2019 CFA level 3 qbank reading 31 risk management answers

10/12/2018 Learning Management System Question #1 of 92 Which of the following is a source of nancial risk? A) Operations B) Taxes C) Commodity prices Explanation in This is true by de nition The sources of nancial risk are: liquidity risk, credit risk, commodity prices, equity prices, exchange rates, interest rates en tre (Study Session 16, Module 31.1, LOS 31.d) Related Material Question #2 of 92 bo ok c SchweserNotes - Book m Which of the following is NOT a practical bene t of the value at risk framework? B) Hedging .o A) Identi cation of risk factors w w C) Comparability across asset classes Explanation w While value at risk may indicate risks that need to be hedged, it is not a hedging tool as such (Study Session 16, Module 31.2, LOS 31.g) Related Material SchweserNotes - Book Question #3 of 92 Which of the following describes the form of stress testing referred to as factor push analysis? https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 1/53 10/12/2018 Learning Management System A) The impact on the portfolio is measured by examining an input at an extreme level B) The e ect on the portfolio from simultaneous changes in several factors is examined C) All factors are examined at levels that in ict the most damage on the portfolio Explanation Related Material Question #4 of 92 bo ok c SchweserNotes - Book en tre (Study Session 16, Module 31.2, LOS 31.h) in In factor push analysis, a factor or factors are pushed to an extreme to examine the impact on the portfolio In scenario analysis, the e ect on the portfolio from simultaneous changes in several factors is examined, which provides several di erent scenarios In maximum loss optimization, the risk factors that have the greatest potential impact on the portfolio are identi ed Once the factors are identi ed, procedures are put in place to limit their impact In worst-case scenario analysis, all factors are pushed to their most damaging impact on the portfolio Factor push analysis, maximum loss optimization, and worst-case scenario analysis are all forms of stressing models m The minimum amount of money that one could expect to lose with a given probability over a o speci c period of time is the de nition of: A) delta w w B) the hedge ratio w C) value at risk (VAR) Explanation This is an often-used de nition of VAR (Study Session 16, Module 31.2, LOS 31.e) Related Material SchweserNotes - Book Question #5 of 92 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 2/53 10/12/2018 Learning Management System Suppose that in a currency swap, counterparty A makes a payment to counterparty B who, unbeknownst to A, defaults on the payment that is due at the same time to A This is called: A) settlement risk B) accounting risk C) liquidity risk Explanation This is a classic example of settlement risk (Study Session 16, Module 31.1, LOS 31.d) in Related Material en tre SchweserNotes - Book bo ok c Question #6 of 92 The long position of a forward contract bears the credit risk if the market price of the underlying is: A) greater than the exercise price m B) less than the exercise price w w Explanation o C) equal to the exercise price This is true because the long position will be in-the-money, which means there is a possibility of not being paid what is owed w (Study Session 16, Module 31.3, LOS 31.i) Related Material SchweserNotes - Book Question #7 of 92 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 3/53 10/12/2018 Learning Management System BigBank engages in foreign exchange transactions They have just provided a forward contract to a major multinational corporation that allows the corporation to sell Swiss francs in 90 days They have also entered into a currency swap that allows them to receive Japanese yen in exchange for paying U.S dollars Furthermore, they are in the process of selling a large position in Canadian dollars in the spot market Which of the following risks is NOTexplicitly mentioned in these series of transactions by BigBank? A) Herstatt risk B) Liquidity risk C) Operations risk .in Explanation bo ok c en tre Operations risk is the potential for failures in the rm's operating systems due to personnel, technological, mechanical, or other problems Although BigBank is sure to have exposure to operations risk, it is not explicitly described in these transactions Herstatt risk or settlement risk is the possibility that one party could default on a contract while the other is settling This has been a problem in foreign exchange markets due to time di erences and is certainly possible in BigBank's currency swap Liquidity risk refers to the potential for sustaining losses due to the inability to sell or buy a position quickly BigBank's sale of the Canadian dollars is subject to liquidity risk (Study Session 16, Module 31.1, LOS 31.d) Related Material o m SchweserNotes - Book w w Question #8 of 92 w All of the following are considered to be strengths of the historical value at risk (VAR) methodology EXCEPT: A) no variance/covariance matrix is required B) no assumption regarding a normal returns