Risk Management Flashcards

Which risk measure quantifies the maximum expected loss over a given time period at a specified confidence level?

Answer: Value at Risk (VaR)

Value at Risk (VaR) estimates the maximum loss expected over a defined time horizon at a given confidence level (e.g., 95% or 99%).

A portfolio manager notices that a fund's returns correlate strongly with a broad market index during downturns but diverge during upturns. This best describes which type of risk?

Answer: Downside correlation risk

Downside correlation risk refers to the tendency of assets to become more correlated during market downturns, reducing diversification benefits precisely when they are most needed.

Which of the following is a limitation of using historical standard deviation as a standalone risk measure for a portfolio?

Answer: It assumes returns are normally distributed and stationary

Standard deviation assumes normally distributed returns, but portfolio returns often exhibit fat tails and skewness, making historical standard deviation alone insufficient.

Conditional Value at Risk (CVaR) is considered superior to VaR because it:

Answer: Captures the average loss beyond the VaR threshold

CVaR (also called Expected Shortfall) measures the average loss in the worst-case scenarios beyond the VaR cutoff, providing better insight into tail risk.

A portfolio manager wants to hedge interest rate risk in a bond portfolio. The most direct hedging instrument would be:

Answer: Interest rate swaps or Treasury futures

Interest rate swaps and Treasury futures directly offset changes in bond prices caused by interest rate movements, making them the most appropriate hedges.

Which risk management approach involves setting maximum allowable loss thresholds and automatically reducing exposure when they are breached?

Answer: Stop-loss rules

Stop-loss rules are pre-defined thresholds that trigger automatic portfolio de-risking when losses reach a specified level, limiting further downside exposure.