Financial Risk Management Market Risk Management 3

Question 1

Expected Shortfall (ES), also called CVaR, is superior to VaR because it:

Accepted Answer

Satisfies all four properties of a coherent risk measure, unlike VaR

Answer

ES is a coherent risk measure satisfying subadditivity, monotonicity, positive homogeneity, and translation invariance—properties VaR violates.

Question 2

What is basis risk in hedging?

Accepted Answer

The residual risk when the hedging instrument does not perfectly offset the exposure being hedged

Answer

Basis risk arises because the price of the hedging instrument may not move in perfect correlation with the exposure, leaving residual risk.

Question 3

In scenario analysis for market risk, a 'reverse stress test' involves:

Accepted Answer

Starting with a catastrophic outcome and identifying scenarios that could cause it

Answer

Reverse stress tests work backward from a near-failure outcome to identify plausible market scenarios that could cause such losses.

Question 4

Which of the following is an example of specific (idiosyncratic) market risk?

Accepted Answer

A single company's stock dropping due to an earnings miss

Answer

Idiosyncratic risk is unique to a specific company or security and can be reduced through diversification, unlike systematic market risk.

Question 5

The 'Greeks' measure vega as:

Accepted Answer

Sensitivity of option price to changes in implied volatility

Answer

Vega measures how much an option's price changes for each 1% point change in implied volatility.

Financial Risk Management Practice Test