Advanced Topics Flashcards

Under Basel III, which capital buffer is designed to be built up in good times and released during periods of stress to reduce procyclicality?

Answer: Countercyclical capital buffer

The countercyclical capital buffer is varied by national regulators to lean against credit-driven booms and is released in downturns.

A risk manager uses a Cornish-Fisher expansion when computing VaR primarily to adjust for what feature of the return distribution?

Answer: Skewness and kurtosis

The Cornish-Fisher expansion modifies the normal quantile to account for non-zero skewness and excess kurtosis.

In a CDO structure, which tranche absorbs the first losses from the underlying collateral pool?

Answer: Equity tranche

The equity tranche is the most subordinated and takes the first losses, giving it the highest expected return and risk.

The liquidity coverage ratio (LCR) requires banks to hold enough high-quality liquid assets to survive a stress period of how many days?

Answer: 30 days

The LCR ensures sufficient HQLA to cover net cash outflows over a 30-day stress scenario.

Which model is most commonly associated with estimating the probability of default from equity prices using the firm's asset value and volatility?

Answer: Merton structural model

The Merton model treats equity as a call option on firm assets, deriving default probability from asset value and volatility.

Expected shortfall (ES) is generally preferred over VaR as a risk measure mainly because ES is:

Answer: A coherent risk measure that is subadditive

Expected shortfall satisfies subadditivity and the other coherence axioms, which VaR can violate.

In the Basel framework, which approach for operational risk capital was retained under Basel III, replacing the AMA and earlier basic/standardized methods?

Answer: Standardized Measurement Approach (SMA)

Basel III consolidated operational risk capital into a single Standardized Measurement Approach based on a business indicator and loss history.