The Professional Risk Managers’ Handbook

A Comprehensive Guide to Current Theory and Best Practices

___________________________________________________

The Official Handbook for the PRM Designation

2015 Edition
 Table of Contents

PRM  Exam  I  
  FINANCE  THEORY,  FINANCIAL  INSTRUMENTS  AND  FINANCIAL  
MARKETS  
 
PRM  Handbook  Volume  I:  Book  1  –  Financial  Theory  Application  –  2015  Edition  
 
I.A.0  Interest  Rates  and  Time  Value  
I.A.0.1  Compounding  Methods  
I.A.0.2  Interest  Rates:    Nominal,  Periodic,  Continuous,  or  Effective  
I.A.1  Risk  and  Risk  Aversion  
I.A.1.1   Introduction  
I.A.1.2   Mathematical  Expectations:  Prices  or  Utilities?    
I.A.1.3   The  Axiom  of  Independence  of  Choice  
I.A.1.4   Maximizing  Expected  Utility  
I.A.1.5   Encoding  a  Utility  Function  
I.A.1.6   The  Mean–Variance  Criterion  
I.A.1.7   Risk-­‐Adjusted  Performance  Measures  
I.A.1.8   Application:  Choice  of  an  Optimal  Portfolio  and  Assessment  of  its  Risk-­‐
adjusted  Performance  
I.A.1.9   Conclusions  
 
I.A.2  Portfolio  Mathematics  
I.A.2.1   Means  and  Variances  of  Past  Returns  
I.A.2.2   Mean  and  Variance  of  Future  Returns  
I.A.2.3   Mean-­‐Variance  Tradeoffs  
I.A.2.4   Multiple  Assets  
I.A.2.5      A  Hedging  Example  
I.A.2.6   Serial  Correlation  
I.A.2.7   Normally  Distributed  Returns  
 
I.A.3  Capital  Allocation  
I.A.3.1   An  Overview  
I.A.3.2   Mean-­‐Variance  Criterion  
I.A.3.3   Efficient  Frontier:  Two  Risky  Assets  
I.A.3.4   Asset  Allocation  
I.A.3.5   Combining  the  Risk-­‐Free  Asset  with  Risky  Assets  
I.A.3.6   The  Market  Portfolio  and  the  CML  
I.A.3.7   The  Market  Price  of  Risk  and  the  Sharpe  Ratio  
I.A.3.8   Separation  Principle  
I.A.3.9   Summary  
   

2015 © The Professional Risk Managers’ International Association 2

I.A.4  The  CAPM  and  Multifactor  Models  
I.A.4.1   Overview  
I.A.4.2   Capital  Asset  Pricing  Model  
I.A.4.3   Security  Market  Line  
I.A.4.4   Performance  Measures  
I.A.4.5   The  Single-­‐Index  Model  
I.A.4.6   Multifactor  Models  and  the  APT  
I.A.4.7   Summary  
 
I.A.5  Basics  of  Capital  Structure  
I.A.5.1   Introduction  
I.A.5.2   Maximizing  Shareholder  Value,  Incentives,  and  Agency  Costs  
I.A.5.3   Characteristics  of  Debt  and  Equity  
I.A.5.4    Choice  of  Capital  Structure  
I.A.5.5   Making  the  Capital  Structure  Decision  
I.A.5.6   Conclusion  
 
I.A.6  The  Term  Structure  of  Interest  Rates  
I.A.6.1    Yield  Curve  Fundamentals  
I.A.6.2  Curve  Construction  and  Interpolation  Techniques  
I.A.6.3  Theories  of  the  Term  Structure  
I.A.6.4  Term  Structure  Models  
I.A.6.5  Using  Term  Structure  Models  to  Evaluate  Bonds  
I.A.6.6  Summary  and  Conclusions  

PRM  Handbook  -­‐  Volume  I:  Book  2  –  Financial  Instruments  –  2015  Edition  
 
