Risk Management Flashcards

Which of the following is an example of operational risk in portfolio management?

Answer: A trading error caused by a system failure

Operational risk encompasses losses from failed internal processes, systems, or human errors — such as a trade entry mistake caused by a technology failure.

The maximum drawdown metric is used to assess:

Answer: The largest peak-to-trough decline in portfolio value over a period

Maximum drawdown measures the largest cumulative decline from a portfolio's peak value to its subsequent trough, indicating the worst-case historical loss experience.

A risk budget allocates risk across portfolio segments based on:

Answer: Each segment's contribution to total portfolio risk relative to expected return

A risk budget assigns risk capacity to each portfolio segment in proportion to the expected return contribution, ensuring risk is taken where it is most rewarded.

Which of the following scenarios represents counterparty risk?

Answer: A derivatives counterparty defaults before settling an OTC contract

Counterparty risk is the risk that the other party in a financial contract (especially OTC derivatives) will fail to fulfill its obligations before settlement.

Scenario analysis in risk management is primarily used to:

Answer: Evaluate portfolio performance under specific hypothetical or historical events

Scenario analysis evaluates how a portfolio would perform under specific, defined events (such as a recession or interest rate shock), helping managers understand potential vulnerabilities.

Which metric combines both return and risk into a single measure by dividing excess return by the portfolio's standard deviation?

Answer: Sharpe ratio

The Sharpe ratio measures risk-adjusted return by dividing a portfolio's excess return (above the risk-free rate) by its standard deviation of returns.