Financial Risk Management Advanced 3

Question 1

Which of the following best describes the 'wrong-way risk' in counterparty credit risk?

Accepted Answer

Exposure increases precisely when counterparty creditworthiness deteriorates

Answer

Wrong-way risk arises when the exposure to a counterparty is positively correlated with the counterparty's probability of default, amplifying potential losses.

Question 2

In a variance-covariance VaR model, increasing the holding period from 1 day to 10 days scales VaR by which factor (assuming i.i.d. returns)?

Accepted Answer

√10 ≈ 3.162

Answer

Under the square-root-of-time rule for i.i.d. returns, VaR scales by the square root of the holding period, so 1-day VaR × √10 gives the 10-day VaR.

Question 3

Which liquidity risk metric measures the time it would take to liquidate a portfolio under stressed market conditions?

Accepted Answer

Liquidity-Adjusted VaR (LVaR)

Answer

LVaR incorporates bid-ask spreads and market depth to estimate losses from unwinding positions over a realistic liquidation horizon under stress.

Question 4

A credit default swap (CDS) with a notional of $10M and a 200 bps spread requires annual premium payments of:

Accepted Answer

$200,000

Answer

Annual premium = Notional × CDS spread = $10,000,000 × 0.0200 = $200,000.

Question 5

Under FRTB (Fundamental Review of the Trading Book), which risk measure replaces VaR as the primary internal model metric?

Accepted Answer

Expected Shortfall at 97.5%

Answer

FRTB mandates Expected Shortfall at 97.5% confidence (calibrated to a stressed period) in place of the previous 99% VaR, better capturing tail risk.

Financial Risk Management Practice Test

Financial Risk Management Practice Test

Financial Risk Management Advanced 3