Financial Risk Management Flashcards

A bank's Value at Risk (VaR) at the 99% confidence level over a 10-day horizon is $5 million. What does this mean?

Answer: There is a 1% chance losses will exceed $5M over 10 days

VaR at 99% confidence means there is a 1% probability that losses will exceed the stated amount over the specified horizon.

Which stress testing approach applies historical market scenarios (e.g., the 2008 financial crisis) directly to the current portfolio?

Answer: Historical simulation

Historical simulation replays actual past market movements against the current portfolio to estimate potential losses.

Credit Default Swaps (CDS) are primarily used by banks to:

Answer: Transfer credit risk to a third party

A CDS allows the protection buyer to transfer the credit risk of a reference entity to the protection seller in exchange for periodic premiums.

The Liquidity Coverage Ratio (LCR) requires banks to hold enough High Quality Liquid Assets (HQLA) to survive a stress scenario of how many days?

Answer: 30 days

Under Basel III, the LCR requires banks to maintain HQLA sufficient to cover net cash outflows over a 30-day stress period.

In the context of market risk, 'Greeks' refer to:

Answer: Sensitivity measures of option prices to various factors

The Greeks (Delta, Gamma, Vega, Theta, Rho) measure how an option's price changes in response to changes in underlying variables.

Which risk arises when a bank cannot easily sell or liquidate an asset without significantly affecting its price?

Answer: Market liquidity risk

Market liquidity risk (asset liquidity risk) occurs when an asset cannot be traded quickly enough in the market without causing a significant price impact.

A bank with a Tier 1 Capital Ratio of 7% under Basel III would be classified as:

Answer: Adequately capitalized

Under Basel III, a Tier 1 Capital Ratio of at least 6% is required for adequate capitalization, while well-capitalized requires at least 8%.