distribution is required C) minimal data is needed Explanation Historical VAR requires a lot of returns data, which may not be available for some asset classes (Study Session 16, Module 31.2, LOS 31.f) Related Material https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 4/53 10/12/2018 Learning Management System SchweserNotes - Book Question #9 of 92 Which of the following most accurately describes the relationship between computing internal capital requirements using a stress testing approach versus a value at risk (VAR) capital strength approach? Stress testing approaches: A) can never be combined with VAR approaches because they are based on di erent in probability distributions of potential outcomes en tre B) are substitutes for VAR approaches since they better measure the entire spectrum C) complement VAR approaches since they account for scenarios that may not be properly considered in VAR approaches bo ok c Explanation Since VAR often relies on common probability distributions, it may not properly capture extreme, but possible, events Stress testing involves evaluating the e ects that these events would have on the institution and then establishing capital requirement based on the ndings The two approaches are natural complements m (Study Session 16, Module 31.4, LOS 31.m) o Related Material w w w SchweserNotes - Book Question #10 of 92 In the Sortino ratio, the excess return is divided by the: A) standard deviation using only the returns below a minimum level B) maximum drawdown C) standard deviation Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 5/53 10/12/2018 Learning Management System The Sortino ratio examines the downside risk of returns It is calculated as the portfolio return minus the minimum acceptable return (MAR) divided by a standard deviation that only uses returns below the MAR It is similar to the target semivariance Both remaining responses refer to other measures of risk-adjusted performance The Sharpe ratio divides the excess return above the risk-free rate by the standard deviation An example of a riskadjusted return on invested capital (RAROC) measure would be to divide the portfolio's expected return by the VAR The RoMAD (return over maximum drawdown) is the average portfolio return divided by the maximum drawdown Drawdown refers to the percentage di erence between the highest and lowest portfolio values during a period (Study Session 16, Module 31.4, LOS 31.l) Related Material en tre in SchweserNotes - Book Question #11 of 92 A) Setting portfolio risk limits bo ok c Which of the following is NOT an appropriate application of VAR for portfolio managers? B) Identi cation of key portfolio risks C) Determining the rm’s total VAR by summing the individual business unit’s VARs m Explanation w w o Value at risk (VAR) is useful to compare performance of di erent business units with di erent asset classes and risk characteristics because VAR is interpreted the same regardless of the assets in question VAR can be used in risk budgeting where upper management allocates VAR across the di erent business units and the goal is to maximize return for the allocated VAR The total VAR for the rm is normally not the sum of each business unit's VAR due to the correlation between business units being less than 1, i.e., less than perfectly correlated w (Study Session 16, Module 31.2, LOS 31.g) Related Material SchweserNotes - Book Question #12 of 92 A disadvantage of the Monte Carlo method for calculating value at risk is that: A) it requires the normality assumption https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 6/53 10/12/2018 Learning Management System B) all of these choices are correct C) it is computationally intensive Explanation For the Monte Carlo method, the advantages are that it does not require the normality assumption, and it is exible insofar as it can accommodate a variety of assumptions regarding complex relationships The main disadvantage is that it is often computationally intensive (Study Session 16, Module 31.2, LOS 31.f) Related Material in SchweserNotes - Book en tre Sheila Myers, CFA, has recently been promoted from analyst to Senior Vice President of Risk Management at Treetop Investment Inc Myers recently attained her CFA charter While studying for the exams, she became very interested in risk measurement and management bo ok c Previously, the focus of her career was on fundamental equity analysis Myers recently attended a conference on risk measurement techniques including the concept of value at risk (VAR) She learned that many managers and nance professionals are using VAR as a measure of asset, project, and portfolio risk Rick Bishop, the key presenter at the conference on topics related to VAR, de ned VAR as "the minimum amount of money that a m rm could expect to lose with a given probability over a speci c period of time." One participant o asked "I thought VAR was the maximum loss the rm could expect Am I incorrect in this assumption?" Bishop replied that in its most basic form, VAR is de ned as the largest potential w w portfolio loss over a given period