Banking Exam Financial Risk Management 2 — Questions and Answers
Question 1: Which risk metric measures the maximum expected loss over a given time horizon at a specified confidence level?
- Expected Shortfall
- Value at Risk (VaR) (Correct answer)
- Beta coefficient
- Sharpe Ratio
Correct answer: Value at Risk (VaR)
Value at Risk (VaR) quantifies the maximum potential loss over a specific period at a given confidence level, such as 99% over one day.
Question 2: A bank's net interest margin (NIM) is most directly affected by which type of risk?
- Operational risk
- Interest rate risk (Correct answer)
- Liquidity risk
- Reputational risk
Correct answer: Interest rate risk
Interest rate risk directly impacts NIM because changes in rates affect the spread between interest earned on assets and interest paid on liabilities.
Question 3: Under Basel III, what is the minimum Common Equity Tier 1 (CET1) capital ratio required for banks?
- 2.0%
- 4.5% (Correct answer)
- 6.0%
- 8.0%
Correct answer: 4.5%
Basel III mandates a minimum CET1 ratio of 4.5% of risk-weighted assets, representing the highest quality capital buffer.
Question 4: What is 'duration gap' used to measure in banking?
- The difference between short-term and long-term loan volumes
- The sensitivity of a bank's net worth to changes in interest rates (Correct answer)
- The time lag between loan origination and funding
- The gap between regulatory capital and required reserves
Correct answer: The sensitivity of a bank's net worth to changes in interest rates
Duration gap measures the difference between the weighted average duration of assets and liabilities, indicating how sensitive a bank's net worth is to interest rate changes.
Question 5: Which of the following best describes 'concentration risk' in a loan portfolio?
- Risk from holding too many liquid assets
- Excessive exposure to a single borrower, sector, or geography (Correct answer)
- Risk that interest rates will rise faster than expected
- The risk that collateral values will decline
Correct answer: Excessive exposure to a single borrower, sector, or geography
Concentration risk arises when a bank has excessive exposure to a single counterparty, industry, or region, making losses highly correlated.
Question 6: A bank experiences unexpected large cash withdrawals that it cannot immediately fund. This scenario describes which type of risk?
- Credit risk
- Market risk
- Liquidity risk (Correct answer)
- Settlement risk
Correct answer: Liquidity risk
Liquidity risk is the risk that a bank cannot meet its short-term financial obligations due to inability to convert assets to cash quickly.
Question 7: What does 'Expected Loss' (EL) in credit risk modeling equal?
- PD × LGD × EAD (Correct answer)
- VaR × Confidence Interval × Time Horizon
- Capital Ratio × Risk-Weighted Assets
- NIM × Total Assets
Correct answer: PD × LGD × EAD
Expected Loss equals Probability of Default multiplied by Loss Given Default multiplied by Exposure at Default, forming the core of credit risk measurement.
Banking Exam Financial Risk Management 2
Which risk metric measures the maximum expected loss over a given time horizon at a specified confidence level?