CBP Financial Risk Management 2 — Questions and Answers
Question 1: A bank's Value at Risk (VaR) at the 99% confidence level over a 10-day horizon is $5 million. What does this mean?
- There is a 1% chance losses will exceed $5M over 10 days (Correct answer)
- The bank will lose exactly $5M in 10 days
- The bank's expected loss over 10 days is $5M
- There is a 99% chance losses will exceed $5M
Correct answer: There is a 1% chance losses will exceed $5M over 10 days
VaR at 99% confidence means there is a 1% probability that losses will exceed the stated amount over the specified horizon.
Question 2: Which stress testing approach applies historical market scenarios (e.g., the 2008 financial crisis) directly to the current portfolio?
- Monte Carlo simulation
- Historical simulation (Correct answer)
- Sensitivity analysis
- Reverse stress testing
Correct answer: Historical simulation
Historical simulation replays actual past market movements against the current portfolio to estimate potential losses.
Question 3: Credit Default Swaps (CDS) are primarily used by banks to:
- Increase interest rate exposure
- Transfer credit risk to a third party (Correct answer)
- Hedge foreign exchange risk
- Reduce liquidity requirements
Correct answer: Transfer credit risk to a third party
A CDS allows the protection buyer to transfer the credit risk of a reference entity to the protection seller in exchange for periodic premiums.
Question 4: The Liquidity Coverage Ratio (LCR) requires banks to hold enough High Quality Liquid Assets (HQLA) to survive a stress scenario of how many days?
- 7 days
- 14 days
- 30 days (Correct answer)
- 90 days
Correct answer: 30 days
Under Basel III, the LCR requires banks to maintain HQLA sufficient to cover net cash outflows over a 30-day stress period.
Question 5: In the context of market risk, 'Greeks' refer to:
- Credit rating agencies in Europe
- Sensitivity measures of option prices to various factors (Correct answer)
- Regulatory capital ratios under Basel III
- Counterparty default probability metrics
Correct answer: Sensitivity measures of option prices to various factors
The Greeks (Delta, Gamma, Vega, Theta, Rho) measure how an option's price changes in response to changes in underlying variables.
Question 6: Which risk arises when a bank cannot easily sell or liquidate an asset without significantly affecting its price?
- Funding liquidity risk
- Market liquidity risk (Correct answer)
- Operational risk
- Settlement risk
Correct answer: Market liquidity risk
Market liquidity risk (asset liquidity risk) occurs when an asset cannot be traded quickly enough in the market without causing a significant price impact.
Question 7: A bank with a Tier 1 Capital Ratio of 7% under Basel III would be classified as:
- Well-capitalized
- Adequately capitalized (Correct answer)
- Undercapitalized
- Critically undercapitalized
Correct answer: Adequately capitalized
Under Basel III, a Tier 1 Capital Ratio of at least 6% is required for adequate capitalization, while well-capitalized requires at least 8%.
CBP Financial Risk Management 2
A bank's Value at Risk (VaR) at the 99% confidence level over a 10-day horizon is $5 million.
What does this mean?