CFA CFA Risk Management & Analysis 2 — Questions and Answers
Question 1: Systematic risk is best characterized as risk that:
- Cannot be eliminated through diversification (Correct answer)
- Affects only a single security
- Arises from poor corporate governance
- Can be removed by holding a large portfolio
Correct answer: Cannot be eliminated through diversification
Systematic risk, also called market risk, affects all assets and cannot be diversified away.
Question 2: Which of the following is a primary tool used to hedge interest rate risk?
- Interest rate swaps (Correct answer)
- Equity collars
- Credit default swaps
- Currency forwards
Correct answer: Interest rate swaps
Interest rate swaps allow parties to exchange fixed and floating rate payments, effectively hedging interest rate exposure.
Question 3: The risk that a specific company or sector underperforms is known as:
- Unsystematic (idiosyncratic) risk (Correct answer)
- Market risk
- Macroeconomic risk
- Systemic risk
Correct answer: Unsystematic (idiosyncratic) risk
Unsystematic or idiosyncratic risk is company- or industry-specific and can be reduced through diversification.
Question 4: Which metric measures the loss a portfolio has experienced from its peak value to its subsequent trough?
- Maximum drawdown (Correct answer)
- Tracking error
- Information ratio
- Sortino ratio
Correct answer: Maximum drawdown
Maximum drawdown captures the largest peak-to-trough decline in portfolio value over a specified period.
Question 5: Counterparty risk in a derivatives contract is the risk that:
- The other party defaults before the contract settles (Correct answer)
- The underlying asset price moves unfavorably
- Regulatory changes alter contract terms
- Transaction costs erode derivative gains
Correct answer: The other party defaults before the contract settles
Counterparty risk is the probability that the other party to a derivatives contract will fail to meet its obligations.
Question 6: Stress testing in risk management involves:
- Evaluating portfolio performance under extreme but plausible adverse scenarios (Correct answer)
- Calculating average returns during normal market conditions
- Optimizing the portfolio's Sharpe ratio
- Rebalancing the portfolio to match a benchmark
Correct answer: Evaluating portfolio performance under extreme but plausible adverse scenarios
Stress testing assesses how a portfolio would perform under severe market conditions such as the 2008 financial crisis.
CFA CFA Risk Management & Analysis 2
Systematic risk is best characterized as risk that: