Questions and Answers of Risk Management Financial

Suppose that the assets of a bank consist of $200 million of retail loans (not mortgages). The PD is 1% and the LGD is 70%. What are the risk-weighted assets under the Basel II IRB approach? What are
What are the three major components of Basel II.5?
What are the six major components of Basel III?
What is the difference between VaR as it has been traditionally measured and stressed VaR?
Explain how the incremental risk charge is calculated. Why was it introduced by the Basel Committee?
What is the difference between the capital required for a AAA-rated ABS with principal of $100 million and a AAA-rated ABS CDO with a principal of $100 million using the standardized approach?
By how much has the Tier 1 equity capital (including the capital conservation buffer) increased under Basel III compared with the Tier 1 equity capital requirement under Basel I and II?
Suppose that the Tier 1 equity ratio for a bank is 6%. What is the maximum dividend, as a percent of earnings, that can be paid if (a) there is no countercyclical buffer and (b) there is a 2.5%
Explain how the leverage ratio differs from the usual capital ratios calculated by regulators.
Explain how the liquidity coverage ratio and the net stable funding ratio are defined.
What is CVA? What new regulations concerning CVA were introduced in Basel III?
Explain how CoCo bonds work. Why are they attractive to (a) banks and (b) regulators?
A bank has the following balance sheet: Cash Treasury Bonds (> 1 yr) Corporate Bonds Rated A Mortgages Small Business Loans ( 1 yr) 60 Tier 2 Capital 10 Tier 1 Capital 100 25 15 44 4 3 9. 100
Outline the differences between the way market risk capital is calculated in (a) Basel I, (b) Basel II.5, and (c) the FRTB.
What are the advantages of expected shortfall over value at risk?
What types of risk are included in business risk?
What determines the confidence level used by a AA-rated financial institution in its economic capital calculations?
In what respects are the models used to calculate economic capital for market risk, credit risk, and operational risk likely to be different from those used to calculate regulatory capital?
A bank is considering expanding its asset management operations. The main risk is operational risk. It estimates the expected operational risk loss from the new venture in one year to be $2 million
RAROC can be used in two different ways. What are they?
Explain the terms disintermediation and reintermediation.
What is meant by (a) machine learning and (b) distributed ledger technologies?
Explain how P2P lending and equity crowdfunding work.
Why might a central bank switch from fiat money to digital money?
When thinking about the impact of FinTech, financial institutions should be thankful for regulation.” Explain.
“Index funds are a great idea, but if everyone chose them there would be no price discovery.” Do you agree with this argument?
What is meant by RegTech? Give some examples.
“Banks should aim to respond to change like IBM, not like Kodak.” Discuss this statement.
Explain how machine learning is changing the way lending decisions are made. What are the risks in relying on machine learning algorithms for these decisions?
The delta of a derivatives portfolio dependent on an index is −2,100. The index is currently 1,000. Estimate what happens to the value of the portfolio when the index increases to 1,005.
The vega of a derivatives portfolio dependent on the dollar– sterling exchange rate is 200 (per %). Estimate the effect on the portfolio of an increase in the volatility of the exchange rate from
The gamma of a delta‐neutral portfolio is 30. Estimate what happens to the value of the portfolio when the price of the underlying asset (a) suddenly increases by $2 and (b) suddenly decreases by
“Static options replication assumes that the volatility of the underlying asset will be constant.” Explain this statement.
Suppose that a trader using the static options replication technique wants to match the value of a portfolio of exotic derivatives with the value of a portfolio of regular options at 10 points on a
Why is an Asian option easier to hedge than a regular option?
Explain why there are economies of scale in hedging options.
An investment has probabilities 0.1, 0.2, 0.35, 0.25, and 0.1 of giving returns equal to 40%, 30%, 15%, −5%, and −15%. What are the expected returns and the standard deviations of returns?
For the two investments considered in Figure 1.2 and Table 1.2, what are the alternative risk‐return combinations if the correlation is (a) 0.3, (b) 1.0, and (c) −1.0? Table 1.2,Figure 1.2 ww2
What is the difference between systematic and nonsystematic risk? Which is more important to an equity investor? Which can lead to the bankruptcy of a corporation?
Outline the arguments leading to the conclusion that all investors should choose the same portfolio of risky investments. What are the key assumptions?
The capital structure decision of a company is a trade‐off between bankruptcy costs and the tax advantages of debt.” Explain this statement.
Arbitrage pricing theory is an extension of the capital asset pricing model.” Explain this statement.
What is meant by risk aggregation and risk decomposition? Which requires an in‐depth understanding of individual risks? Which requires a detailed knowledge of the correlations between risks?
A bank's profit next year will be normally distributed with a mean of 0.6% of assets and a standard deviation of 1.5% of assets. The bank's equity is 4% of assets. What is the probability that the
Why do you think that banks are regulated to ensure that they do not take too much risk but most other companies (for example, those in manufacturing and retailing) are not?
List the bankruptcy costs incurred by the company in Business Snapshot 1.1. BUSINESS SNAPSHOT 1.1 The Hidden Costs of Bankruptcy: A Hypothetical Scenario Several years ago, a company had a market
The return from the market last year was 10% and the risk‐ free rate was 5%. A hedge fund manager with a beta of 0.6 has an alpha of 4%. What return did the hedge fund manager earn?
How did concentration in the U.S. banking system change between 1984 and 2022?
What government policies led to the large number of small community banks in the United States?
What risks does a bank take if it funds long‐term loans with short‐term deposits?
Suppose that an out‐of‐control trader working for DLC Bank (see Tables 2.2 and 2.3) loses $7 million trading foreign exchange. What do you think would happen? Table 2.2 Summary Balance Sheet for
What is meant by net interest income?
