CAIA Risk Management Flashcards

Model risk in alternative investments refers to:

Answer: The risk that a quantitative model is incorrectly specified, estimated, or applied

Model risk arises from reliance on flawed mathematical models for pricing, risk measurement, or trading, which can lead to systematic mispricing or loss.

The maximum drawdown metric measures:

Answer: The peak-to-trough decline in portfolio value over a specified period

Maximum drawdown captures the largest cumulative loss from a peak to a subsequent trough, indicating the worst historical experience for an investor.

In the context of hedge funds, 'redemption gates' are used to:

Answer: Limit the percentage of fund assets that can be redeemed in any given period to protect remaining investors

Redemption gates cap redemptions (e.g., 25% of NAV per quarter) to prevent fire sales of illiquid assets that would harm investors who remain in the fund.

Operational risk in alternative investment funds most commonly arises from:

Answer: Failures in internal processes, people, systems, or external events such as fraud or cyber attacks

Operational risk encompasses non-market risks including trade settlement errors, valuation manipulation, cybersecurity breaches, and key-person dependency.

Correlation risk in a multi-strategy portfolio refers to:

Answer: The risk that asset correlations increase during market stress, reducing diversification benefits precisely when they are most needed

During crises, correlations between previously uncorrelated strategies tend to spike toward 1.0, eliminating diversification benefits at the worst possible time.

Which risk management approach combines scenario analysis with sensitivity testing to assess portfolio vulnerability to specific factor changes?

Answer: Factor stress testing

Factor stress testing evaluates how a portfolio responds to targeted changes in specific risk factors (e.g., credit spreads widening 200bps, equity markets falling 30%).