Financial Risk Management Flashcards
7 cards from real Financial Risk Management practice questions. Tap to flip, then mark Knew It or Still Learning — missed cards come back until you master them.
Read the first 7 Financial Risk Management flashcards as text
Which of the following is an example of operational risk as defined by Basel II/III?
Answer: A rogue trader executes unauthorized trades that result in large losses
Operational risk includes losses from inadequate internal processes, people, and systems — unauthorized trading by an employee falls squarely in this category.
What is the 'carry trade' and what is its primary risk?
Answer: Borrowing in a low-yield currency to invest in a high-yield currency; primary risk is sudden exchange rate reversal
A carry trade borrows cheaply in a low-rate currency to invest in a higher-yielding one, but is vulnerable to sudden currency depreciation that wipes out accumulated carry.
A portfolio manager wants to reduce interest rate duration without selling bonds. Which derivative strategy is most appropriate?
Answer: Enter a payer interest rate swap (pay fixed, receive floating)
In a payer swap, the manager pays fixed and receives floating, which offsets the fixed-rate exposure of the bond portfolio and reduces duration.
What does 'model risk' refer to in financial risk management?
Answer: The risk of loss due to incorrect or misused pricing or risk models
Model risk is the potential for financial loss resulting from errors in model development, implementation, or inappropriate application of a model.
Under the standardized approach for credit risk in Basel III, how are risk weights primarily determined?
Answer: External credit ratings from recognized rating agencies
The standardized approach uses external credit ratings from recognized agencies (like Moody's and S&P) to assign risk weights to different exposures.
What is the difference between 'mark-to-market' and 'mark-to-model' valuation?
Answer: Mark-to-market uses observable market prices; mark-to-model uses theoretical pricing models for illiquid instruments
Mark-to-market values positions using current observable market prices, while mark-to-model is used when no reliable market price exists and a pricing model must be used instead.
Which of the following best describes 'rollover risk' in the context of bank funding?
Answer: The risk that short-term liabilities cannot be refinanced when they mature
Rollover risk is the danger that a bank relying on short-term funding cannot renew that funding at maturity, potentially leading to a liquidity crisis.
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