Financial Risk Management Risk Measurement and Analytics 2

Question 1

Monte Carlo simulation in risk management is used to:

Accepted Answer

Generate thousands of random scenarios to build a loss distribution for complex portfolios

Answer

Monte Carlo simulation generates many random market paths using assumed statistical processes to build empirical distributions of portfolio losses, especially for non-linear instruments.

Question 2

What is 'volatility clustering' and why is it relevant to risk models?

Accepted Answer

The empirical pattern where high-volatility periods tend to be followed by more high-volatility periods

Answer

Volatility clustering means risk is time-varying; GARCH models capture this by allowing volatility to evolve dynamically based on recent market observations.

Question 3

Risk-adjusted return on capital (RAROC) is used to:

Accepted Answer

Measure the return earned per unit of economic capital, enabling comparison across business lines

Answer

RAROC = risk-adjusted return / economic capital, enabling apples-to-apples comparison of profitability across activities with different risk profiles.

Question 4

What is a copula in financial risk modeling?

Accepted Answer

A statistical function that links marginal distributions to model joint dependency structures

Answer

A copula separates the modeling of marginal distributions from their dependency structure, allowing flexible modeling of joint extreme events between risk factors.

Question 5

The 'Sharpe ratio' measures:

Accepted Answer

Risk-adjusted return defined as excess return per unit of total volatility

Answer

Sharpe ratio = (Portfolio Return − Risk-Free Rate) / Portfolio Standard Deviation, measuring return earned per unit of total risk taken.

Financial Risk Management Practice Test

Financial Risk Management Practice Test

Financial Risk Management Risk Measurement and Analytics 2