CPFM Financial Risk Management 2 — Questions and Answers
Question 1: A company holds receivables denominated in euros while reporting in U.S. dollars. What type of risk does this exposure primarily represent?
- Transaction (foreign exchange) risk (Correct answer)
- Interest rate risk
- Commodity price risk
- Operational risk
Correct answer: Transaction (foreign exchange) risk
Foreign-currency receivables expose the firm to transaction risk because exchange-rate movements alter the dollar value of the amount collected.
Question 2: Which instrument is most commonly used to hedge the risk of rising interest rates on a floating-rate loan?
- Interest rate swap (pay fixed, receive floating) (Correct answer)
- Currency forward
- Commodity futures
- Credit default swap
Correct answer: Interest rate swap (pay fixed, receive floating)
A pay-fixed/receive-floating swap converts floating-rate exposure into a fixed cost, neutralizing the impact of rising rates.
Question 3: Value at Risk (VaR) at a 95% confidence level over one day is best described as:
- The maximum loss expected to be exceeded only 5% of the time (Correct answer)
- The guaranteed maximum loss possible
- The average daily gain
- The total capital at risk
Correct answer: The maximum loss expected to be exceeded only 5% of the time
A 95% one-day VaR estimates a loss threshold that should be exceeded on only about 5% of trading days.
Question 4: A key limitation of standard VaR is that it:
- Does not describe the magnitude of losses beyond the VaR threshold (Correct answer)
- Always overstates risk
- Cannot be calculated for equities
- Eliminates tail risk entirely
Correct answer: Does not describe the magnitude of losses beyond the VaR threshold
VaR identifies a loss threshold but says nothing about how severe losses can become once that threshold is breached.
Question 5: Which risk measure addresses the shortcoming of VaR by averaging losses in the tail?
- Conditional VaR (Expected Shortfall) (Correct answer)
- Standard deviation
- Beta
- Sharpe ratio
Correct answer: Conditional VaR (Expected Shortfall)
Conditional VaR, or Expected Shortfall, averages the losses that occur beyond the VaR cutoff.
Question 6: Diversification reduces which type of risk?
- Unsystematic (specific) risk (Correct answer)
- Systematic (market) risk
- Sovereign risk
- Inflation risk
Correct answer: Unsystematic (specific) risk
Holding many uncorrelated assets averages away firm-specific (unsystematic) risk, but systematic risk remains.
Question 7: A natural hedge for a U.S. exporter with euro revenues would be to:
- Incur euro-denominated costs or debt (Correct answer)
- Borrow more in U.S. dollars
- Buy additional euro assets
- Increase dollar receivables
Correct answer: Incur euro-denominated costs or debt
Matching euro costs or liabilities against euro revenues offsets currency exposure without using derivatives.
CPFM Financial Risk Management 2
A company holds receivables denominated in euros while reporting in U.S. dollars.
What type of risk does this exposure primarily represent?