Financial Risk Management Flashcards

Credit risk is best defined as the risk that:

Answer: A counterparty fails to meet its contractual obligations

Credit risk is the potential loss arising when a borrower or counterparty defaults on its obligations.

Which of the following best describes liquidity risk?

Answer: The risk of being unable to sell an asset or meet obligations without significant loss

Liquidity risk arises when an entity cannot convert assets to cash or fund obligations without accepting a sizable price concession.

A bond's duration measures its sensitivity to changes in:

Answer: Interest rates

Duration estimates the percentage change in a bond's price for a given change in interest rates.

Stress testing differs from VaR primarily because it:

Answer: Examines impact of extreme, often hypothetical scenarios

Stress testing evaluates portfolio impact under severe but plausible scenarios that statistical models may underweight.

The risk that a firm cannot roll over its short-term debt as it matures is called:

Answer: Refinancing (funding) risk

Refinancing or funding risk is the danger of being unable to replace maturing debt on acceptable terms.

Which technique transfers risk to a third party in exchange for a premium?

Answer: Insurance

Insurance transfers specified risks to an insurer in return for premium payments.

Basis risk in a hedge arises when:

Answer: The hedging instrument and the underlying exposure do not move perfectly together

Basis risk is the residual risk that the price of the hedge and the hedged item diverge.