Financial Risk Management Advanced 4

Question 1

What does the Incremental Risk Charge (IRC) in Basel 2.5 capture that standard VaR does not?

Accepted Answer

Default and migration risk for credit-sensitive positions in the trading book

Answer

IRC was introduced to capture the default and credit migration risk for unsecuritized credit products in the trading book over a one-year horizon at 99.9% confidence.

Question 2

In extreme value theory (EVT), the Generalized Pareto Distribution (GPD) is used to model:

Accepted Answer

The distribution of losses that exceed a high threshold

Answer

EVT uses GPD to fit the tails of loss distributions, specifically modeling observations that exceed a high threshold to better estimate extreme quantiles like VaR and ES.

Question 3

A firm's operational risk capital under the Basel III Standardized Approach (SA) is primarily driven by:

Accepted Answer

Business Indicator (BI) scaled by an Internal Loss Multiplier

Answer

The Basel III SA uses the Business Indicator (a proxy for revenue) multiplied by marginal coefficients and an Internal Loss Multiplier based on the firm's historical losses.

Question 4

Which of the following is a key assumption of the Merton structural model of credit risk?

Accepted Answer

A firm defaults when asset value falls below the face value of debt at maturity

Answer

In the Merton model, equity is a call option on firm assets; default occurs if asset value falls below debt face value at the debt's maturity date.

Question 5

Gamma risk in options trading refers to:

Accepted Answer

The rate of change of delta with respect to the underlying price

Answer

Gamma measures how much delta changes for a unit move in the underlying, indicating the curvature of the option's price-underlying relationship.

Financial Risk Management Practice Test

Financial Risk Management Practice Test

Financial Risk Management Advanced 4