Financial Risk Management Market Risk Measurement 3

Question 1

Which of the following best describes 'stress testing' in market risk management?

Accepted Answer

Evaluating portfolio performance under extreme but plausible adverse scenarios

Answer

Calculating VaR at a 99.9% confidence level

Answer

Running Monte Carlo simulations with 10,000 paths

Answer

Backtesting a model against 250 days of historical data

Question 2

What is backtesting in the context of VaR models?

Accepted Answer

Comparing predicted VaR estimates to actual observed losses to validate the model

Answer

Recalculating VaR using a longer data window

Answer

Stress testing a portfolio against historical market crashes

Answer

Adjusting VaR for liquidity horizons

Question 3

Under the Basel traffic-light backtesting framework, a bank in the 'red zone' (10+ exceptions in 250 days) faces which consequence?

Accepted Answer

Capital surcharge multiplication factor of up to 4.0 applied to market risk capital

Answer

No action required

Answer

Automatic model approval

Answer

Mandatory switch to historical simulation VaR

Question 4

What is 'liquidity-adjusted VaR' (LVaR)?

Accepted Answer

VaR that incorporates the additional cost of unwinding a position over a liquidation horizon longer than one day

Answer

VaR that excludes illiquid positions entirely

Answer

VaR computed using only liquid instruments as proxies

Answer

VaR adjusted for bid-ask spread on day one only

Question 5

What is the 'square root of time' rule used for in market risk?

Accepted Answer

To convert a one-day VaR estimate to a multi-day VaR estimate by scaling by the square root of the number of days

Answer

To scale annual volatility down to daily volatility

Answer

To calculate the correlation between two assets over different time horizons

Answer

To determine the convexity adjustment for long-dated options

Question 6

Which of the following is a key assumption underlying the parametric (variance-covariance) VaR approach?

Accepted Answer

Portfolio returns are normally distributed and positions are linear

Answer

Returns follow a fat-tailed distribution

Answer

Correlations between assets are zero

Answer

Historical scenarios recur exactly in the future