ARM Financial Risk Management 3

Question 1

Which of the following strategies is specifically designed to use financial derivatives to offset potential losses from price movements?

Accepted Answer

Hedging with derivatives

Answer

Hedging with derivatives (such as options, futures, or swaps) creates a counterbalancing position that offsets losses from adverse price movements in an underlying exposure.

Question 2

Portfolio diversification reduces financial risk primarily by:

Accepted Answer

Reducing unsystematic (idiosyncratic) risk by spreading investments across assets that do not move perfectly together

Answer

Diversification lowers unsystematic risk because losses in one asset tend to be offset by gains in others when their returns are not perfectly correlated, though it cannot eliminate systematic market risk.

Question 3

Risk-Adjusted Return on Capital (RAROC) is used in financial risk management to:

Accepted Answer

Compare the profitability of activities or business lines after accounting for the risk they consume

Answer

RAROC divides risk-adjusted net income by economic capital, allowing organizations to compare the true risk-adjusted profitability of different activities and allocate capital to highest-value uses.

Question 4

Credit derivatives such as credit default swaps (CDS) are primarily used to:

Accepted Answer

Transfer credit risk from one party to another without transferring the underlying asset

Answer

A CDS allows the protection buyer to transfer the credit risk of a reference entity to the protection seller, who receives periodic payments in exchange for compensating the buyer if a credit event (e.g., default) occurs.

Question 5

Collateral in credit risk management serves primarily to:

Accepted Answer

Provide the lender with an asset claim to recover losses if the borrower defaults

Answer

Collateral reduces the lender's loss given default (LGD) by giving the creditor a legal claim on specified assets, which can be seized and liquidated to recover the outstanding obligation.

ARM - Associate in Risk Management Practice Test

ARM - Associate in Risk Management Practice Test

ARM Financial Risk Management 3