 I.B.1  General  Characteristics  of  Bonds  
I.B.1.1   Definition  of  a  Bullet  Bond  
I.B.1.2   Terminology  and  Convention  
I.B.1.3   Market  Quotes  
I.B.1.4   Non-­‐bullet  Bonds  
I.B.1.5   Summary  
 
I.B.2  The  Analysis  of  Bonds  
I.B.2.1    Features  of  Bonds  
I.B.2.2   Non-­‐conventional  Bonds  
I.B.2.3    Pricing  a  Conventional  Bond  
I.B.2.5   Relationship  between  Bond  Yield  and  Bond  Price  
I.B.2.6   Duration  
I.B.2.7   Hedging  Bond  Positions  
I.B.2.8   Convexity  
I.B.2.9   Summary  of  Market  Risk  Associated  with  Bonds  
 
   

2015 © The Professional Risk Managers’ International Association 3

I.B.3  Forward  and  Futures  Prices  
I.B.3.1.  Pricing  Forward  Contracts  
I.B.3.2.  Dividends,  Storage  Costs,  and  Convenience  Yield  
I.B.3.3.  Commodity  Futures  
I.B.3.4.  Value  of  a  Forward  Contract  
I.B.3.5.  Summary  
 
I.B.4  Uses  of  Futures  and  Forwards  
I.B.4.1   Introduction  
I.B.4.2.  Stock  Index  Futures  
I.B.4.3   Currency  Forwards  and  Futures  
I.B.4.4   Forward  Rate  Agreements  
I.B.4.5   Short-­‐Term  Interest-­‐Rate  Futures  
I.B.4.6  T-­‐bond  Futures  
I.B.4.7  Stack  and  Strip  Hedges  
I.B.4.8   Concluding  Remarks  
 
I.B.5  Swaps  
I.B.5.1  Overview  of  swap  markets  
I.B.5.2  What  is  a  swap?  
I.B.5.3  Terminology  and  Conventions  
I.B.5.4  Types  of  Swaps  
I.B.5.5  Valuation  of  Swaps  
I.B.5.6  Risks  
I.B.5.7  Uses  of  Swaps  
I.B.5.8  Unwinding  Swap  Positions  
I.B.5.9  Documentation  
I.B.5.10  Conclusion  
 
I.B.6  Vanilla  Options  
I.B.6.1   Stock  Options  –  Characteristics  and  Payoff  Diagrams  
I.B.6.2   American  versus  European  Options  
I.B.6.3   Strategies  Involving  a  Single  Option  and  a  Stock  
I.B.6.4   Spread  Strategies  
I.B.6.5   Other  Strategies  
I.B.6.6   Basics  of  Valuing  Options  
I.B.6.7   Binomial  Model  and  the  Riskless  Portfolio  
I.B.6.8   The  Black–Scholes–Merton  Pricing  Formula  
I.B.6.9   The  Greeks  
I.B.6.10  Implied  Volatility  
I.B.6.11  Intrinsic  versus  Time  Value  
 
   

2015 © The Professional Risk Managers’ International Association 4

I.B.7  Credit  Derivatives  
I.B.7.1   Introduction  
I.B.7.2    Credit  Default  Swaps  
I.B.7.3    Credit-­‐Linked  Notes  
I.B.7.4    Total  Return  Swaps  
I.B.7.5    Credit  Options  and  Tranched  Products  
I.B.7.6    Synthetic,  Collateralized  Debt  Obligations  
I.B.7.7    Applications  of  Credit  Derivatives  still  valid  today  
I.B.7.8   Summary  
 
I.B.8  Caps,  Floors,  and  Swaptions  
I.B.8.1   Caps,  Floors,  and  Collars:  Definition  and  Terminology  
I.B.8.2   Pricing  Caps,  Floors,  and  Collars  
I.B.8.3   Uses  of  Caps,  Floors  and  Collars  
I.B.8.4   Swaptions:  Definition  and  Terminology  
I.B.8.5   Pricing  Swaptions  
I.B.8.6   Uses  of  Swaptions  

