Financial Risk Assessment & Mitigation Flashcards

A firm's net interest margin is declining as rates rise because its liabilities reprice faster than its assets. What type of interest rate risk does this describe?

Answer: Repricing risk

Repricing risk arises from timing differences in when assets and liabilities reprice to current market rates, affecting net interest income.

Which collateral arrangement in an OTC derivative contract requires daily posting of collateral based on mark-to-market changes?

Answer: Variation margin

Variation margin is exchanged daily (or intraday) to reflect changes in the fair value of outstanding derivative contracts.

A CRO is evaluating a structured product backed by subprime mortgages. Which risk arises specifically from the fact that mortgage borrowers can prepay their loans?

Answer: Prepayment risk

Prepayment risk is the risk that mortgage borrowers will repay principal earlier than expected, typically when rates fall, reinvesting proceeds at lower yields.

In a risk-adjusted performance measurement framework, what does RAROC stand for and what does its numerator represent?

Answer: Risk-Adjusted Return on Capital; after-tax risk-adjusted net income

RAROC = (Risk-Adjusted Net Income) / Economic Capital, enabling comparison of returns across business lines with different risk profiles.

What is 'wrong-way risk' in counterparty credit risk management?

Answer: The exposure to a counterparty increases precisely when that counterparty is more likely to default

Wrong-way risk occurs when exposure and counterparty credit quality deteriorate together, compounding potential losses (e.g., buying protection from a bank on that bank's own debt).

A corporate bond has a modified duration of 6 years and a yield increases by 50 basis points. What is the approximate percentage price change?

Answer: -3.0%

Price change ≈ -Modified Duration × Δyield = -6 × 0.005 = -0.03 = -3.0%; prices fall when yields rise.

Which liquidity risk metric measures the number of days a firm can meet its cash obligations using only its liquid asset buffer without accessing new funding?

Answer: Survival horizon

The survival horizon (or liquidity horizon) measures how long the firm can survive a stress scenario solely by liquidating its high-quality liquid asset buffer.