Exam Questions Financial Risk
Management (16/20)And Answers
Risk Management Components - correct answers-(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 - correct answers-(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 - correct answers-(1) Counterparty: Individual, Corporation and
Government, (2) Issuer Risk, (3) Issue Default Risk and (4) Sovereign Risk
Downgrade Risk - correct answers-Borrowing costs increase, more difficult to do
transactions, price of bonds will change, investors may not be able to hold
Credit Spread Risk - correct answers-Risk that yields of same duration will more in
different directions.
Measurement of Credit Risk - correct answers-(1) Basic Methodology: notional
amounts, (2) Simple methodology: notional amounts * general risk-weights & (3)
Advanced Method = Prob of default*Notional amnt* (1-recovery rate)
Measuring FOREX Economic Risk - correct answers-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 - correct answers-(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 for FOREX risk management - correct answers-(1) Retain [do nothing], (2)
Hedge or (3) Increase
Costs of Hedging - correct answers-Implicit (potential profit lost, incurred side
costs) and Explicit (premium)
Benefits to Hedge - correct answers-Reduce distress liklihood, volatility reduced,
predictable CFs, hedge against extraneous/ unrelated risks and make risk adverse
managers/firms more willing
Lending and Borrowing - correct answers-(1) Close FX position in the spot market,
(2) Lend currency until needed, (3) Borrow sold currency until same day.
*Difference between interest earned and borrowing interest*
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