Financial Risk Assessment & Mitigation Flashcards

Under the Basel III Net Stable Funding Ratio (NSFR), what does the ratio require?

Answer: Available stable funding must be at least 100% of required stable funding over a one-year horizon

The NSFR requires banks to maintain sufficient stable funding (liabilities with maturity > 1 year) relative to the stable funding required by their asset mix.

A portfolio manager is hedging equity risk using index futures. After hedging, residual returns still fluctuate. What risk remains?

Answer: Basis risk from imperfect correlation between the portfolio and the index

Basis risk is the residual risk when the hedging instrument does not perfectly correlate with the exposure being hedged, leaving imperfect offset.

In credit portfolio management, what is the 'granularity adjustment' used for?

Answer: To correct for concentration risk in portfolios with few large exposures

The granularity adjustment increases capital requirements when a portfolio is concentrated in few large obligors rather than being well-diversified.

A CRO reviews a model that consistently underestimates losses during market stress. This is an example of which risk?

Answer: Model risk

Model risk is the risk of loss due to errors or limitations in financial models, including systematic underestimation of tail losses.

Which financial instrument provides the buyer with the right, but not the obligation, to sell an asset at a predetermined price, thereby hedging downside risk?

Answer: Put option

A put option grants the holder the right to sell the underlying asset at the strike price, providing insurance against price declines.

What is the key difference between 'expected loss' (EL) and 'unexpected loss' (UL) in credit risk management?

Answer: EL is absorbed by loan pricing and reserves; UL requires economic capital as a buffer

Banks price EL into lending spreads and cover it with loan loss provisions; economic capital is held against UL to absorb losses beyond expectations.

A firm uses a collar strategy to hedge commodity price risk. Which combination of instruments does this involve?

Answer: Buying a put option and selling a call option on the same underlying

A collar involves purchasing a put (floor) for downside protection and selling a call (cap) to offset the premium, limiting both downside and upside.