of time with a certain level of probability He went on to explain that a portfolio manager might compute the value at risk for his portfolio over the next w months at $5 million with percent probability What this means is that over the next months, there is a percent probability that the portfolio will lose $5 million or more Alternatively, it can be said that over the next three months there is a 99 percent chance that the most the portfolio will lose is $5 million Sarah George asked Bishop "Is VAR comparable across various asset classes managed by the rm?" A second participant, Ben Cooper, says that he has heard that VAR is "relatively incomparable across managers" Myers attended a session on the use of VAR to evaluate credit risk The session leader, Justin Banks, said that while it is possible to use VAR in credit risk analysis, the interpretation is somewhat di erent He said, "Credit risk increases as the value of positions held increases." https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 7/53 10/12/2018 Learning Management System Myers then replied "I see what you're implying We must thus focus on the lower tail of the distributions of gains on positions held when using VAR to evaluate credit risk." Blake Smith held a panel session on stress testing He indicated that the best use of stress testing in VAR analysis is to "vary the inputs to the VAR estimation process a little bit and analyze the impact of this movement on the computed VAR." Georgia Burns said that it is "stress testing the return generating process used to develop the scenarios or paths in Monte Carlo analysis" An entire session was devoted to estimating VAR There are several methods that may be used including the historical method, the Monte Carlo simulation method, and the variance- in covariance method Session panel members were asked to discuss the advantages and disadvantages of each method of estimation Jane Blatt said "the key disadvantage of the en tre historical method is that we have to assume normally distributed returns." Jim McAdams said "a key advantage of the Monte Carlo simulation method is that it can accommodate the required assumptions for complex relationships." Finally, Beth Berry said "the key disadvantage what can occur in the future." bo ok c of the variance-covariance method is that it assumes that past performance is representative of After the seminar, Myers was intrigued by the power of VAR but was apprehensive about actually adopting VAR as a risk measurement tool She asked Bishop to identify the most m fundamental problem with estimating VAR .o Question #13 of 92 w w Bishop, in response to George's question regarding comparability across asset classes, is most likely to respond that VAR: w A) measures risk comparably across asset classes B) does not measure risk comparably across asset classes C) measures risk comparably across asset classes that have normal distributions (i.e., there are no embedded options) Explanation VAR measures risk comparably across asset classes The result is that with VAR, the risk of a bond portfolio can be compared against the risk of an equity portfolio It is quite versatile in a portfolio management context This is one of VAR's key strengths (Study Session 16, Module 31.2, LOS 31.g) Related Material https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 8/53 10/12/2018 Learning Management System SchweserNotes - Book Question #14 of 92 In response to Cooper's statement regarding VAR's incomparability across managers, Myers is most likely to: A) disagree and add that the characteristics of a competitor's portfolio can be estimated through VAR modeling techniques en tre C) agree and add that this is due to its inherent model risk .in B) agree and add that it is because of the complexity of the calculations involved Explanation bo ok c VAR is relatively incomparable across managers due to its inherent model risk For example, two people can be given an assignment to compute the VAR for the same underlying asset and the results will likely be di erent due to the use of di erent methodologies and model assumptions Neither answer is necessarily wrong The bottom line here is that peer group evaluation using VAR is not very useful unless one can be sure that the same VAR techniques and assumptions are used to evaluate all portfolios (Study Session 16, Module 31.2, LOS 31.g) w w o SchweserNotes - Book m Related Material w Question #15 of 92 With respect to the use of stress testing in VAR analysis, Burns and Smith are, respectively: A) correct; incorrect B) incorrect; incorrect C) incorrect; correct Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 9/53 10/12/2018 Learning Management System Burns is incorrect and Smith is incorrect A particular VAR estimate is based on a given model and its parameters In stress testing (or scenario analysis), the analyst varies the inputs to the VAR estimation process sometimes to the extreme and analyzes the impact of this movement on the computed VAR Stress testing is "what if" analysis, and its main contribution is that it shows how reliable a