 
 
PRM  Handbook  Volume  I:  Book  3  –  Financial  Markets

I.C.1  The  Structure  of  Financial  Markets  

I.C.1.1   Introduction  
I.C.1.2   Global  Markets  and  Their  Terminology  
I.C.1.3   Drivers  of  Liquidity  
I.C.1.4   Liquidity  and  Financial  Risk  Management  
I.C.1.5   Structured  finance  and  credit  markets:  Before  and  after  the  crisis  
I.C.1.6   OTC  markets  before  and  after  the  crisis  
I.C.1.7   Post-­‐trade  Processing  
I.C.1.8   Underwriting,  trade  execution,  and  the  technology  of  trading  
I.C.1.9   Conclusion  
 
I.C.2  The  Money  Markets  
I.C.2.1   Introduction  
I.C.2.2   Size  trends  for  the  global  money  market  
I.C.2.3   Investors’  perspectives  
I.C.2.4   Historical  yield  levels  
I.C.2.5   Types  of  money  market  instruments  
I.C.2.6   Yield  conventions  in  the  money  market  
I.C.2.7   LIBOR  as  a  reference  rate  in  the  money  market  
I.C.2.8   Conclusions  
 
   

2015 © The Professional Risk Managers’ International Association 5

I.C.3  Bond  Markets  
I.C.3.1   Introduction  
I.C.3.2   The  Players  
I.C.3.3   Bonds  by  Issuers  
I.C.3.4   The  Markets  
I.C.3.5   Credit  Risk  
I.C.3.6   Summary  
 
I.C.4  Foreign  Exchange  Markets  
I.C.4.1   Introduction  
I.C.4.2   Historical  Perspective  
I.C.4.3   Foreign  Exchange  Market  Structure  
I.C.4.4   Foreign  Exchange  Market  Participants  
I.C.4.5   Foreign  Exchange  Spot  Market  
I.C.4.6          Foreign  Exchange  Risks  
I.C.4.7      Properties  of  FX  Spot  Prices/Returns  and  the  Volatility  of  Foreign  
Exchange  
I.C.4.8   Foreign  Exchange  Forward  Market  
I.C.4.9   Foreign  Exchange  Swaps  and  Cross-­‐Currency  Swaps  
I.C.4.10  Foreign  Exchange  Options  Market  
I.C.4.11  Foreign  Exchange  Exotic  Options  
I.C.4.12  Foreign  Exchange  Contract  Mechanics  
I.C.4.13  Foreign  Exchange  Market  Trends  
I.C.4.14  Summary  
 
I.C.5  The  Stock  Market  
I.C.5.1   Introduction  
I.C.5.2   The  Characteristics  of  Common  Stock  
I.C.5.3   Stock  Markets  and  their  Participants  
I.C.5.4   The  Primary  Market  -­‐  IPOs  and  Private  Placements  
I.C.5.5   The  Secondary  Market  -­‐  the  Exchange  versus  OTC  Market  
I.C.5.6   Trading  Costs  
I.C.5.7   Buying  on  Margin  
I.C.5.8   Short  Sales  and  Stock  Borrowing  Costs  
I.C.5.9   Exchange-­‐Traded  Derivatives  on  Stocks  
I.C.5.10  Summary  
 
I.C.6  Derivatives  Exchanges  
I.C.6.1   Overview  of  Derivatives  Exchanges  
I.C.6.2   Features  and  Characteristics  of  Derivatives  Contracts  
I.C.6.3    How  Trading  Takes  Place  on  Derivatives  Exchanges  
I.C.6.4   Clearing,  Settlement,  and  Management  of  Counterparty  Risk  
I.C.6.5   Regulation  
I.C.6.6    Summary  
 
   

2015 © The Professional Risk Managers’ International Association 6

I.C.7.  The  Structure  of  Commodities  Markets  
I.C.7.1   Introduction  
I.C.7.2   The  Commodity  Universe  and  Anatomy  of  Markets  
I.C.7.3   Spot-­‐Forward  Pricing  Relationships  
I.C.7.4   Exchange  Limits  
I.C.7.5    Characteristics  of  Commodity  Prices  
I.C.7.6    Risk  Management  for  Commodities  
 
