FINANCIAL RISK MANAGEMENT
CORRECT QUESTIONS &
ANSWERS(RATED A+)
Risk Management Components - ANSWER (1) Objective Setting: policy & strategy; risk
appetite; direction, balance, control & approval (2) Internal Environment, (3)
Organization: allocation of roles & responsibilities, (4) Event Identification, (5) Risk
Assessment: survey or RIM or scenario analysis
Counterparty Default Risk - ANSWER (1)Receive payment first, (2) Credit scores and
analysis, (3) Replace risk: Guarantor, Letter of Credit, Credit Insurance (accounts
receivable insurance, CDS), (4) Collateral, (5) Netting Agreement, (6) Covenants, (7)
Price according to risk, (8) Sell loans without recourse
Default Risk - ANSWER (1) Counterparty: Individual, Corporation and Government, (2)
Issuer Risk, (3) Issue Default Risk and (4) Sovereign Risk
Downgrade Risk - ANSWER Borrowing costs increase, more difficult to do transactions,
price of bonds will change, investors may not be able to hold
Credit Spread Risk - ANSWER Risk that yields of same duration will more in different
directions.
Measurement of Credit Risk - ANSWER (1) Basic Methodology: notional amounts, (2)
Simple methodology: notional amounts * general risk-weights & (3) Advanced Method =
Prob of default*Notional amnt* (1-recovery rate)
Foreign Exchange Risk - ANSWER (1) Transaction Exposure, (2) Translation Exposure
and (3) Economic Exposure
Measuring FOREX Transaction Risk - ANSWER Nominal amount * Daily Volatility
Measuring FOREX Economic Risk - ANSWER Value at Risk (VaR) - developed by JP
Morgan in 1994. Only x% probability that the company will suffer a value decline greater
than y in n days.
VaR Methods - ANSWER (1) Historical: % change per day, sort highest to lowest; (2)
Variance - Covariance: never used in real life, assumes normal distribution,
cumbersome and (3) VaR Monte Carlo Simulation
Options - ANSWER (1) Call or put? (2) American or European? (3) Date? (4) Strike
Price (5) Volatility of Rate and (6) Expiration - Intrinsic Value + Time Value
CORRECT QUESTIONS &
ANSWERS(RATED A+)
Risk Management Components - ANSWER (1) Objective Setting: policy & strategy; risk
appetite; direction, balance, control & approval (2) Internal Environment, (3)
Organization: allocation of roles & responsibilities, (4) Event Identification, (5) Risk
Assessment: survey or RIM or scenario analysis
Counterparty Default Risk - ANSWER (1)Receive payment first, (2) Credit scores and
analysis, (3) Replace risk: Guarantor, Letter of Credit, Credit Insurance (accounts
receivable insurance, CDS), (4) Collateral, (5) Netting Agreement, (6) Covenants, (7)
Price according to risk, (8) Sell loans without recourse
Default Risk - ANSWER (1) Counterparty: Individual, Corporation and Government, (2)
Issuer Risk, (3) Issue Default Risk and (4) Sovereign Risk
Downgrade Risk - ANSWER Borrowing costs increase, more difficult to do transactions,
price of bonds will change, investors may not be able to hold
Credit Spread Risk - ANSWER Risk that yields of same duration will more in different
directions.
Measurement of Credit Risk - ANSWER (1) Basic Methodology: notional amounts, (2)
Simple methodology: notional amounts * general risk-weights & (3) Advanced Method =
Prob of default*Notional amnt* (1-recovery rate)
Foreign Exchange Risk - ANSWER (1) Transaction Exposure, (2) Translation Exposure
and (3) Economic Exposure
Measuring FOREX Transaction Risk - ANSWER Nominal amount * Daily Volatility
Measuring FOREX Economic Risk - ANSWER Value at Risk (VaR) - developed by JP
Morgan in 1994. Only x% probability that the company will suffer a value decline greater
than y in n days.
VaR Methods - ANSWER (1) Historical: % change per day, sort highest to lowest; (2)
Variance - Covariance: never used in real life, assumes normal distribution,
cumbersome and (3) VaR Monte Carlo Simulation
Options - ANSWER (1) Call or put? (2) American or European? (3) Date? (4) Strike
Price (5) Volatility of Rate and (6) Expiration - Intrinsic Value + Time Value
