CTP Financial Risk Management 5 — Questions and Answers
Question 1: Which of the following is NOT a typical component of a corporate risk management policy statement?
- Approved hedging instruments and counterparties
- Specific profit targets from speculative trading positions (Correct answer)
- Reporting requirements and frequency
- Delegated authority levels for executing transactions
Correct answer: Specific profit targets from speculative trading positions
Corporate risk management policies govern hedging of existing exposures, not speculation; profit targets from speculative trading would be inconsistent with a hedging mandate.
Question 2: The Dodd-Frank Act's clearing and reporting mandates for OTC derivatives were primarily intended to:
- Eliminate all bilateral OTC derivatives transactions
- Reduce systemic risk by increasing transparency and moving standard contracts to CCPs (Correct answer)
- Lower the cost of hedging for corporate end-users
- Require all derivatives to be exchange-traded
Correct answer: Reduce systemic risk by increasing transparency and moving standard contracts to CCPs
Dodd-Frank mandated central clearing for standardized OTC derivatives and trade reporting to swap data repositories to increase market transparency and reduce systemic risk.
Question 3: A pension fund manager notices that the fund's liability duration is 15 years but its asset portfolio duration is only 8 years. To reduce this duration gap, the manager should:
- Sell long-dated bonds and buy short-dated bonds
- Enter receive-fixed interest rate swaps with long maturities (Correct answer)
- Buy interest rate caps
- Sell Treasury bond futures
Correct answer: Enter receive-fixed interest rate swaps with long maturities
Receiving fixed in a long-dated swap increases the portfolio's effective duration, narrowing the gap between asset and liability duration.
Question 4: A company discovers that it has inadvertently created a 'speculative position' rather than a qualifying hedge under ASC 815. The immediate accounting consequence is that:
- The derivative must be terminated immediately
- All fair value changes of the derivative must flow through earnings each period (Correct answer)
- The derivative is reclassified as a held-to-maturity security
- The gain or loss is frozen in OCI until requalification
Correct answer: All fair value changes of the derivative must flow through earnings each period
Derivatives that do not qualify for hedge accounting under ASC 815 are marked to market with all changes recorded directly in the income statement each reporting period.
Question 5: In risk management, 'rollover risk' most commonly refers to:
- The risk that interest rates increase before debt can be refinanced
- The risk that a hedge cannot be rolled forward at acceptable cost or terms (Correct answer)
- The risk of foreign exchange losses when hedges are renewed
- The risk that short-term borrowing facilities are not renewed
Correct answer: The risk that a hedge cannot be rolled forward at acceptable cost or terms
Rollover risk in a hedging context is the risk that expiring hedge contracts cannot be replaced or rolled forward under favorable terms, leaving exposure temporarily unhedged.
Question 6: When using Monte Carlo simulation for risk analysis, increasing the number of simulation trials primarily improves:
- The accuracy of the underlying probability distribution assumption
- The statistical precision and stability of the risk estimates (Correct answer)
- The speed of the computation
- The qualitative judgment of the risk analyst
Correct answer: The statistical precision and stability of the risk estimates
More simulation trials reduce sampling error and produce more statistically stable estimates of risk metrics like VaR, but they do not correct flawed distributional assumptions.
Question 7: Which of the following represents an operational risk rather than a financial market risk in a treasury context?
- A sudden rise in SOFR increasing borrowing costs
- A trader entering a transaction in the wrong currency due to a system error (Correct answer)
- A decline in the dollar weakening the value of foreign receivables
- A counterparty defaulting on a swap payment
Correct answer: A trader entering a transaction in the wrong currency due to a system error
Operational risk arises from failures in people, processes, or systems; a transaction entry error is a process/system failure, not a market price movement.
CTP Financial Risk Management 5
Which of the following is NOT a typical component of a corporate risk management policy statement?