| Course | FIN-3820 Risk Management |
|---|---|
| Module | Module 7 |
| Paper type | Written assignment 7: operational, liquidity and model risks |
| Length | About 678 words, 5 pages |
| Format | APA 7 student paper |
| School | Thomas Edison State University |
| Program | B.S.B.A. in Finance |
| Updated | October 2026 |
Free sample paper for FIN 3820 Module 7
Software, Deposits and Models: Three Risks That Do Not Show Up in a Loan File
Student Name
B.S.B.A. in Finance, Thomas Edison State University
FIN-3820: Risk Management
Mentor Name
Month Day, Year
Software, Deposits and Models: Three Risks That Do Not Show Up in a Loan File
Operational Risk
Basel defines operational risk as the risk of loss from inadequate or failed internal processes, people and systems, or from external events (Hull, 2023). It includes fraud, cyberattacks, processing errors, legal risk and disasters. Unlike market and credit risk, it is not taken on deliberately in exchange for a return; it is a by-product of doing business. Diamond and Dybvig (1983) showed why deposit-funded banks are vulnerable to runs, the risk that liquidity ratios are designed to contain.
On August 1, 2012, Knight Capital, then one of the largest U.S. equity market makers, deployed new trading software in which an old, unused function was accidentally reactivated on one of its servers. In about 45 minutes, the system sent millions of erroneous orders, accumulating large unwanted positions that cost the firm about $440 million to unwind, more than its capital. Knight required an emergency rescue and was soon acquired. The Securities and Exchange Commission later found deficiencies in its controls over software deployment and risk limits.
Measuring operational risk is difficult because large losses are rare. Banks combine internal loss data, external loss databases, scenario analysis and indicators of risk such as transaction volumes. Basel's current standardized approach sets operational risk capital mainly from a bank's income, adjusted for its own historical losses.
Liquidity Risk
Liquidity risk has two forms: funding liquidity risk, the inability to meet obligations as they come due, and market liquidity risk, the inability to sell assets without large price concessions. The 2008 crisis and the 2023 regional bank failures showed how quickly funding can disappear.
Basel III introduced two ratios. The liquidity coverage ratio requires high-quality liquid assets at least equal to net cash outflows over a 30-day stress period. The net stable funding ratio requires available stable funding at least equal to required stable funding over one year, discouraging long-term assets funded with short-term money. U.S. rules apply them in full only to larger banks, but the logic is useful for any institution.
The bank meets a 100 percent standard, but its uninsured business deposits drive most of the stressed outflow. Concentration among a few large depositors, as at Silicon Valley Bank, is the variable to watch.
| Community bank funding | Amount | Assumed 30-day runoff in stress | Outflow |
|---|---|---|---|
| Insured retail deposits | $760 million | 5% | $38 million |
| Uninsured business deposits | $210 million | 40% | $84 million |
| Brokered and wholesale funding | $60 million | 100% | $60 million |
| Total stressed outflows | | | $182 million | |
| Expected inflows, capped | | | $40 million | |
| Net cash outflows | | | $142 million | |
| High-quality liquid assets | | | $165 million | |
| Coverage ratio | | | 116% |
Model Risk
Model risk is the risk of loss from errors in models or from using them inappropriately. In early 2012, JPMorgan Chase's Chief Investment Office replaced its VaR model with a new one that roughly halved reported VaR for its credit derivatives portfolio. The new model contained calculation errors in spreadsheets and had not been adequately tested; the lower VaR allowed the position to grow, and the bank ultimately lost about $6.2 billion (JPMorgan Chase & Co., 2013). Federal supervisory guidance on model risk management requires independent validation of models before use, ongoing monitoring and clear documentation of their limitations.
