Financial Risk Management Advanced 5

Question 1

What is the primary distinction between specific risk and general market risk in trading book capital requirements?

Accepted Answer

Specific risk relates to individual issuers; general market risk relates to broad market movements

Answer

Specific risk capital covers idiosyncratic credit and event risk of individual issuers, while general market risk capital covers broad interest rate, equity, FX, and commodity moves.

Question 2

In a Copula-based credit portfolio model, the Gaussian copula was widely criticized after 2008 primarily because:

Accepted Answer

It severely underestimated tail dependence and joint default probabilities during stress

Answer

The Gaussian copula assumes asset correlations remain constant and underestimates the tendency for multiple credits to default together in tail scenarios, a fatal flaw in structured products.

Question 3

A bank's Net Stable Funding Ratio (NSFR) is defined as:

Accepted Answer

Available Stable Funding divided by Required Stable Funding ≥ 100%

Answer

NSFR = ASF / RSF ≥ 100%; it ensures a bank has sufficient stable funding to support its assets and off-balance-sheet activities over a one-year horizon.

Question 4

In the context of market microstructure risk, what does 'adverse selection' refer to for a market maker?

Accepted Answer

Trading with informed counterparties who have superior information about the true asset value

Answer

Adverse selection risk means the market maker systematically trades with better-informed counterparties, suffering losses as prices move against the quoted position.

Question 5

Which of the following best describes a 'convexity adjustment' needed when pricing interest rate derivatives?

Accepted Answer

A correction to forward rate pricing due to the non-linear relationship between bond prices and yields

Answer

Convexity adjustments correct for the asymmetric (non-linear) price-yield relationship of bonds, particularly important when pricing futures versus forwards on interest rates.

Financial Risk Management Practice Test

Financial Risk Management Practice Test

Financial Risk Management Advanced 5