Financial Risk Management Risk Measurement and Analytics

Question 1

What is the difference between 'expected loss' and 'unexpected loss' in risk management?

Accepted Answer

Expected loss is the average anticipated loss priced into products; unexpected loss requires capital as a buffer

Answer

Expected loss is the average loss built into pricing and provisions; unexpected loss is the deviation above expected that economic capital is designed to absorb.

Question 2

Backtesting a VaR model involves:

Accepted Answer

Comparing VaR forecasts against actual trading P&L to assess model accuracy

Answer

Backtesting compares the VaR estimate with actual daily P&L outcomes to assess whether exceptions (losses exceeding VaR) occur at the modeled frequency.

Question 3

In risk management, what is the concept of 'fat tails' (leptokurtosis)?

Accepted Answer

A distribution where extreme losses occur more frequently than predicted by a normal distribution

Answer

Fat tails describe return distributions with excess kurtosis where extreme events occur more often than a normal distribution would predict, understating risk if normality is assumed.

Question 4

What is economic capital in the context of financial risk management?

Accepted Answer

The capital a firm estimates it needs to absorb unexpected losses at a specified confidence level

Answer

Economic capital is internally calculated based on the firm's own risk models to absorb unexpected losses at a high confidence level (e.g., 99.9%), independent of regulatory minima.

Question 5

Which measure captures how much a single position contributes to overall portfolio VaR?

Accepted Answer

Component VaR

Answer

Component VaR allocates total portfolio VaR to individual positions, showing each position's contribution including diversification effects.

Financial Risk Management Practice Test

Financial Risk Management Practice Test

Financial Risk Management Risk Measurement and Analytics