particular VAR estimate is (Study Session 16, Module 31.2, LOS 31.g) Related Material SchweserNotes - Book in Question #16 of 92 en tre In response to Myers' question about the most fundamental problem associated with estimating VAR, Bishop is most likely to reply that the main problem is: A) that VAR calculations depend on symmetrical payout pro les portfolio under evaluation bo ok c B) the inability to accurately derive the "true" probability distribution for the asset or C) the lack of available data to compute VAR Explanation o m The fundamental problem with VAR analysis is that the analyst must estimate the "true" probability distribution for the asset or portfolio under evaluation This means that in order to give the analyst reliable results, the quantitative model must accurately describe the price process of the asset w w (Study Session 16, Module 31.2, LOS 31.g) Related Material w SchweserNotes - Book Question #17 of 92 Regarding credit risk and VAR, Banks and Myers are, respectively: A) incorrect; correct B) correct; correct C) correct; incorrect https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 10/53 10/12/2018 Learning Management System Which of the common methods of computing value at risk relies on the assumption of normality? A) Variance/covariance B) Historical C) Monte Carlo simulation Explanation The variance/covariance method relies on the assumption of normality (Study Session 16, Module 31.2, LOS 31.f) in Related Material en tre SchweserNotes - Book bo ok c Question #66 of 92 Frank Meinrod is in charge of the risk management committee for Alpha Portfolio Managers Recently, the value of one of the company's bond positions has decreased due to a potential steep rate hike by the Federal Reserve Meinrod believes that the rate hike will be moderate and that the decline in the bond portfolio value is temporary Which of the following is the best m action for Meinrod to take? Meinrod should advise the risk management committee that they o should: w w A) hedge the position by selling interest rate futures B) hedge the position by buying interest rate futures w C) take no action at all Explanation Meinrod should advise the risk management committee that they should take no action at all In most cases, when there is a risk management problem that is viewed as temporary, the best course of action is often to take no action at all (Study Session 16, Module 31.1, LOS 31.b) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 39/53 10/12/2018 Learning Management System Question #67 of 92 Which of the following is a type of market risk? A) Operations risk B) Interest rate risk C) Accounting risk Explanation Market risk can be caused by changes in: interest rates, exchange rates, equity prices, and commodity prices .in (Study Session 16, Module 31.4, LOS 31.j) Related Material bo ok c Question #68 of 92 en tre SchweserNotes - Book One goal of all risk management systems should be to: A) eliminate all risk, i.e., reduce risk to zero m B) make the risk level equal to the prevailing level in the market w w Explanation o C) bring the level of risk to a desired level of risk, which may exceed zero w Since return and risk go together, risk managers should determine the appropriate level of risk that is acceptable The acceptable level should be based upon the nature of the rm and the risk tolerance of the stakeholders Those that manage risk should be separate from those that take the risks (Study Session 16, Module 31.1, LOS 31.a) Related Material SchweserNotes - Book Question #69 of 92 Which of the following regarding an e ective risk management model is least accurate? https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 40/53 10/12/2018 Learning Management System A) When a risk management problem is viewed as a long-run change in fundamentals, corrective action is required B) When a risk management problem is viewed as temporary, the best course of action is often to take no action at all C) Duration and delta are su cient for modeling the risk of bonds and options Explanation Duration and delta by themselves are not su cient measures of bond and option risk Second order e ects (convexity and gamma) must also be considered Risk managers should consider asset sensitivities to factors as well as how those sensitivities change Both remaining responses are correct .in (Study Session 16, Module 31.1, LOS 31.c) en tre Related Material Question #70 of 92 bo ok c SchweserNotes - Book A company has a portfolio composed of several securities with large bid/ask spreads This is an indication that the portfolio has: m A) high liquidity risk, which means high nancial risk .o B) high liquidity risk, but the nancial risk is not a ected w w C) low liquidity risk, but the nancial risk is not a ected Explanation w The bid/ask spread is a good measure of liquidity The larger the spread the greater the liquidity risk Liquidity risk is a subset of nancial risk—the larger the liquidity risk, the larger the nancial risk (Study Session 16, Module 31.1, LOS 31.d) Related Material SchweserNotes - Book Question #71 of 92 Which of the