I.C.8  The  Energy  Markets  
I.C.8.1   Introduction  
I.C.8.2   Market  Overview  
I.C.8.3   Energy  Futures  Markets  
I.C.8.4   OTC  Energy  Derivative  Markets  
I.C.8.5   Emerging  Energy  Markets  
I.C.8.6   The  Future  of  Energy  Trading  
I.C.8.7   Conclusion  

 
PRM  Exam  II  
MATHEMATICAL  FOUNDATIONS  OF  RISK  MEASUREMENTS
 
PRM  Handbook  Volume  II:  Mathematical  Foundations  of  Risk  Measurements  –  2015  
Edition    
 
II.A  Foundations    
II.A.1   Symbols  and  Rules  
II.A.2   Sequences  and  Series  
II.A.3   Exponentiation  and  Logarithms  
II.A.4   Equations  and  Inequalities  
II.A.5   Functions  and  Graphs  
II.A.6   Applying  Some  Simple  Math  to  a  Common  Financial  Issue:  The  Time  
Value  of  Money    
II.A.7   Summary  
 
II.B  Descriptive  Statistics    
II.B.1   Introduction  
II.B.2   Data  
II.B.3   The  Moments  of  a  Distribution  
II.B.4   Measures  of  Location  or  Central  Tendency  -­‐  Averages  
II.B.5   Measures  of  Dispersion  
II.B.6   Bivariate  Data  
II.B.7  Case  Study:  Interpretation  of  Statistical  Output  
 
   

2015 © The Professional Risk Managers’ International Association 7

II.C  Calculus    
II.C.1   Differential  Calculus  
II.C.2   Case  Study:  Modified  Duration  of  a  Bond  
II.C.3   Higher-­‐Order  Derivatives  
II.C.4   Financial  Applications  of  Second  Derivatives  
II.C.5   Differentiating  a  Function  of  More  than  One  Variable  
II.C.6   Optimization  
II.C.7  Integral  calculus  or  integration  
 
II.D  Matrix  Algebra    
II.D.1   Matrix  Algebra  
II.D.2  Using  Matrix  Algebra  to  Solve  Simultaneous  Equations.  
II.D.3   Applications  of  Matrix  Algebra  in  Finance.  
II.D.4  Checking  the  Variance-­‐Covariance  Matrix  
II.D.5   Eigenvalues  and  Eigenvectors  
II.D.6   Cholesky  Decomposition  
II.D.7   Quadratic  Forms  
 
II.E  Probability  Theory  in  Finance    
II.E.1   Definitions  and  Rules  
II.E.2   Probability  Distributions  
II.E.3   Joint  Distributions  
II.E.4   Specific  Probability  Distributions  
 
II.F  Regression  Analysis  in  Finance    
II.F.1   Univariate  Linear  Regression  
II.F.2   Multiple  Linear  Regression  
II.F.3   Evaluating  the  Regression  Model  
II.F.4   Confidence  Intervals  
II.F.5   Hypothesis  Testing  
II.F.6   Prediction  
II.F.7   Breakdown  of  OLS  Assumptions  
II.F.8   Stationary  Data  for  Time  Series  Regressions  
II.F.9   Maximum  Likelihood  Estimation  
II.F.10    Summary  
 
II.G  Numerical  Methods    
II.G.1   Solving  (Non-­‐differential)  Equations  
II.G.2   Numerical  Optimization  
II.G.3   Numerical  Methods  for  Valuing  Options  
II.G.4   Monte  Carlo  Simulation  
II.G.4   Summary  
 

