CRO Financial Risk Assessment & Mitigation 3 โ Questions and Answers
Question 1: 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?
- Repricing risk (Correct answer)
- Yield curve risk
- Basis risk
- Options risk
Correct answer: Repricing risk
Repricing risk arises from timing differences in when assets and liabilities reprice to current market rates, affecting net interest income.
Question 2: Which collateral arrangement in an OTC derivative contract requires daily posting of collateral based on mark-to-market changes?
- Variation margin (Correct answer)
- Initial margin
- Independent amount
- Threshold amount
Correct answer: Variation margin
Variation margin is exchanged daily (or intraday) to reflect changes in the fair value of outstanding derivative contracts.
Question 3: 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?
- Prepayment risk (Correct answer)
- Extension risk
- Convexity risk
- Basis risk
Correct 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.
Question 4: In a risk-adjusted performance measurement framework, what does RAROC stand for and what does its numerator represent?
- Risk-Adjusted Return on Capital; after-tax risk-adjusted net income (Correct answer)
- Risk-Adjusted Return on Capital; gross revenue before expenses
- Rate-Adjusted Return on Credit; net interest income
- Risk-Adjusted Rate of Capital; economic capital requirement
Correct 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.
Question 5: What is 'wrong-way risk' in counterparty credit risk management?
- The exposure to a counterparty increases precisely when that counterparty is more likely to default (Correct answer)
- A counterparty that hedges in the opposite direction of the firm
- Losses that exceed initial margin posted by the counterparty
- Market risk that cannot be hedged with standard instruments
Correct 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).
Question 6: 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?
- -3.0% (Correct answer)
- +3.0%
- -6.0%
- +0.5%
Correct answer: -3.0%
Price change โ -Modified Duration ร ฮyield = -6 ร 0.005 = -0.03 = -3.0%; prices fall when yields rise.
Question 7: 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?
- Survival horizon (Correct answer)
- Liquidity Coverage Ratio (LCR)
- Net Stable Funding Ratio (NSFR)
- Loan-to-deposit ratio
Correct 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.
CRO Financial Risk Assessment & Mitigation 3
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?