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investment risk management

Questions and Answers of Investment Risk Management

Explain the circumstances under which VaR would be a “good” risk measure.
Discuss VaR’s advantages and disadvantages.
Explain what a “good” risk measure should be and relate it to the coherency axioms.
Discuss the weighting schemes of VaR, ES, and a spectral risk measure and relate these weighting schemes to the “utility” function of the risk manager.
Identify the potential disadvantages of spectral risk measures.
Discuss the potential dangers of regulating financial markets using VaR and other risk measures.
Assume that the interest rate sensitivities of a financial institution’s assets and liabilities are perfectly matched. Discuss whether the institution has a zero-interest rate risk.
Discuss whether the following statement is correct: For direct foreign exchange risk calculations, off-balance sheet positions need to be excluded from the net open position.
Identify which type of foreign exchange solvency risk is larger for most banks—direct or indirect—and explain why.
Discuss the differences between a “pure” and “macro” interbank contagion test.
Discuss whether the following statement is correct: The “worst-case approach” to stress testing allows for creating more stressful scenarios than the “threshold approach.”
Discuss the nature of financial intermediation.
Identify several factors that drive financial innovation.
Define regulatory arbitrage.
Discuss the primary objectives of the Basel Accords.
Discuss the importance of measuring risk in a way that is consistent with the criterion used for asset allocation.
Discuss why VaR is not a coherent risk measure and why having coherence risk measures is important.
Discuss why dollar weights differ from risk weights in a portfolio.
Some contend that the method used to compound returns is important, but others argue that compounding, high (low) returns always leads to high (low) returns. Thus, the method is irrelevant as long as
Explain the difference between VaR and CVaR.
Maximum drawdowns become more severe as more data become available. Discuss whether this statement implies that risk increases over time.
Discuss countering views as to whether a higher or lower negative Sharpe ratio is better.
Stochastic dominance implies that if the same return can be obtained with two different investments, X and Y, yet the likelihood of a return exceeding a threshold α is greater for X, investors will
Relative to the Kappa index, considerable debate exists about which order, and threshold values are best for ranking funds. Indicate what the following options imply: (a) A higher Kappa order
Discuss the advantages and disadvantages of using VaR as a risk measurement.
Discuss the consequences of using drawdown to evaluate a manager’s ability.
Discuss why considering performance attribution alone can be misleading in evaluating portfolio performance. Identify what the process lacks to be consistent with financial theory.
Discuss why risk attribution is defined by tracking-error volatility decomposition and not by volatility decomposition.
Discuss the different decompositions of the standard deviation of the tracking error.
Discuss why risk attribution applied to Markowitz efficient portfolios does not lead to perfect consistency with performance attribution.
Discuss an issue arising when undertaking risk-adjusted performance attribution.
Discuss borrower and property characteristics that lenders should consider in qualifying someone for a mortgage.
Describe differences between the CFPB’s ability to repay standards and the “affordability products” originated in the subprime market.
Discuss how the over valuation of properties contributed to the housing bubble associated with the financial crisis of 2007–2008 and how CRAs are now attempting to determine sustainable home prices.
Describe the difference between a loan issued under the ATR standard and one that is classified as a Qualified Mortgage.
Using the Merton (1974) model, describe how credit risk embedded in corporate debt can be understood as an option.
Summarize three measures that the ISDA undertook to mitigate the credit risk inherent in OTC derivatives.
List and describe the three components of a unilateral CVA.
Using a vanilla interest-rate swap, describe the determinants of CVA for both counterparties.
Describe the circumstances leading to including CVA in the Basel III Accord and how the CVA requirement might be expected to alleviate future problems.
List and explain several examples of hedge fund downside and drawdown risk measures.
Discuss the advantages of risk-adjusted returns relative to absolute return measures. In particular, compare and contrast the Sharpe ratio with the Sortino, Sterling, and Calmar ratios.
Discuss the nonlinear payoff structure of hedge fund returns and provide an example of how hedge fund returns need to be adjusted for risk in this case.
Discuss the possible types and the importance of operational risks for managing hedge fund risks. Provide an example of how to quantify operational risks in the hedge fund context.
Distinguish between a call option and a put option.
Explain how exchange-traded options differ from OTC options.
Define the separation and full-hedging theorems.
Explain why the separation and full-hedging theorems hold in the context of the competitive firm under output price uncertainty.
Identify possible reasons that support the hedging role of options.
When themultiplicative revenue shock prevails, the competitive firm optimally uses options for hedging purposes. Identify the key factors that drive the firm to include options in its optimal hedge
Comment on the validity of the following statement. “A naive ratio of one is completely useless for hedging. Either find the optimal hedge ratio or don’t hedge at all.”
Discuss whether hedging is useless in markets where the commodity is not storable given the lack of a relationship tying the futures price to the spot price.
Discuss whether an airline company can hedge its oil demand given that jet oil futures do not trade with sufficient liquidity on the exchanges.
Describe how hedgers can use weather futures and commodity futures to hedge both price and quantity risk simultaneously.
Explain why some hedging techniques might be superior to others.
Mowal Plc. is offered a bank loan at a fixed rate of 6 percent or a floating rate of LIBOR + 0.5 percent. Sika Ltd. can borrow at a floating rate of LIBOR + 0.25 percent or a fixed rate of 5.25
Discuss the main benefits of entering into a swap contract involving a financial intermediary.
Al Maya Plc. can borrow capital at a fixed rate of 8.5 percent or a floating rate of LIBOR + 0.5 percent. Dil Plc. has been offered a fixed rate of 7.75 percent and a floating rate of LIBOR + 0.25
Discuss the effects of using a swap on a firm’s risk exposure.
Describe credit default swaps and their benefits for risk management in banking and finance.
With basis risk and unbiased futures markets, the optimal hedge with credit derivatives is a fixed proportion of the exposure. Discuss why this result is important for risk management in banking and
Discuss how hedge performance can be measured.
Discuss why the use of credit derivatives by banks may be limited.
Explain why a banking firm might consider the business cycle of the economy when devising its optimal hedging strategy with credit derivatives.
Assume an offshore FX derivative market is unavailable for Dominican Republic Peso (DOP) and a corporation approaches a commercial bank offshore to sell its DOPrevenues and buy USD. Determine the
Discuss why the existence of a well-developed capital market is considered a perquisite or at least a crucial parameter for the development of a derivative market.
Summarize some of the factors driving differences between offshore and onshore yield curves.
Discuss the two phases in which crises are usually divided.
Define systemic risk and explain how it can be mitigated.
Discuss the difference between economic capital and regulatory capital.
Define the “Minsky moment” and discuss how this is important to identify crises.
Discuss the main objective of ERM.
Define risk appetite and discuss why financial institutions should focus on it.
Define regulatory risk and identify five major regulations that are likely to have the largest impact on the future of risk management.
Define the two most common risk measures in terms of global use and describe differences between these measures including limitations and benefits.
Indicate whether derivatives are a risky or safe risk management tool and provide evidence that derivatives add value to a firm.
Discuss the unique characteristics of two risk management objectives on risk manager’s wish lists.

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