2015 © The Professional Risk Managers’ International Association 8

PRM  Exam  III  
|  Risk  Management  Frameworks  |  Operational  Risk  |  Credit  Risk  |  
|  Counterparty  Risk  |  Market  Risk  |  Asset  Liability  Management  |  
|  Funds  Transfer  Pricing  |
PRM  Handbook  Volume  III:  Book  1  –  Risk  Management  Frameworks  and  Operational  Risk  –  
2015  Edition  
 
Part  1  -­‐  Risk  Management  Frameworks  

Chapter  1:  Foreword  

Embedding  Good  Practice  in  a  Changed  Regulatory  Environment  
Chapter  2:  Risk  Governance  
Governing  and  Governance  
People  
Process  
Result  
Horizons  of  Risk  Governance  
Conclusion  

Chapter  3:  The  Risk  Management  Framework  

Introduction  
Risk  Capacity  
Risk  Appetite  
Example  Risk  Appetite  Statement  
Risk  Policy  
Risk  Pricing  
Risk  Culture  
 
Part  2  -­‐  Operational  Risk  
Introduction  to  Operational  Risk,  by  Penny  Cagan  

Chapter  4:  Risk  Assessment  

Risk  Assessment  Overview  
Risk  Assessment  Lifecycle  
Determining  Risk  Assessment  Units:  the  Functional  vs.  Process  Approach  
Top-­‐Down  Risk  Identification  
Control  identification:  Linking  top-­‐down  and  bottom-­‐up  work  
Process  Reviews  
Control  Assessment  
Identify  Issues  and  Design  action  Plans  
Issue  Management  
Residual  Risk  
Management  Validation  
Risk  Assessment  of  New  and  Expanded  Products  and  Services  
Factors  to  Consider  when  Assessing  New  and  Expanded  Products  and  Services  
Risk  Assessments  of  Third  Party  Service  Providers  

2015 © The Professional Risk Managers’ International Association 9

 Conclusion  

Chapter  5:  Risk  Information  

Learning  Outcome  Statements  
Introduction  
Risk  Appetite  
Risk  Profile  
Expected  Loss  
Unexpected  Loss  
Loss  Investigation  
Collecting  Loss  Data  
Quantifying  Losses  
Loss  Data  Fields  
Boundary  Issues  
External  Loss  Data  
Key  Risk  Indicators  
Selecting  Appropriate  KRIs  
Interdependent  KRIs  
Implementing  a  KRI  Framework  
Toolsets  and  Reporting  

Chapter  6:  Risk  Modeling  

Introduction  
From  Basic  to  Advanced  Approach  
Operational  Risk  Data  
Overarching  Principles  
Unit  of  Measure  Definition  
Frequency  Modeling  
Statistical  Foundations  of  Severity  Fitting  
ILD  Severity  Model  
Fitting  Algorithms  
Scenario  Based  Model  
Combining  the  ILD  and  Scenario  Models  
Combining  ILD  Model  with  Scenario  Assessment  
ELD  Model  
Combining  ILD  with  ELD  
Dependency  Modeling  and  Risk  Aggregation  
Capital  Allocation  

Chapter  7:  Insurance  Mitigation  

Insurance  Mitigation  
Risk  Taxonomy  and  Mapping  
Qualification  Criteria  of  Insurance  Mitigation  
Calculation  of  Capital  Relief  
References  
 
 
   

2015 © The Professional Risk Managers’ International Association 10

PRM  Handbook  Volume  III:  Book  1  –  Credit  Risk  and  Counterparty  Risk  –  2015  Edition  
 
Part  1  –  Credit  Risk  
 
Chapter  1  -­‐  Classic  Credit  Products    
Important  Credit  Instruments    
Building  Blocks    
Instruments    
 
Chapter  2  -­‐  Classic  Credit  Life  Cycle    
Introduction/Basics    
Origination  Phase    
Credit  Risk  Assessment    
Monitoring  Phase    
Workout  Phase    
Other  Considerations    
 
Chapter  3  -­‐  Classic  Credit  Risk  Methodology    
Introduction  And  Setting  The  Scene    
Fundamental  Credit  Analysis    
Analysing  Wholesale  Credit    
Analysing  Retail  Credit    
Conclusion:  Classic  Vs.  Modern  Credit  Analysis  Methodologies    
 
