Financial Risk Management Market Risk Measurement 2 — Questions and Answers
Question 1: What is the Greeks term 'Delta' used to measure in options risk?
- Sensitivity of option price to changes in volatility
- Sensitivity of option price to changes in the underlying asset price (Correct answer)
- Sensitivity of option price to the passage of time
- Sensitivity of option price to changes in interest rates
Correct answer: Sensitivity of option price to changes in the underlying asset price
Delta measures how much an option's price changes for a $1 move in the underlying asset, ranging from 0 to 1 for calls and -1 to 0 for puts.
Question 2: Which Greek measures the rate of change of Delta with respect to the underlying asset price?
- Vega
- Theta
- Rho
- Gamma (Correct answer)
Correct answer: Gamma
Gamma measures the curvature of the option price–underlying relationship and is highest for at-the-money options near expiry.
Question 3: What does 'Vega' represent in the context of options risk management?
- Sensitivity to changes in interest rates
- Sensitivity to changes in the underlying dividend yield
- Sensitivity to changes in implied volatility (Correct answer)
- Sensitivity to changes in time to expiry
Correct answer: Sensitivity to changes in implied volatility
Vega quantifies how much an option's value changes for a 1% change in implied volatility, and is always positive for long option positions.
Question 4: What is basis risk in the context of market risk hedging?
- The risk that a hedge instrument moves in the same direction as the exposure
- The risk that the price difference between the hedge instrument and the underlying exposure changes unexpectedly (Correct answer)
- The risk of counterparty default on a futures contract
- The risk of regulatory changes affecting derivative pricing
Correct answer: The risk that the price difference between the hedge instrument and the underlying exposure changes unexpectedly
Basis risk arises when the hedge does not perfectly offset the exposure because the two instruments do not move in lockstep, leaving a residual risk.
Question 5: A portfolio has a duration of 5 years and interest rates rise by 100 bps. Approximately how much does the portfolio value change?
- Increases by 5%
- Decreases by 5% (Correct answer)
- Increases by 0.5%
- Decreases by 0.5%
Correct answer: Decreases by 5%
Using the modified duration approximation, ΔP/P ≈ −Duration × Δy, so a 100 bps rise gives −5 × 0.01 = −5% change in value.
Question 6: What is 'convexity' in fixed income risk management?
- A measure of a bond's credit quality
- A second-order measure of interest rate sensitivity that accounts for the curvature of the price-yield relationship (Correct answer)
- The difference between a bond's coupon rate and its yield to maturity
- The correlation between bond prices and equity prices
Correct answer: A second-order measure of interest rate sensitivity that accounts for the curvature of the price-yield relationship
Convexity improves the duration approximation by capturing the non-linear price response to large interest rate changes, always benefiting long bond holders.
Financial Risk Management Market Risk Measurement 2
What is the Greeks term 'Delta' used to measure in options risk?