Financial Risk Management Market Risk Management 2 — Questions and Answers
Question 1: What is the 'Greeks' in options risk management?
- Ancient financial philosophers who invented derivatives
- Sensitivity measures that describe how an option's price changes with market variables (Correct answer)
- Regulatory capital ratios for options positions
- The set of mathematical models used for pricing European options
Correct answer: Sensitivity measures that describe how an option's price changes with market variables
The Greeks (delta, gamma, theta, vega, rho) quantify how an option's value responds to changes in underlying price, time, volatility, and interest rates.
Question 2: Gamma risk in options refers to:
- The risk that implied volatility will increase sharply
- The risk that the delta of an option changes as the underlying price moves (Correct answer)
- Interest rate sensitivity of options on bonds
- The daily time decay of option premium
Correct answer: The risk that the delta of an option changes as the underlying price moves
Gamma measures the rate of change of delta, so high gamma means delta is unstable and the position requires frequent re-hedging.
Question 3: Under the Basel III framework, what is the Fundamental Review of the Trading Book (FRTB)?
- A review of all trading book positions for accounting purposes
- A revised market risk capital framework replacing the internal models approach (Correct answer)
- A stress test required quarterly for all US banks
- The process for reclassifying assets between banking and trading books
Correct answer: A revised market risk capital framework replacing the internal models approach
FRTB is Basel III's revamped market risk capital standard, replacing VaR with Expected Shortfall and tightening internal model standards.
Question 4: What is 'wrong-way risk' in the context of market risk?
- Risk arising from incorrect model parameters in VaR calculations
- The risk that exposure to a counterparty increases as the counterparty's creditworthiness deteriorates (Correct answer)
- Trading losses caused by erroneous order entry
- Basis risk between hedging instrument and the exposure being hedged
Correct answer: The risk that exposure to a counterparty increases as the counterparty's creditworthiness deteriorates
Wrong-way risk occurs when credit exposure to a counterparty is positively correlated with the counterparty's probability of default.
Question 5: A portfolio manager uses a duration of 5 years for a bond portfolio. If interest rates rise by 100 basis points, the approximate price change is:
- -0.5%
- -5% (Correct answer)
- +5%
- -50%
Correct answer: -5%
The approximate price change equals negative duration times the change in yield, so −5 × 0.01 = −5%.
Question 6: Which approach for market risk VaR uses actual historical market returns without distributional assumptions?
- Monte Carlo simulation
- Historical simulation (Correct answer)
- Parametric (variance-covariance) method
- Delta-normal approach
Correct answer: Historical simulation
Historical simulation applies actual past returns to the current portfolio to estimate the distribution of possible losses without assuming normality.
Financial Risk Management Market Risk Management 2
What is the 'Greeks' in options risk management?