Chapter  4  -­‐  Credit  Derivatives  And  Securitization    
Structured  Credit  As  A  Funding  Tool    
Linear  Credit  Risk  Transfer    
Structured  Credit  As  A  Risk  Management  Tool  
Bespoke  Structured  Credit    
 
Chapter  5  -­‐  Modern  Credit  Risk  Modelling    
Credit  Risk  Parameters  
Credit  Var  Models  
Implementation  
Modelling  Credit  Risk  Mitigation    
Risk  Allocation  And  Performance  Management    
 
Chapter  6  -­‐  Credit  Portfolio  Management    
CPM  Goals  And  Philosophy    
CPM  Instruments    
CPM  Analytics    
CPM  In  Practice    
 
   

2015 © The Professional Risk Managers’ International Association 11

Part  2  –  Counterparty  Risk    
 
Chapter  7  -­‐  Basics  of  Counterparty  Risk  
Historical  Perspective  
The  OTC  Derivative  Market  
Exposure  Measurement    
Risk  Appetite    
 
Chapter  8  -­‐  Risk  Mitigation    
Documentation    
Netting  
Collateral    
Clearing    
Compression    
Guarantees,  Intermediation,  and  Credit  Insurance    
 
Chapter  9  -­‐  Credit  Valuation  Adjustment,  CVA    
CVA  Definition  and  Calculating  CVA    
Debit  Valuation  Adjustment,  DVA    
Wrong-­‐way  Risk    
Organizational  Challenge  
 
Chapter  10  -­‐  CVA-­‐related  Aspects  –  Toward  XVA    
Funding  Valuation  Adjustment,  FVA    
Capital    
Leverage  Ratio    
Liquidity  Ratios    
 
Chapter  11  -­‐  Managing  Counterparty  Risk  and  CVA    
Hedging  CVA  
Central  Clearing  Counterparties  (CCP)  
Managing  Distressed  Names  and  Defaults  
 
PRM  Handbook  Volume  III:  Book  3  –  Market  Risk,  Asset  Liability  Management  and  Funds  
Transfer  Pricing  –  2015  Edition  

Part  1  –  Market  Risk    

 
Chapter  1  -­‐  Market  Risk  Introduction    
Typology  of  Market  Risk  Exposures    
Asset-­‐liability  Management    
Funds  Transfer  Pricing    
Industry  Best  Practices    
Content  of  Market  Risk  Section    
 
   

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Chapter  2  -­‐  Market  Risk  Governance  and  Management  
Introduction  
The  Post-­‐Crisis,  Risk-­‐Regulatory  Framework  
Setting  Stage  For  Market  Risk  Governance    
True  Market  Risk  Governance    
Committees:  Market  Risk  Appetite  &  Market  Risk  Limits    
Roles  And  Responsibilities  In  Practice    
Market  Risk  Limits  And  Limit  Policies    
Risk  Management  Systems    
Risk  Management  Data    
Monitoring  Market  Risk    
What  Is  The  Role  Of  The  Audit  Function?    
Model  Risk  Governance    
Valuation  in  a  Marked-­‐to-­‐Market  World  during  Low  Liquidity    
Conclusion:  Steps  To  Success    
Appendix  
 
Chapter  3  Market  Risk  Measurement    
Value  at  Risk  -­‐  Overview    
Advanced  VAR  Models  -­‐  Univariate    
Advanced  VaR  Models  -­‐  Multivariate    
 
Chapter  4  Market  Risk  in  the  Trading  Books:  Business  Specific  Context  
Contextual  Introduction  to  Bank  Trading  Activities  &  Historical  Development  
of  Financial  Product  Markets  
Fixed  Income    
FX  &  Rates  Trading    
Equity  Market  Trading    
 
Chapter  5  –  Commodities  market  risk  management  
Introduction    
Market  Participants  
Key  products  and  instruments    
Risk  Implications  of  Physical  Nature  of  Commodities    
Price  risk  management    
Stress  testing    
 