following statements best describes the uses of stress analysis? https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 41/53 10/12/2018 Learning Management System A) Stress analysis has several advantages over a value at risk (VAR) only approach that includes: highlighting inappropriate assumptions, hidden vulnerabilities, and the bili b bl f b bili f b d i B) Stress analysis can be used to enhance VAR analysis by focusing on the extent of loss in an extreme event C) Scenario analysis, which is a special case of stress analysis, su ers from limitations on implementing a consistent and manageable approach Explanation This is the only valid use of stress analysis among the statements listed Both remaining statements either not pertain to uses, even if true in some other context, or are not true .in (Study Session 16, Module 31.2, LOS 31.h) en tre Related Material Question #72 of 92 bo ok c SchweserNotes - Book When describing the risk exposures that an analyst should examine as part of an enterprise risk management system, what terms describe the risks pertaining to the factors that directly External Capital Market w w o Firm/Portfolio Value m a ect rm or portfolio values and the risks associated with external capital markets? Financial risk B) Systematic risk Financial risk C) Market risk Factor risk w A) Market risk Explanation Financial and non- nancial risk factors are general terms Financial risk factors are those associated with external capital markets and the transactions within external markets Nonnancial risk factors capture other types of risk Financial risk factors include market risk, liquidity risk, credit risk, and sovereign risk Market risk pertains to the factors that a ect rm or portfolio values (e.g interest rates, exchange rates, equity prices, commodity prices, etc.) Non- nancial risk factors include settlement (Herstatt) risk, operations risk, model risk, sovereign risk, regulatory risk, and other miscellaneous risk factors Note that sovereign risk has both nancial and non- nancial risk components (Study Session 16, Module 31.1, LOS 31.d) https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 42/53 10/12/2018 Learning Management System Related Material SchweserNotes - Book Question #73 of 92 All of the following are sources of non- nancial risk EXCEPT: A) accounting practices B) regulations Explanation Commodity prices are a source of nancial risk (Study Session 16, Module 31.1, LOS 31.d) SchweserNotes - Book m Question #74 of 92 bo ok c Related Material en tre in C) commodity prices .o Which of the following would NOT be a characteristic of an e ective enterprise risk w w management system? A) Decentralization of risk monitoring and control procedures w B) Allocation of capital on a risk-adjusted basis C) Allowance for all potential combinations of risk factors facing the rm Explanation An e ective enterprise risk management system should provide for performance monitoring by a risk management committee that reports directly to upper management Both remaining responses above are all components of an e ective enterprise risk management system (Study Session 16, Module 31.1, LOS 31.c) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 43/53 10/12/2018 Learning Management System Question #75 of 92 A property that is usually necessary for a risk source to be considered nancial is that it involves: A) money and interest rates only B) a transaction with a party outside the rm C) money only Explanation Financial risks are usually associated with transactions with other parties .in (Study Session 16, Module 31.1, LOS 31.d) en tre Related Material Question #76 of 92 bo ok c SchweserNotes - Book Which of the methods for calculating Value At Risk (VAR) asset managers most commonly use? o B) Historical m A) Monte Carlo simulation w w C) Variance/covariance Explanation w The variance/covariance (or parametric) method is most commonly used by asset managers (Study Session 16, Module 31.2, LOS 31.f) Related Material SchweserNotes - Book Question #77 of 92 Which of the following is the nal step in the risk management process? A) Monitoring the process and taking any necessary corrective actions https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 44/53 10/12/2018 Learning Management System B) Identifying and measuring speci c risk exposures C) Reporting risk exposures (deemed appropriate) to stakeholders Explanation The risk management process is a continual process of: Identifying and measuring speci c risk exposures Setting speci c tolerance levels Reporting risk exposures (deemed appropriate) to stakeholders Monitoring the process and taking any necessary corrective actions (Study Session 16, Module 31.1, LOS 31.a) Related Material en tre in SchweserNotes - Book Question #78 of 92 bo ok c Which of the following would NOT be a characteristic of an e ective enterprise risk management system? A) Identifying all relevant external and internal risk factors m B) Using a model that accounts for changing risk factor sensitivities Explanation o C) Allocating capital according to the returns generated w w w An