CISI Risk - Chapter 5

Question 1

What is market risk

Answer 1

The risk or loss of earnings or capital from changes in the value of financial instruments

Question 2

4 assets effected by Market Risk?

Answer 2

Money market instruments & Bonds

Equities

Commodities

Derivatives

Question 3

What is a direct factor

Answer 3

Directly reflect the performance of a company, such as management

Question 4

What is a Indirect factor

Answer 4

Indirectly effects performance of the firm, like macroeconomic variables.

Question 6

What is Market Liquidity Risk

Answer 6

The risk of loss through not being able to trade in a market. Ie not being able to sell at the price you want when you want

Question 6

What is volatility risk

Answer 6

Price movements, can be adverse or expected

Question 7

What is currency risk

Answer 7

Adverse movements in exchange rates

Question 8

What is basis risk

Answer 8

Risk that instruments behaves in a similar, but not identical, manners.

Question 9

What is basis risk usually associated with?

Answer 9

Derivatives and hedging with them

Question 10

What 4 instruments does interest rate risk effect

Answer 10

Fixed income securities, Futures, Options 7 Forwards

Question 11

What is (H)edging

Answer 11

Reducing the risk of adverse price movements by taking an offsetting position in a related product

Question 12

What is Market Risk Limitations

Answer 12

Specifying the max acceptable loss

Question 13

What is usually used in to aid Market Risk Limitations

Answer 13

Stop-Loss limits

Question 14

What is diversification

Answer 14

Eggs in many many baskets

Question 15

What can HFT firms offer?

Answer 15

Tight price speads

Question 16

How are the models in a market risk management function validated?

Answer 16

Independent validation

Question 17

What is distribution analysis

Answer 17

Statistical means of using historical data to predict future events. Uses probability distributions

Question 18

What is another name for the term Typical Value

Answer 18

Central tendency

Question 19

What curve does normal distribution have?

Answer 19

Bell Curve

Question 20

What % of confidence level will be in the mean in standard deviation

Answer 20

68

Question 21

What is the equation for Quartile Deviation

Answer 21

0.5 (Q3-Q1)

Question 22

What is Beta ?

Answer 22

How closely a portfolio mirros that of the general market

Question 23

What is distribution analysis

Answer 23

Using historical data to predict future events

Question 24

What distribution exhibits “Fat Tails”

Answer 24

Normal Distribution

Question 25

What is regression analysis

Answer 25

Relationship between vairables

Question 26

How is Regression analysis displayed?

Answer 26

Scattter-gram

Question 27

What is a positive correlation?

Answer 27

An increase in price of one share is associated with the increase in another

Question 28

What is negative correlation

Answer 28

An increase in price of one share is associated with the decrease in another

Question 29

What does an asset with a Beta of 0 mean?

Answer 29

Price is not correlated to the market at all

Question 30

What does an asset with a Beta of 1 mean?

Answer 30

It follows the market

Question 31

What does an asset with a Beta of -1 mean?

Answer 31

It goes against the market

Question 32

What is optimisation

Answer 32

Portfolio construction techniques that obtain the best expected returns from the right mix of assets

Question 33

What is VAR

Answer 33

Value at risk, the maximum loss that can occour over a specific time period and confidence level

Question 34

3 advantages to using VAR

Answer 34

Provides a statistical probability of potential loss
Readily understood by non-risk managers
Common standard

Question 35

Main disadvantage to using VAR?

Answer 35

Events/losses outside the confidence level

Question 36

What is Historical Simulation

Answer 36

Looking back at past data and predicting the future

Question 37

What is the parametric approach?

Answer 37

The distribution of returns can be plotted and the data can be “Read off a graph”

Question 38

Advantage of Historical Simulation

Answer 38

Conceptually simple and no need to estimate volatilizes

Question 39

Main disadvantage to Historical Simulation?

Answer 39

Assumes history will repeat itself

Question 40

How are returns distributed in the Parametric Approach

Answer 40

Normally Distributed

Question 41

Main advantage of the parametric approach

Answer 41

Simple methodology, little computation

Question 42

Main disadvantage of the parametric approach

Answer 42

if actual returns are not normally distributed, the results will be inaccurate

Question 43

What instrument can NOT be used with the parametric approach?

Answer 43

Securities

Question 44

What is the Monte Carlo simulation

Answer 44

Producing random numbers and using them to plot return distribution

Question 45

Main advantage of the Monte Carlo approach

Answer 45

Can be used for non-normally distributed instruments

Question 46

What instrument would utilize the Monte Carlo approach

Answer 46

Options

Question 47

What is the main disadvantage of the Monte Carlo Approach

Answer 47

Computing power required is HEFTY

Question 48

What is back testing

Answer 48

Comparing the actual daily trading exposure to previously predicted VAR figure