Explication:
According to the Law of One Price. identical assets selling in different locations should
be priced identically in the different locations. For example, assume the common stock of
CH Inc. is listed on both the NYSE and NASDAQ.
Explication:
The number of factors to include in a factor model should be as small as possible, yet still
capture the priced sources of nondiversifiable (or systematic) risk. The simplest version of
the model consists ofjust one macro factor: the single-factor model.
Explication:
The factor beta, equals the sensitivity of the stock return to a i-unit change in the factor.
Explication:
The mean—variance efficient market portfolio is essential to the capital asset pricing
model, but is not required in multifactor models.
Explication:
The action of buying an asset in the cheaper market and simultaneously selling that
asset in the more expensive market is called arbitrage.
Explication:
The firm-specific return, is the portion ofthe stock's return that is unexplained by macro
factors lie, the F terms in the equation).
Explication:
According to the Basel Committee on Banking Supervision, risk data aggregation means
“defining, gathering and processing risk data according to the bank's risk reporting
requirements to enable the bank to measure its performance against its risk tolerance/
appetite."
Explication:
During the global financial crisis that began in 2007, many banks were unable to quickly
and accurately identify concentrations of risk across business lines and at the bank group
level due, in part, to an inability to aggregate risk exposures and report bank-wide risks
effectively.
Explication:
The derivation ofthe single—factor security market line does not rely on the assumption
that a mean-variance efficient market portfolio exists. This is in contrast with the capital
asset pricing model, which relies on the existence of the mean—variance efficient market
portfolio.
Explication:
Systems should be in place to produce aggregated risk data quickly in stress/crisis
situations for all critical risks. Critical risks include, but are not limited to:
— Aggregated credit exposures to large corporate borrowers.
— Counterparty credit risk exposures, including derivatives.
—Trading exposures, positions, and operating limits.
— Market concentrations by region and sector.
— Liquidity risk indicators.
—Time-critical operational risk indicators.
Explication:
An arbitrage situation exists if a risk-free, zero net investment can be created that
produces a positive profit. The arbitrage return need not exceed the risk-free rate.
Explication:
To ensure the accuracy of risk reports the bank should:
- Create reasonableness checks 0 f the data.
- Define the processes used to create risk reports.
- Create error reports that identify, report, and explain weaknesses or errors in the
data.
- Include descriptions of mathematical and logical relationships in the data that
should be verified.
Explication:
A factor portfolio is a well—diversified portfolio that has a factor beta equal to one for a
single risk factor, and factor betas equal to zero on the remaining factors. By shorting the
hedge portfolio, the investor will offset the factor risks ofthe original portfolio. In this case,
the 0.40 and 0.50 exposures to the two risk factors are offset by the short position in the
hedge portfolio that also has 0.40 and 0.50 exposures to the two risk factors.
Explication:
Bank supervisors should be satisfied that the bank's risk reporting is sufficient in terms of
coverage, analysis, and comparability across institutions. A risk report should include, but
not be limited to, information regarding:
— Credit risk.
— Market risk.
— Liquidity risk.
— Operational risk.
- Results 0 f stress tests.
— Capital adequacy.
— Regulatory capital.
- Liquidity projections.
— Capital projections.
— Risk concentrations.
- Funding plans.
Explication:
Factor portfolios can be used to hedge multiple risk factors by combining the original
portfolio with offsetting positions in the factor portfolios.
Explication:
Record level consistency is consistency between one set of data values and another set
within the same record. Temporal level consistency is consistency between one set of
data values and another set within the same record at different points in time.
Explication:
Governance principles for risk data aggregation relate to overall bank processes and the
roles of senior management and the board in supporting risk data aggregation and
reporting. Data sources relate to the accuracy and integrity of the data, not governance.
In addition, the bank should strive to have a single source for risk data, not multiple
sources.
Explication:
Data aggregation and risk reporting practices should be:
Independently reviewed and validated by individuals with expertise in information
technology (IT) and data and risk reporting functions.
Fully documented.
Unaffected by the bank’s structure. Specifically, decisions regarding data aggregation
and reporting should be independent of the bank's physical location or geographical
presence and/or legal organization.
Considered when the firm undergoes new initiatives, including new product
development, acquisitions, and/or divestitures.
Explication:
Principle 2, data architecture and infrastructure, requires that risk data aggregation and
reporting practices should be a part of the bank's planning processes and subject to
business impact analysis. Banks should establish integrated data classifications and
architecture across the banking group. Multiple data models may be used as long as
there are robust automated reconciliation measures in place. In addition, data
architecture should include information on data characteristics (metadata) and naming
conventions for legal entities, counterparties, customers, and account data.
Explication:
Excess return for Chrome is 12% — 2% = 10%.
Chromes Sharpe ratio is 10% / 5% = 2.0.
Excess return for Nickel is given as 8%. Nickel’s Sharpe ratio is 8% / 4% = 2.0
An investor should be indifferent between these two funds because they provide the
same expected excess return per unit of risk.
Explication:
Hamanaka established a dominant long position in futures contracts and simultaneously
purchased large quantities of physical copper. As well, to help finance his long copper
positions, he even sold put options on copper. In essence, here was a “triple long" strategy
that would only pay off if the price of copper or copper futures increased. At the same
time, there was a huge risk of losses should the prices fall. Unfortunately, there was a
continuation of plummeting copper prices after other copper traders began selling their
copper holdings in anticipation of Sumitomo doing the same. The end result was total
losses of $2.6 billion for Sumitomo.
Explication:
Risk metrics aid the management process by providing managers a target to achieve
(e.g., a particular VaR level).
Explication:
Some risks may not be known explicitly, but they can still be accounted for. In this case,
risk management can still be successful. Also, not knowing the risks themselves but
understanding the results of the risk (i.e., the distribution of returns) can be adequate for
successful risk management.
Explication:
A risk-free asset is a security that has a return known ahead oftime, so the variance of the
return is zero.
Explication:
This universally agreed upon optimal risky portfolio is called the market portfolio, M, and
it is defined as the portfolio of all marketable assets weighted in proportion to their
relative market values.
