Review and Assessment Flashcards

A review of economic capital versus regulatory capital concludes that economic capital is:

Answer: An internal estimate of capital needed for the bank's actual risk profile

Economic capital is the institution's own assessment of capital required to remain solvent given its specific risks.

Assessing a wrong-way risk situation, what is the defining characteristic?

Answer: Exposure rises as counterparty credit quality deteriorates

Wrong-way risk occurs when exposure to a counterparty increases precisely as its default probability rises.

A review of a VaR model uses a 250-day backtest with 4 breaches at 99%. Under Basel's traffic-light approach this falls in which zone?

Answer: Green zone (acceptable)

At 99% over 250 days, up to 4 exceptions place the model in the green zone, indicating acceptable accuracy.

When assessing interest rate risk in the banking book, which measure captures long-term value sensitivity?

Answer: Economic value of equity (EVE)

EVE measures the present-value sensitivity of the bank's equity to interest rate changes over the long term.

A risk review identifies that a strategy has negative skew and positive carry. What is the typical hidden danger?

Answer: Steady small gains punctuated by rare large losses

Negative-skew carry strategies often earn small steady profits but are exposed to infrequent severe losses.

Reviewing risk governance, the 'three lines of defense' model places independent risk management in which line?

Answer: Second line (risk management and compliance)

The second line of defense consists of risk management and compliance functions that oversee the first line.

An assessment of a leverage ratio finds it is non-risk-based. Why did Basel III add it alongside risk-weighted capital?

Answer: As a backstop against model risk and excessive leverage

The leverage ratio serves as a simple, non-risk-based backstop that limits buildup of leverage and guards against model error.