> For the complete documentation index, see [llms.txt](https://docs.sierra.money/llms.txt). Markdown versions of documentation pages are available by appending `.md` to page URLs; this page is available as [Markdown](https://docs.sierra.money/building-with-sierra/risk-framework.md).

# Risk Framework

## Risk Types

All [Available Yield Sources](/building-with-sierra/available-yield-sources.md) have gone through their respective Underwriting Process by Sierra's [Advisory Council](/building-with-sierra/advisory-council.md) using our Risk Framework. The Risk Framework analyzes each yield source for 11 risk types:

* **Duration Risk:** Risk that an interest rate change causes the value of the reserve assets to change
* **Credit Risk:** Risk that the issuer or obligor of the bonds, debt or other forms of yield default on their interest payments or overall debt obligations
* **Liquidity Risk:** Risk that SIERRA's reserves will incur loss through withdrawing, redeeming or recalling reserve assets from a yield source
* **Term Risk:** Risk that reserve assets in a yield source are completely illiquid until the term or deposit period expires, which may cause SIERRA to not be able to meet all of its redemption obligations in a timely fashion
* **Currency Risk:** Risk that reserve assets are deployed in a yield source denominated in another  currency than USD and that currency depreciates against USD. Additionally, there is a similar risk that a yield source relies on a different USD-denominated stablecoin than USDC and it depegs below $1
* **Yield Volatility Risk:** Risk that the floating-rate yield sources vary from the initial rate that reserve assets were deployed
* **Smart Contract Risk:** Risk that bugs or vulnerabilities in the underlying smart contracts for DeFi yield sources result in partial or full loss of reserve assets deployed
* **Exploit Risk:** Risk that a malicious actor uses a DeFi yield source in an unintended way that results in partial or full loss of reserve assets deployed
* **Financial Crime Risk:** Risk that a high-risk entity (i.e. sanctioned wallets or darknet marketplace users), based on wallet scoring by AML analytics platforms, comingle their assets in a DeFi yield source that Sierra has reserve assets deployed into
* **Regulatory Risk:** Risk that regulators sue, or take similar action, against one of the DeFi yield sources that Sierra has reserve assets deployed into
* **Correlation Risk:** Risk that problems with one yield source could trigger issues in another, making additional losses more likely to happen

## Underwriting Process

Every Available Yield Source and all new yield sources are assessed using Sierra's Risk Framework by:

1. **Scoring Risk Types -** We assess each yield source against the applicability of each risk type
2. **Discounting Methodology -** We apply a discounting methodology to a yield source's return based on the applicability and severity of all risk types (i.e. uncollateralized lending has higher credit risk than investment-grade commercial paper, so it receives a larger discounted return) to obtain risk-adjusted returns
3. **Establishing Maximum Portfolio Allocation -** We also assign a parameter as the maximum exposure a Vault or LVT can have to an underlying yield source
4. **Periodic Review -** The Advisory Council continually monitors yield sources for residual risks that are not captured in any of the 11 risk types, as well as changing market conditions or other factors that materially affect a given yield source's discounting methodology


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