Chapter 6 - Risk

Question 1

What is risk in investment operations?

Answer 1

The possibility of financial loss due to uncertainty in markets, counterparties, or processes.

Question 2

Why is risk management important in financial markets?

Answer 2

To minimize losses, maintain market stability, and comply with regulations.

Question 3

What are the main categories of risk in securities operations?

Answer 3

Market risk, credit risk, liquidity risk, operational risk, systemic risk, and legal/regulatory risk.

Question 4

What is the risk-return tradeoff?

Answer 4

The principle that higher potential returns come with higher risk.

Question 5

What is diversification?

Answer 5

A strategy to reduce risk by spreading investments across different asset classes.

Question 6

What is market risk?

Answer 6

The risk of financial loss due to fluctuations in market prices.

Question 7

What are the main types of market risk?

Answer 7

Equity risk, interest rate risk, currency risk, and commodity price risk.

Question 8

What is equity risk?

Answer 8

The risk that stock prices will decline, reducing portfolio value.

Question 9

What is interest rate risk?

Answer 9

The risk that changes in interest rates will affect bond prices and investment returns.

Question 10

What is currency risk (foreign exchange risk)?

Answer 10

The risk of financial loss due to changes in exchange rates.

Question 11

How does inflation risk impact investments?

Answer 11

Rising inflation erodes the purchasing power of investment returns.

Question 12

What is duration risk?

Answer 12

The sensitivity of a bond’s price to changes in interest rates.

Question 13

What is Value at Risk (VaR)?

Answer 13

A statistical measure estimating potential portfolio losses over a given period.

Question 14

What is beta in market risk?

Answer 14

A measure of a stock’s volatility relative to the market.

Question 15

What is hedging?

Answer 15

A strategy using derivatives to reduce exposure to price movements.

Question 16

What is credit risk?

Answer 16

The risk that a borrower or counterparty will default on obligations.

Question 17

What is counterparty risk?

Answer 17

The risk that the other party in a trade or contract defaults.

Question 18

What is default risk?

Answer 18

The likelihood that a borrower fails to meet debt payments.

Question 19

What is credit spread risk?

Answer 19

The risk that the difference between corporate and government bond yields changes.

Question 20

How do credit ratings impact credit risk?

Answer 20

Higher credit ratings (AAA) indicate lower risk, while lower ratings (BB or below) indicate higher risk.

Question 21

What are credit default swaps (CDS)?

Answer 21

Financial instruments that transfer credit risk between parties.

Question 22

What is a margin call in securities trading?

Answer 22

A demand for additional funds when an investor’s position falls below the required level.

Question 23

What is collateralization in credit risk management?

Answer 23

The use of assets to secure a loan or trading position.

Question 24

What is a sovereign risk?

Answer 24

The risk that a government will default on its debt obligations.

Question 25

What is exposure in credit risk?

Answer 25

The total amount of money at risk with a particular borrower or counterparty.

Question 26

What is liquidity risk?

Answer 26

The risk of not being able to buy or sell an asset quickly without significant price changes.

Question 27

What is funding liquidity risk?

Answer 27

The risk that an institution cannot meet short-term financial obligations.

Question 28

What is market liquidity risk?

Answer 28

The risk that an asset cannot be traded due to a lack of market demand.

Question 29

How does liquidity risk impact securities markets?

Answer 29

It can increase volatility and widen bid-ask spreads.

Question 30

What is the bid-ask spread in liquidity risk?

Answer 30

The difference between the buying (bid) and selling (ask) prices of a security.

Question 31

What is operational risk?

Answer 31

The risk of loss due to failed internal processes, human errors, or technological failures.

Question 32

What are examples of operational risk?

Answer 32

System failures, fraud, data breaches, and mismanagement.

Question 33

What is the Basel Committee’s definition of operational risk?

Answer 33

"The risk of loss resulting from inadequate or failed internal processes, people, and systems or external events."

Question 34

What is a rogue trader?

Answer 34

A trader who makes unauthorized and risky trades, causing financial losses.

Question 35

What is cyber risk in operational risk?

Answer 35

The risk of data breaches, hacking, or cyberattacks on financial systems.

Question 36

What is systemic risk?

Answer 36

The risk that the failure of one financial institution will cause widespread instability in the market.

Question 37

What is the too-big-to-fail concept?

Answer 37

The idea that some financial institutions are so large that their failure would severely harm the economy.

Question 38

What role do central banks play in managing systemic risk?

Answer 38

They provide liquidity and regulate financial institutions to prevent collapses.

Question 39

What is contagion in systemic risk?

Answer 39

The spread of financial instability from one institution or country to others.

Question 40

What was the impact of the 2008 financial crisis on systemic risk?

Answer 40

It exposed weaknesses in the global financial system and led to stronger regulatory measures.

Question 41

What is legal risk?

Answer 41

The risk of financial loss due to lawsuits, contract failures, or regulatory changes.

Question 42

What is regulatory risk?

Answer 42

The risk of financial loss due to changes in laws or regulations affecting investments.

Question 43

What is compliance risk?

Answer 43

The risk of failing to meet legal and regulatory obligations.

Question 44

What is Know Your Customer (KYC)?

Answer 44

A legal requirement for financial institutions to verify client identities.

Question 45

What is Anti-Money Laundering (AML)?

Answer 45

Laws and regulations designed to prevent financial crimes like money laundering.

Question 46

What is climate risk in investing?

Answer 46

The financial impact of environmental changes on companies and investments.

Question 47

How does artificial intelligence impact risk management?

Answer 47

AI enhances fraud detection, risk assessment, and market analysis.

Question 48

What is scenario analysis in risk management?

Answer 48

Evaluating potential risks by modeling different economic scenarios.

Question 49

What is stress testing in risk management?

Answer 49

Simulating extreme market conditions to assess financial stability.

Question 50

What is risk mitigation?

Answer 50

Implementing strategies to reduce or transfer risk, such as hedging or insurance.