Financial Risk Management Risk Measurement and Analytics

Question 1

What is the difference between 'expected loss' and 'unexpected loss' in risk management?

Accepted Answer

Expected loss is the average anticipated loss priced into products; unexpected loss requires capital as a buffer

Answer

Expected loss is for credit risk only; unexpected loss applies to market and operational risk

Answer

Expected loss uses historical data; unexpected loss uses scenario analysis exclusively

Answer

Expected loss triggers provisioning; unexpected loss is written off immediately

Question 2

Backtesting a VaR model involves:

Accepted Answer

Comparing VaR forecasts against actual trading P&L to assess model accuracy

Answer

Running VaR calculations backward in time using current market parameters

Answer

Re-running historical stress scenarios with updated portfolio compositions

Answer

Testing whether VaR captures more risk than Expected Shortfall for the same portfolio

Question 3

In risk management, what is the concept of 'fat tails' (leptokurtosis)?

Accepted Answer

A distribution where extreme losses occur more frequently than predicted by a normal distribution

Answer

A portfolio that has excessive exposure to long-dated assets at the far end of the yield curve

Answer

The widening of credit spreads on bonds with long maturities during risk-off periods

Answer

A characteristic of VaR models that causes them to overstate small, frequent losses

Question 4

What is economic capital in the context of financial risk management?

Accepted Answer

The capital a firm estimates it needs to absorb unexpected losses at a specified confidence level

Answer

The total equity capital raised by a financial institution from shareholders

Answer

The minimum capital required by regulators under Basel III Pillar 1 rules

Answer

The difference between book value of equity and market capitalization

Question 5

Which measure captures how much a single position contributes to overall portfolio VaR?

Accepted Answer

Component VaR

Answer

Marginal VaR

Answer

Incremental VaR

Answer

Diversified VaR

Question 6

The 'correlation coefficient' in portfolio risk is important because:

Accepted Answer

It measures the degree to which two asset returns move together, affecting portfolio diversification

Answer

It determines the exact probability of simultaneous defaults in a credit portfolio

Answer

It is used to calculate the VaR of non-linear instruments like options

Answer

It quantifies the sensitivity of a bond's price to interest rate changes