Asim (00:35)
So very exciting, right? I mean, this is just on the heels of a course you published on Basel III and risk management, and now we have the market risk piece. Can you give us some highlights of what the course covers?

Ryan Spendeow (00:47)
Yeah, sure. So the Market Risk course, the fundamental of Market Risk course, it’s our foundational Market Risk course. And so what we aim to achieve in this particular course is to introduce people to the concept of Market Risk so that they understand exactly what Market Risk is. We then look at how Market Risk is measured. And we look at two fundamental ways really of how Market Risk is measured.

We look at the standard deviation of returns of securities, and we particularly focus on the continuously compounded returns, and we talk about why that’s particularly appropriate. And we also look at the annualized standard deviations of returns. So we also look at how do we standardize these returns. And the other thing that we look at in terms of measuring market risk is we look at value at risk. So in this particular course, we introduce the concept of…

so people can understand exactly what value at risk is. And then we look at a methodology that we can use to calculate value at risk. And we use the parametric approach, which is one of three approaches. And we do that not only for single security positions, like a single equity position, but we also look at how we can calculate value at risk for a simple portfolio, which of course, if you’re out as a working as a market risk analyst, this kind of thing becomes really crucial.

Asim (02:18)
Yeah, and I think you’ve taken the example of several big money center banks using their balance sheets, picking off assets that would present a market risk and then making your risk calculations around those. So I guess the heart of this is this is something that banks have to do, right?

Ryan Spendeow (02:18)
Thank you.

Yeah, every single day. If you’re an investment bank and you’ve got trading desks as part of your daily process, and it’s an absolutely huge task when you think about how large these trading desks are and the size and complexity of the trading desks, calculating value at risk is something that has to be done on a daily basis. It’s a huge job and it’s…

becomes really important because a lot of, as we discuss in the course, as you allude to, some banks have a lot of exposure to market risk because of their business model. Some banks have less exposure to market risk because of their business model. And so we do explore that as well. So yeah, this is a big complex task that banks have to do. And if you’re working as a market risk analyst, this course, or if you aspire to work as a market risk analyst, this course gives you a really good insight as to what that might look like.

Asim (03:37)
No, it certainly does. So could you tell us a little bit about the history of VAR? I remember when it was first being talked about and it came into play. Why did the industry or regulators, I should say, go from just looking at kind of standard measures of volatility to now value at risk or VAR?

Ryan Spendeow (03:58)
Yeah, that’s an excellent question. So VAR was an approach to measuring market risk that came out, I’m going to say in the 1980s, the late 80s by a firm called Risk Metrics, if I recall. People are probably going to Google that and prove me wrong, but it was Risk Metrics, which I think was then acquired by JP Morgan.

Asim (04:18)
Hmm.

Ryan Spendeow (04:26)
And so JP Morgan was actually one of the first banks on the street to actually use value at risk. And the idea about value at risk is thinking about, well, over a given time period using some statistical approaches, what loss could we expect with a given probability over a certain time period?

And that just became a lot more of a robust measure of market risk than say, something like the standard deviations of returns. Now, the standard deviations of returns are used in the calculation of parametric VAR as they’re used in the two other methods of calculating VAR. But regulators soon picked up on the fact that actually, value at risk is a really, is a better way to quantify a bank’s exposure to market risk.

We look at the, when we think about the distribution of returns, the value at risk allows us to look at the tail, the lost tail, which is what we want. And it allows banks to quantify their market risk exposure in a very simple way, coming down to basically a number. How much could we lose with a given amount of, with a certain probability over a certain timeframe?

And from that banks have then calculated, well, based on this, how much capital do we need to hold in order to protect ourselves from market risk? And regulators still soon picked up on the robustness and the appropriateness of value at risk, and they back that into the Basel Accords. And so you see value at risk now being calculated by banks like JP Morgan, like Bank of America, like Goldman Sachs, like Wells Fargo, like all the banks around the world.

Asim (05:47)
Hmm.

Ryan Spendeow (06:16)
Not only for internal management purposes but also because it’s a regulatory requirement.

Asim (06:22)
Right, and then in the case of VAR, I guess banks are just kind of looking at the very highly stressed scenario, right? Tail risk, as we say. Yeah.

Ryan Spendeow (06:31)
Yeah, that’s right. That’s right.

Asim (06:34)
Okay, and I think you’ve done a wonderful job in detailing those calculations in a way that’s pretty simple to follow. So if anybody’s interested in learning about market risk generally and how the calculations are done, please check out Ryan’s course. Ryan, also, we talked a bit offline. This course and Basel 3 are kind of all going to be part and parcel of an eventual specialization in risk at CFI, correct?

Ryan Spendeow (07:01)
That’s right. That’s right. I’m really, really excited. We’re working hard to develop a number of other risk -based courses. And sometime in the foreseeable future, we will have a risk specialization for our learners. So that’s really, really exciting. And risk management is such a crucial part of the modern banking environment. There’s so many fantastic career opportunities for people in risk.

So it’s exciting to see if I can support people that aspire to develop careers at risk, that we can support that by developing our upcoming risk specialisation.

Asim (07:41)
Yeah, it’s kind of ironic that I think the greatest job stability is probably in risk, right? Because risk does not go away.

Ryan Spendeow (07:46)
Yeah. And it’s just, it gets bigger and bigger and more important. I’ve been lucky enough to run training programs over the last few years in a few different investment banks. And I used to be a classroom trainer and I’ve seen these risk programs grow from being kind of like an adjunct to other graduate programs to having their own separate graduate training program.

Chief Risk Officers often come along and present them. So yeah, there’s a lot of really exciting career opportunities for people, for finance professionals to develop a fantastic career in risk management.

Asim (08:31)
Terrific. Well, Ryan, thank you so much for your time today, and we look forward to what else is going to come out under the title of Risk and Risk Management. And we’ll see you next time on the podcast.

Ryan Spendeow (08:43)
Fantastic, thanks Asim for having me.

Asim (08:45)
Thank you.