e ective enterprise risk management system would allocate capital on a risk-adjusted basis Capital should not be allocated solely according to returns without accounting for risk Both remaining responses above are all components of an e ective enterprise risk management system (Study Session 16, Module 31.1, LOS 31.c) Related Material SchweserNotes - Book Question #79 of 92 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 45/53 10/12/2018 Learning Management System A manager wishes to lower the nancial risk of a portfolio She looks at the risks of her portfolio associated with currencies and commodities In attempting to lower the nancial risk associated with her portfolio, she should hedge: A) the risk associated with both currencies and commodities B) the risk associated with currencies, but not commodities since commodities are unrelated to nancial risk C) the risk of neither currencies nor commodities because neither are associated with nancial risk Explanation (Study Session 16, Module 31.1, LOS 31.d) Related Material Question #80 of 92 bo ok c SchweserNotes - Book en tre in Market risk is a subset of nancial risk Market risk includes commodities, currencies, equity prices, and interest rates m All of the following are advantages in Monte Carlo simulation approach to VAR estimation w w A) no model risk .o EXCEPT: B) no assumption needed regarding normality w C) no assumption needed regarding linearity Explanation The historical method of VAR relies on past patterns continuing into the future thus you are extrapolating in a linear fashion into the future The analytical method assumes a normal distribution The Monte Carlo method relies on neither assumption and any distribution or correlation between assets can be used This leads to modeling risk in the Monte Carlo simulation because if your inputs are inaccurate your output will also be inaccurate (Study Session 16, Module 31.2, LOS 31.f) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 46/53 10/12/2018 Learning Management System Question #81 of 92 The method for calculating value at risk that is the simplest and rests heavily on means and variances is the: A) Monte Carlo method B) delta-normal method C) historical method Explanation in The delta-normal method uses means and variances and makes calculations under the assumption that the distribution of returns is normal (Study Session 16, Module 31.2, LOS 31.f) en tre Related Material Question #82 of 92 bo ok c SchweserNotes - Book With respect to value at risk (VAR), regulatory agencies: m A) are studying it, but none have adopted its use .o B) have mandatory requirements in all nancial industries w w C) in some industries require its computation and reporting Explanation w The regulation in some industries address VAR, but many not (Study Session 16, Module 31.2, LOS 31.g) Related Material SchweserNotes - Book Question #83 of 92 Which of the following is NOT a use of stress testing? A) It enables the risk manager to eliminate all risk from a portfolio https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 47/53 10/12/2018 Learning Management System B) It can be used for capital allocation across business units C) Stress testing complements value at risk (VAR) Explanation Stress testing cannot be used to eliminate all risk from a position It only highlights the extent of losses in di erent states and enables contingency planning, which is one of its bene ts (Study Session 16, Module 31.2, LOS 31.h) Related Material in SchweserNotes - Book en tre Question #84 of 92 The practice that imposes current credit risk on a periodic basis to lower potential credit risk is called: bo ok c A) marking to market B) potentiality C) netting m Explanation w w o Marking to market is the best answer This reduces potential credit risk by converting what would otherwise be potential credit risk to current credit risk The credit risk becomes current insofar as the counterparty is required to provide additional collateral immediately (rather than in the future) (Study Session 16, Module 31.4, LOS 31.k) w Related Material SchweserNotes - Book Question #85 of 92 Increasing the relative weight on OTC derivatives relative to the weight on exchange-traded derivatives in a portfolio will: A) have no a ect on credit risk or nancial risk B) increase credit risk but decrease nancial risk https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 48/53 10/12/2018 Learning Management System C) increase credit risk and nancial risk Explanation OTC derivatives have much more credit risk than exchange-traded derivatives, so the credit risk will increase Credit risk is a part of nancial risk; therefore, nancial risk increases too (Study Session 16, Module 31.1, LOS 31.d) Related Material SchweserNotes - Book in Question #86 of 92 en tre As a risk measurement, value at risk may be superior to standard deviation because: A) VAR may capture market participant's attitudes towards risk more completely B) most market participants calculate VAR in the same manner bo ok c C) the statistical properties of VAR are more widely understood Explanation