Chapter  6  -­‐  Market  Risk  Stress  Testing  -­‐  Beyond  the  VaR  Threshold    
Introduction    
Dangerous  Unknowns    
Stress  Testing:  Static  and  Otherwise    
Beyond  Comparative  Static  Analysis    
Systemic  Risk  Lessons  from  Beyond  Finance    
Moving  beyond  Value  at  Risk  
Practical  and  Organizational  Considerations  
Challenges  of  Stress  Testing  
Conclusion    
 

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Appendix  A  -­‐  Examples  of  Stress  Testing    
Scenario  Formulation  -­‐  The  Fundamental  Challenge  of  Stress  Testing    
The  Market’s  Greatest  Hits  -­‐  Calibrating  Stress  Scenarios  Based  on  History  
The  Achilles  Heel  Approach    
 
Part  2:  Asset  Liability  Management  &  Funds  Transfer  Pricing    
 
Chapter  7:  ALM  and  the  Recent  Crisis    
Overall  Causes  of  the  Crisis    
Balance  Sheet  Related  Causes  of  the  Crisis  
The  Effects  of  the  Crisis    
In  Focus:  Lehman  Brothers    
Responses  to  the  Crisis    
In  Focus:  The  Irish  Banking  Industry  Crisis    
Into  the  Book:  Lessons  from  the  Crisis  for  Balance  Sheet  Management    
 
Chapter  8:  An  Introduction  to  Asset  Liability  Management    
ALM  Overview    
An  Introduction  to  Gaps    
In  Focus:  Contagion  between  Risk  Types    
Banking  Book  versus  Trading  Book    
ALM  Objectives    
Roles  within  ALM    
 
Chapter  9:  Interest  Rate  Risk    
Overview    
Components  of  Interest  Rate  Risk    
Measurement    
Management    
 
Chapter  10:  Liquidity  Risk    
Overview    
Fundamentals  of  Liquidity    
Measurement  and  Measurement    
Recent  Developments  
Chapter  11:  Balance  Sheet  Management    
Introduction  
The  ALCO  
Capital  Management    
Strategy  and  Products    
Crisis  Management  and  the  Contingency  Funding  Plan    
 
Chapter  12:  Bank  Funds  Transfer  Pricing  (‘FTP’)    
Introduction    
FTP  Governance  and  Management  
FTP  Methods  and  Historical  Development    
Other  FTP  Challenges    
Conclusion    

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 Introduction  

If  you're  reading  this,  you  are  seeking  to  attain  a  higher  standard.  Congratulations!  
 
Those   who   have   been   a   part   of   financial   risk   management   for   the   past   twenty   years,  
have   seen   it   change   from   an   on-­‐the-­‐fly   profession,   with   improvisation   as   a   rule,   to  
one   with   substantially   higher   standards,   many   of   which   are   now   documented   and  
expected   to   be   followed.   It’s   no   longer   enough   to   say   you   know.   Now,   you   and   your  
team  need  to  prove  it.  
 
As   its   title   implies,   this   book   is   the   Handbook   for   the   Professional   Risk   Manager.   It   is  
for  those  professionals  who  seek  to  demonstrate  their  skills  through  certification  as  
a  Professional  Risk  Manager  (PRM)  in  the  field  of  financial  risk  management.  And  it  is  
for  those  looking  simply  to  develop  their  skills  through  an  excellent  reference  source.  
 
With   contributions   from   nearly   40   leading   authors   and   practitioners,   the   PRM  
Handbook   is   designed   to   provide   you   with   the   materials   needed   to   gain   the  
knowledge   and   understanding   of   the   building   blocks   of   professional   financial   risk  
management.   Financial   risk   management   is   not   about   avoiding   risk.   Rather,   it   is  
about   understanding   and   communicating   risk,   so   that   risk   can   be   taken   more  
confidently   and   in   a   better   way.   Whether   your   specialism   is   in   insurance,   banking,  
energy,   asset   management,   weather,   or   one   of   myriad   other   industries,   this  
Handbook  is  your  guide.    
 
