Financial Risk Management Flashcards

Which risk metric measures the maximum expected loss over a given time horizon at a specified confidence level?

Answer: Value at Risk (VaR)

Value at Risk (VaR) quantifies the maximum potential loss over a specific period at a given confidence level, such as 99% over one day.

A bank's net interest margin (NIM) is most directly affected by which type of risk?

Answer: Interest rate risk

Interest rate risk directly impacts NIM because changes in rates affect the spread between interest earned on assets and interest paid on liabilities.

Under Basel III, what is the minimum Common Equity Tier 1 (CET1) capital ratio required for banks?

Answer: 4.5%

Basel III mandates a minimum CET1 ratio of 4.5% of risk-weighted assets, representing the highest quality capital buffer.

What is 'duration gap' used to measure in banking?

Answer: The sensitivity of a bank's net worth to changes in interest rates

Duration gap measures the difference between the weighted average duration of assets and liabilities, indicating how sensitive a bank's net worth is to interest rate changes.

Which of the following best describes 'concentration risk' in a loan portfolio?

Answer: Excessive exposure to a single borrower, sector, or geography

Concentration risk arises when a bank has excessive exposure to a single counterparty, industry, or region, making losses highly correlated.

A bank experiences unexpected large cash withdrawals that it cannot immediately fund. This scenario describes which type of risk?

Answer: Liquidity risk

Liquidity risk is the risk that a bank cannot meet its short-term financial obligations due to inability to convert assets to cash quickly.

What does 'Expected Loss' (EL) in credit risk modeling equal?

Answer: PD × LGD × EAD

Expected Loss equals Probability of Default multiplied by Loss Given Default multiplied by Exposure at Default, forming the core of credit risk measurement.