Recommended Controls for the Community Bank
| Risk | Control |
|---|---|
| Operational | Change management and testing for every system update; segregation of duties; cyber incident response plan and annual tests; fraud monitoring |
| Liquidity | Monthly coverage ratio calculation; limits on uninsured and brokered deposits as shares of funding; tested discount window and Federal Home Loan Bank borrowing capacity |
| Model | Inventory of all models; independent validation of the credit loss, rate risk and VaR models; documented limitations reported to the risk committee |
Conclusion
Operational, liquidity and model risks rarely appear in a loan file or a market position, yet each can bring down an institution quickly. They are managed less by measurement than by discipline: testing systems before they go live, knowing who could withdraw funding and why, and refusing to trust a model that has not been independently checked.
References
Diamond, D. W., & Dybvig, P. H. (1983). Bank runs, deposit insurance, and liquidity. Journal of Political Economy, 91(3), 401-419. https://doi.org/10.1086/261155
Hull, J. C. (2023). Risk management and financial institutions (6th ed.). Wiley.
JPMorgan Chase & Co. (2013). Report of JPMorgan Chase & Co. Management Task Force regarding 2012 CIO losses.
Reading the FIN 3820 Module 7 assignment instructions
Operational, liquidity and model risk share the seventh module. Expect questions defining and measuring operational risk, explaining liquidity measures such as the liquidity coverage and net stable funding ratios and discussing model risk and validation, often with real examples. Diamond and Dybvig's model of bank runs explains why funding liquidity can vanish. The community bank's funding mix here is a composite with illustrative runoff rates. Expect to analyze operational, liquidity and model risk, often through cases such as trading glitches and runs on funding. Some versions ask for a liquidity coverage calculation. Cases are often drawn from well-known failures.
How this FIN 3820 Module 7 example is built
The paper takes one risk per section. Operational risk is defined, illustrated with the Knight Capital loss and discussed for measurement. Liquidity risk is split into its two forms, the Basel III ratios are explained and a table applies a coverage ratio calculation to the bank's funding. Model risk is illustrated with the 2012 VaR model change, with supervisory guidance on validation. A table recommends controls for each risk, and a conclusion draws out what the three have in common. Each risk is illustrated with a real event and a control that would have reduced it. A table summarizes each risk, its case and its control. Controls are tied to each case.
FIN 3820 Module 7 rubric: what earns full marks
Liquidity ratios computed from the bank's own deposits carry this paper. Mentors look for accurate definitions and measurement of each risk, correct explanation of liquidity ratios and use of documented cases to illustrate failures. Applying the concepts to an institution and recommending specific controls show the practical understanding the module aims for. Accurate facts about the cases, drawn from official sources, are expected. Answers that explain how these risks differ from market and credit risk, and how each is measured, show understanding. Mentors also value proposals for independent model validation. Clear links between each case and the risk it illustrates help. Papers that compute the liquidity coverage ratio from the bank's own deposit mix, and propose controls for operational and model risk with owners, show practical understanding.
FIN 3820 Module 7 help from the desk
Answers in this module lose points for defining operational risk too narrowly as fraud, for describing liquidity ratios without applying them and for discussing model risk without explaining validation. Use Basel's definition of operational risk. Show a liquidity calculation with stated runoff assumptions. Explain how models should be validated. Use documented cases accurately. Recommend controls for each risk. A free first sample on your own liquidity and model risk questions is available. Use credible accounts of each case and propose controls a firm could actually implement. Explain how a model's error could cause a real loss. Name the warning signs that were missed in each case.
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FIN 3820 Module 7 questions, answered
Where can I find a free FIN 3820 Module 7 sample paper?
The paper above explains operational, liquidity and model risk with the Knight Capital and 2012 JPMorgan cases and a liquidity coverage calculation for a community bank.
What is operational risk?
The risk of loss from failed internal processes, people or systems, or from external events, as defined by Basel.
What is the liquidity coverage ratio?
High-quality liquid assets divided by net cash outflows over a 30-day stress period, required to be at least 100 percent.
What is model risk?
The risk of loss from errors in models or their inappropriate use, managed through independent validation and monitoring.
What happened at Knight Capital in 2012?
A software deployment error sent millions of erroneous orders in about 45 minutes, costing about $440 million and leading to the firm's rescue.