In   Volume   II,   we   take   you   through   the   mathematical   foundations   of   risk  
management.   While   there   are   many   nuances   to   the   practice   of   risk   management  
that   go   beyond   the   quantitative,   it   is   essential   today   for   every   risk   manager   to   be  
able  to  assess  risks.  The  chapters  in  this  section  are  accessible  to  all  PRM  members,  
including   those   without   any   quantitative   skills.   The   Excel   spreadsheets   that  
accompany   the   examples   are   an   invaluable   aid   to   understanding   the   mathematical  
and   statistical   concepts   that   form   the   basis   of   risk   assessment.     After   studying   all  
these  chapters,  you  will  have  read  the  materials  necessary  for  passage  of  Exam  II  of  
the  PRM  Certification  program.  
 
Those   preparing   for   the   PRM   certification   will   also   be   preparing   for   Exam   I   on  
Finance   Theory,   Financial   Instruments   and   Markets,   covered   in   Volume   I   of   the   PRM  
Handbook,  Exam  III  on  Risk  Management  Practices,  covered  in  Volume  III  of  the  PRM  
Handbook  and  Exam  IV  -­‐  Case  Studies,  Standards  of  Best  Practice  Conduct  and  Ethics  
and   PRMIA   Governance.   Exam   IV   is   where   we   study   some   failed   practices,   standards  
for   the   performance   of   the   duties   of   a   Professional   Risk   Manager,   and   the  
governance   structure   of   our   association,   the   Professional   Risk   Managers’  
International   Association.     The   materials   for   Exam   IV   are   freely   available   on   our  
website  and  are  thus  outside  of  the  Handbook.      
 
At  the  end  of  your  progression  through  these  materials,  you  will  find  that  you  have  
broadened  your  knowledge  and  skills  in  ways  that  you  might  not  have  imagined.  You  

2015 © The Professional Risk Managers’ International Association 15

will   have   challenged   yourself   as   well.   And,   you   will   be   a   better   risk   manager.   It   is   for  
this  reason  that  we  have  created  the  Professional  Risk  Managers’  Handbook.  
 
Our   deepest   appreciation   is   extended   to   our   Handbook   editors,   Prof.   Elizabeth  
Sheedy,   Jonathan   Howitt,   Stefan   Loesch,   Justin   McCarthy,   Oscar   McCarthy   and   Andy  
Condurache,   dedicated   PRMIA   Leaders,   for   their   editorial   work   on   this   publication.  
The   commitment   they   have   shown   to   ensuring   the   highest   level   of   quality   and  
relevance  is  beyond  description.    
 
Our   thanks   also   go   to   the   authors   who   have   shared   their   insights   with   us.   The  
demands   for   sharing   of   their   expertise   are   frequent.   Yet,   they   have   each   taken  
special  time  for  this  project  and  have  dedicated  themselves  to  making  the  Handbook  
and  you  a  success.  We  are  very  proud  to  bring  you  such  a  fine  assembly.  
 
Much   like   PRMIA,   the   Handbook   is   a   place   where   the   best   ideas   of   the   risk  
profession  meet.  We  hope  that  you  will  take  these  ideas,  put  them  into  practice  and  
certify   your   knowledge   by   attaining   the   PRM   designation.   Among   our   membership  
are   several   hundred   Chief   Risk   Officers   /   Heads   of   Risk   and   tens   of   thousands   of  
other   risk   professionals   who   will   note   your   achievements.   They   too   know   the  
importance   of   setting   high   standards   and   the   trust   that   capital   providers   and  
stakeholders  have  put  in  them.  Now  they  put  their  trust  in  you  and  you  can  prove  
your  commitment  and  distinction  to  them.  
 
We  wish  you  much  success  during  your  studies  and  for  your  performance  in  the  PRM  
exams!  
 
PRMIA  
 

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