CFA Derivatives and Risk Management 2

Question 1

Value at Risk (VaR) at a 95% confidence level and a 1-day horizon means:

Accepted Answer

The portfolio will lose more than the VaR amount 5 days out of every 100

Answer

95% VaR means there is a 5% probability of losing more than the VaR amount over the specified horizon; losses exceeding VaR are expected 5 out of every 100 days.

Question 2

Conditional VaR (CVaR), also called Expected Shortfall, improves on VaR because it measures:

Accepted Answer

The expected loss given that the loss exceeds the VaR threshold

Answer

CVaR is the average loss in the tail beyond the VaR threshold, capturing tail risk that VaR ignores by only identifying the threshold but not the severity of losses beyond it.

Question 3

Which of the following best describes a credit default swap (CDS)?

Accepted Answer

A derivative where the protection buyer pays periodic premiums in exchange for a payment if a credit event occurs

Answer

In a CDS, the protection buyer pays periodic premiums to the protection seller, who makes a payment if the reference entity experiences a credit event (e.g., default).

Question 4

Gamma (Γ) of an option is highest when:

Accepted Answer

The option is near-the-money and close to expiration

Answer

Gamma is largest for at-the-money options near expiration because delta is changing most rapidly as the option transitions between in- and out-of-the-money.

Question 5

Which risk management strategy is MOST appropriate when a firm wants to eliminate the risk of an adverse price move but retain the potential to benefit from a favorable move?

Accepted Answer

Buy an option to hedge the downside while retaining upside

Answer

Buying options provides asymmetric protection: you pay a premium to eliminate downside risk while retaining full upside participation if prices move favorably.

CFA Practice Test

CFA Practice Test

CFA Derivatives and Risk Management 2