Financial Risk Management Financial Risk Management MCQ 5

Question 1

Which of the following describes 'model risk' in financial risk management?

Accepted Answer

The risk that a financial model is incorrectly specified, implemented, or used, leading to flawed decisions

Answer

Model risk arises when a model contains errors in its assumptions, mathematics, implementation, or application, potentially causing material losses or mispricing.

Question 2

A firm uses a variance-covariance (parametric) VaR model. Which assumption is fundamental to this approach?

Accepted Answer

Asset returns are normally distributed

Answer

The parametric VaR approach assumes normally distributed returns, allowing VaR to be computed analytically using the mean, standard deviation, and a standard normal z-score.

Question 3

In risk management, what does a 'risk appetite statement' define?

Accepted Answer

The types and amounts of risk the organization is willing to accept in pursuit of its objectives

Answer

A risk appetite statement articulates the level and types of risk a firm is prepared to accept, guided by its business strategy and stakeholder expectations.

Question 4

Which of the following is an example of 'market liquidity risk'?

Accepted Answer

An investor unable to sell a large position without significantly moving the market price

Answer

Market liquidity risk is the risk that a position cannot be sold quickly enough at a fair price, often because the position is too large relative to the market's depth.

Question 5

The 'probability of default' (PD) in credit risk models is typically estimated over which time horizon for regulatory capital purposes?

Accepted Answer

One year

Answer

Under Basel IRB approaches, PD is conventionally estimated as the one-year probability of default, representing the likelihood a borrower defaults within the next 12 months.

Financial Risk Management Practice Test

Financial Risk Management Practice Test

Financial Risk Management Financial Risk Management MCQ 5