CRA Financial Risk Assessment 2 — Questions and Answers
Question 1: Which metric best captures the potential loss in a portfolio during a market stress event beyond normal volatility?
- Expected Shortfall (CVaR) (Correct answer)
- Standard Deviation
- Beta Coefficient
- Sharpe Ratio
Correct answer: Expected Shortfall (CVaR)
Expected Shortfall (CVaR) measures average loss beyond the VaR threshold, making it better than VaR for capturing tail risk during stress events.
Question 2: A bank's loan portfolio has a 1-year probability of default (PD) of 2% and loss given default (LGD) of 45%. What is the expected loss rate?
- 0.90% (Correct answer)
- 2.25%
- 0.45%
- 4.50%
Correct answer: 0.90%
Expected Loss = PD × LGD = 0.02 × 0.45 = 0.009 = 0.90%.
Question 3: Which approach to credit risk modeling uses historical default data and transition matrices to estimate future credit migration?
- CreditMetrics (Correct answer)
- KMV Model
- CreditRisk+
- Merton Structural Model
Correct answer: CreditMetrics
CreditMetrics, developed by J.P. Morgan, uses credit migration matrices and historical data to estimate portfolio credit risk across rating transitions.
Question 4: A financial institution notices that two major trading counterparties are both exposed to the same sovereign debt. This illustrates which type of credit risk concentration?
- Sectoral concentration risk (Correct answer)
- Single-name concentration risk
- Wrong-way risk
- Correlation risk
Correct answer: Sectoral concentration risk
Sectoral concentration risk arises when multiple counterparties share common exposure to the same industry or asset class, amplifying potential correlated defaults.
Question 5: Under the Basel III framework, the Liquidity Coverage Ratio (LCR) is designed to ensure banks can survive a stress scenario lasting how long?
- 30 days (Correct answer)
- 7 days
- 90 days
- 1 year
Correct answer: 30 days
The LCR requires banks to hold enough high-quality liquid assets to cover net cash outflows over a 30-day stress period.
Question 6: Which financial risk assessment technique simulates thousands of random scenarios to model the distribution of portfolio outcomes?
- Monte Carlo simulation (Correct answer)
- Historical simulation
- Delta-normal method
- Factor analysis
Correct answer: Monte Carlo simulation
Monte Carlo simulation generates thousands of random scenarios based on assumed distributions to model portfolio risk across a full range of outcomes.
Question 7: When assessing a company's financial risk, a Debt Service Coverage Ratio (DSCR) below 1.0 indicates what?
- The company cannot cover debt payments from operating income (Correct answer)
- The company has excessive equity
- The company's debt is investment grade
- The company has strong liquidity
Correct answer: The company cannot cover debt payments from operating income
A DSCR below 1.0 means operating income is insufficient to service debt obligations, signaling significant financial distress risk.
CRA Financial Risk Assessment 2
Which metric best captures the potential loss in a portfolio during a market stress event beyond normal volatility?