Review and Assessment Flashcards
7 cards from real FRM practice questions. Tap to flip, then mark Knew It or Still Learning — missed cards come back until you master them.
Read the first 7 Review and Assessment flashcards as text
When assessing credit risk, what does Expected Loss (EL) equal?
Answer: PD × LGD × EAD
Expected Loss is the product of Probability of Default, Loss Given Default, and Exposure at Default.
A review of a duration-based hedge finds it fails for large rate moves. What property explains this?
Answer: Convexity, the curvature of the price-yield relationship
Duration is a linear approximation; convexity captures the curvature that matters for large yield changes.
In assessing liquidity risk, the Liquidity Coverage Ratio (LCR) ensures a bank can survive how long under stress?
Answer: 30 days
The LCR requires enough high-quality liquid assets to cover net cash outflows over a 30-day stress period.
A risk committee reviews a trade with high gamma. What does high gamma imply about hedging?
Answer: The delta hedge needs frequent rebalancing
High gamma means delta changes rapidly with the underlying, requiring frequent rebalancing of the hedge.
An assessment of correlation assumptions during a crisis should account for which phenomenon?
Answer: Correlations often rise toward 1 in crises (correlation breakdown)
In stress periods, asset correlations frequently spike, reducing diversification benefits when they are needed most.
Reviewing a Sharpe ratio comparison, which adjustment improves assessment when returns are non-normal?
Answer: Consider downside-risk measures like the Sortino ratio
The Sortino ratio penalizes only downside volatility, better reflecting risk when return distributions are skewed.
A model review notes the use of historical simulation for VaR. What is its main drawback?
Answer: It assumes the future resembles the chosen historical window
Historical simulation assumes past observed returns are representative of future risk, which may not hold.