VAR, which measures downside risk, more completely captures the attitudes of many market participants towards risk .o Related Material m (Study Session 16, Module 31.2, LOS 31.g) w w w SchweserNotes - Book Question #87 of 92 The method for calculating value at risk that uses the fewest assumed inputs is the: A) delta-normal method B) Monte Carlo method C) historical method Explanation https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 49/53 10/12/2018 Learning Management System The historical method uses past values and makes no explicit assumptions about inputs It assumes that past patterns are indicative of future patterns (Study Session 16, Module 31.2, LOS 31.f) Related Material SchweserNotes - Book Question #88 of 92 A) is a single and easily understood measure C) has a well-de ned method for calculation Explanation en tre B) measures the maximum amount that can be lost .in Value at risk (VAR) is attractive because it: bo ok c VAR is an easily understood measure, but there are many ways to compute it It is not a measure of the most that can be lost (Study Session 16, Module 31.2, LOS 31.g) Related Material w w o m SchweserNotes - Book Question #89 of 92 w Which methodology for computing value at risk (VAR) relies on the assumption of normally distributed returns? A) Binomial VAR B) Historical VAR C) Variance/Covariance VAR Explanation The variance/covariance VAR methodology relies on the assumption that returns are normally distributed (Study Session 16, Module 31.2, LOS 31.f) https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 50/53 10/12/2018 Learning Management System Related Material SchweserNotes - Book Question #90 of 92 Yoshi Chu and Ryan Dobson have been tasked with creating an enterprise-wide risk management (ERM) system for Reliant Financial Services After creating a centralized data warehousing facility, their next step is creating a useful analytics system Which of the following in features would be least likely included in their system? B) Legal risk analysis C) Derivative valuation models Explanation en tre A) Monte Carlo simulations bo ok c A useful analytics system for an ERM is used for assessing risk, not valuing individual assets The useful system would include several VAR methodologies including historical VAR and Monte Carlo simulation, credit risk analysis, liquidity risk analysis, operational risk analysis, and legal risk analysis Related Material w w o SchweserNotes - Book m (Study Session 16, Module 31.1, LOS 31.a) w Question #91 of 92 https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 51/53 10/12/2018 Learning Management System Robert Meznar is currently employed as a senior software architect in a large established software company He is 38 years old, and his current salary is $80,000 after tax Meznar recently sold his stock (acquired through stock options) in an Internet start up company The entire proceeds of $2 million is held in treasury securities John Snow, CFA, of Capital Associates has been forwarded the le of Meznar to suggest an appropriate portfolio Snow relies heavily on the following forecasts, furnished by the rm, for long term returns for di erent asset classes He has already developed three possible portfolios for Meznar Standard Deviation X 12.0% 16% 40% Non U.S Stocks 14.0 24% U.S Corporate bonds 7.0 10% Municipal Bonds 5.0 8% REIT 14 14% Z 25% 15 25% 60 15 0 20 25 20 25 en tre 30% bo ok c U.S Stock Y in Return Asset Class What may be the lowest value of portfolio Z within the next one year according to value at risk, m at 95% probability given the standard deviation of portfolio Z is 22%? B) $1,760,000 w w C) $1,499,000 .o A) $1,900,000 Explanation w VAR = Vp[Expected return-(z)(standard deviation)] Expected return = (0.25)(12) + (0.25)(14) + (0.25)(5) + (0.25)(14) = 11.25% VAR = 2,000,000[0.1125 − (1.65)(0.22)] = −501,000 2,000,000 − 501,000 = 1,499,000 (Study Session 16, Module 31.2, LOS 31.f) Related Material SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 52/53 10/12/2018 Learning Management System Question #92 of 92 Which of the following is a source of market risk? A) Taxes B) Operations C) Equity prices Explanation There are three types of market risk: interest rates, exchange rates, and equity prices .in (Study Session 16, Module 31.4, LOS 31.j) Related Material w w w o m bo ok c en tre SchweserNotes - Book https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice/qbank/24038518/quiz/83447821/print 53/53 ... https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice /qbank/ 24 038 518/quiz/ 834 47821/print 33 / 53 10/12/2018 Learning Management System C) be used to set risk limits on an absolute level Explanation VAR can be used to set risk limits... Module 31 .2, LOS 31 .g) Related Material https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice /qbank/ 24 038 518/quiz/ 834 47821/print 8/ 53 10/12/2018 Learning Management. .. the current level of risk https://www.kaplanlearn.com/education/dashboard/index/66a9ea0d62bb71ab495925615029a3fd/practice /qbank/ 24 038 518/quiz/ 834 47821/print 31 / 53 10/12/2018 Learning Management