Explain the terms “private placement” and “public offering.” What is the difference between “best efforts” and “firm commitment” for a public offering?
The bidders in a Dutch auction are as follows: The number of shares being auctioned is 150,000. What is the price paid by investors? How many shares does each investor receive? Bidder Number of
What is the attraction of a Dutch auction over the normal procedure for an IPO? In what ways was Google's IPO different from a standard Dutch auction?
Management sometimes argues that poison pills are in the best interests of shareholders because they enable management to extract a higher price from would‐be acquirers. Discuss this argument.
Give three examples of the conflicts of interest in a large bank. How are conflicts of interest handled?
What is the difference between the banking book and the trading book?
How has accounting for loans changed since the 2007– 2008 Global Financial Crisis?
What is the originate‐to‐distribute model?
Explain the meaning of variable life insurance and universal life insurance.
A life insurance company offers whole life and annuity contracts. In which contracts does it have exposure to (a) longevity risk, (b) mortality risk?
“Equitable Life gave its policyholders a free option.” Explain the nature of the option.
Use Table 3.1 to calculate the minimum premium an insurance company should charge for a $1 million two‐year term life insurance policy issued to a woman age 50. Assume that the premium is paid at
From Table 3.1, what is the probability that a man age 30 will live to 90? What is the same probability for a woman age 30? Table 3.1 Mortality Table from 2019 Data Male Age (Years) 0 1 2 3 30 31
What features of the policies written by a property‐casualty insurance company give rise to the most risk?
How does health insurance in the United States differ from that in Canada and the United Kingdom?
An insurance company decides to offer individuals insurance against losing their jobs. What problems is it likely to encounter?
Why do property‐casualty insurance companies hold more capital than life insurance companies?
Explain what is meant by “loss ratio” and “expense ratio” for a property‐casualty insurance company. “If an insurance company is profitable, it must be the case that the loss ratio plus
Suppose that in a certain defined benefit pension plana. Employees work for 40 years earning wages that increase with inflation.b. They retire with a pension equal to 75% of their final salary.
What is the difference between an open‐end and closed‐end mutual fund?
How is the NAV of an open‐end mutual fund calculated? When is it calculated?
What are the two NAVs of a closed‐end mutual fund? Are they usually the same?
What is an index fund? How is it created?
What is a mutual fund's (a) front‐end load and (b) back‐end load?
Explain how an exchange‐traded fund that tracks an index works. What are the advantages of an exchange‐traded fund over (a) an open‐end mutual fund and (b) a closed‐end mutual fund?
What is the difference between the geometric mean and the arithmetic mean of a set of numbers? Why is the difference relevant to the reporting of mutual fund returns?
Explain the meaning of (a) late trading, (b) market timing, (c) front running, and (d) directed brokerage.
Give three examples of the rules that apply to mutual funds, but not to hedge funds.
If 70% of convertible bond trading is by hedge funds, I would expect the profitability of that strategy to decline.” Discuss this viewpoint.
Explain the meanings of the terms hurdle rate, high–water mark clause, and clawback clause when used in connection with the incentive fees of hedge funds.
It is important for a hedge fund to be right in the long term. Short‐term gains and losses do not matter.” Discuss this statement.
he risks that hedge funds take are regulated by their prime brokers.” Discuss this statement.
An investor enters into a short forward contract to sell 100,000 British pounds for U.S. dollars at an exchange rate of 1.3000 U.S. dollars per pound. How much does the investor gain or lose if the
What is the difference between the over‐the‐counter market and the exchange‐traded market? Which of the two markets do the following trade in: (a) a forward contract, (b) a futures contract,
A company has money invested at 3% for five years. It wishes to use the swap quotes in Table 5.5 to convert its investment to a floating‐rate investment. Explain how it can do this. Table 5.5
A company has borrowed money for five years at 5%. Explain how it can use the quotes in Table 5.5 to convert this to a floating‐rate liability. Table 5.5 Swap Quotes Made by a Market Maker
A company has a liability that costs the floating‐rate plus 1%. Explain how it can use the quotes in Table 5.5 to convert this to a three‐year fixed‐rate liability. Table 5.5 Swap Quotes Made
An airline executive has argued: “There is no point in our hedging the price of jet fuel. There is just as much chance that we will lose from doing this as that we will gain.” Discuss the
Does a knock‐out barrier call option become more or less valuable as the frequency with which the barrier is observed is increased?
Explain how a 5 × 8 option contract on electricity for May 2024 with daily exercise works. Explain how a 5 × 8 option contract on electricity for May 2024 with monthly exercise works. Which is
A U.S. investor writes five call option contracts (i.e., options to buy 500 shares). The option price is $3.50, the strike price is $60, and the stock price is $57. What is the initial margin
A trader shorts 500 shares of a stock when the price is $50. The initial margin is 160% and the maintenance margin is 130%. How much margin is required from the investor initially? How high does the
What is the difference between the margin required by an exchange from one of its members for a future contract and the margin required by a broker from one of its clients?
A trader buys 200 shares of a stock on margin. The price of the stock is $20 per share. The initial margin is 60% and the maintenance margin is 30%. How much money does the trader have to provide
A company's investments earn the floating‐rate minus 0.5%. Explain how it can use the quotes in Table 5.5 to convert them to (a) three‐, (b) five‐, and (c) ten‐year fixed‐rate
What is the difference between using an ISDA master agreement and using a CCP for clearing OTC derivative transactions?
Explain the new regulations introduced since the 2007– 2008 Global Financial Crisis that (a) require certain derivative transactions to be cleared using CCPs and (b) require extra collateral for
Why might the regulations introduced since the 2007–2008 Global Financial Crisis create liquidity problems for some financial institutions?

Showing 100 - 200 of 446