MODULE B RISK MANAGEMENTUNIT 8

Check Your Progress

A) Investment in Post Office time deposit is(i) Zero-risk investment(ii) Low-risk investment(iii)Medium-risk investment(iv) High-risk investmentAns: Zero-risk investment

B) Zero-risk investment implies(i) Zero variation in cash flow from investment(ii) Investment in zero coupon bonds(iii)Investment in government securities(iv) Investment in bank fixed depositAns: Zero variation in cash flow from investment

C) Which of the following statements is correct?(i) Higher the risk-higher would be risk premium(ii) Higher the risk-lower would be risk premium(iii)Lower the risk-higher would be risk premium(iv) None of the statements is correctAns: Higher the risk-higher would be risk premium

D) Which of the following statements is correct?(i) Higher the risk in a business, higher would be capital requirement(ii) Higher the risk in a business, higher would be return expectation(iii)Higher the risk in a business, higher would be capital requirement and higher

would be return expectation(iv) None of the statements is correctAns: Higher the risk in a business, higher would be capital requirement

E) What is most critical function of Risk Management?(i)Controlling the level of risk to an organization's capacity(ii)Identification of risks(iii)Estimating the costs of risk(iv)Measurement of riskAns: Controlling the level of risk to an organization's capacity

Terminal Questions(A) Capital charge component of pricing accounts for1.Cost of capital2.Internal generation of capital3.Loss provisionWhich of the following is True?(i)All the statements are correct(ii)Statements 1 and 2 are correct(iii)Statements 2 and 3 are correct

(iv)Statements 3 and 1 are correctStatements 3 and 1 are correct

(B) Daily volatility of a stock is 0.5%. What is its 10-day volatility?(i)5%(ii)0.25%(iii)1.58%(iv)None of these1.58%

(C) Risk mitigation results in1.Reduction of downside potential2.Reduction in profit potentialWhich of the following is True?(i)All the statements are correct(ii)Statement 1 is correct(iii)Statement 2 is correct(iv)Both are incorrectAll the statements are correct

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Unit 9

Tick the Correct Answer(A) Financial Risk is defined as(i)Uncertainties resulting in adverse variation of profitability or outright losses(ii)Uncertainties that result in outright losses(iii)Uncertainties in cash flow(iv)Variations in net cash flowsVariations in net cash flows

(B) Strategic Risk is a type of(i)Interest rate risk(ii)Operational risk(iii)Liquidity risk(iv)None of theseNone of these

(C)A bank funds its assets from a pool of composite liabilities. Apart from credit and operational risks, it faces

(i)Basis risk(ii)Mismatch risk(iii)Market risk(iv)Liquidity riskBasis risk

(D)A branch sanctions Rs 1 crore loan to a borrower, which of the following risks the branch is taking

1.Liquidity risk2.Interest rate risk3.Market risk4.Credit risk5.Operational risk(i)All of them(ii)1, 2 and 3 only(iii)1, 4 and 5 only(iv)1, 2, 4 and 5 only1, 2, 4 and 5 only

(E) Premature payment of a term loan will result in interest rate risk of type(i)Basis risk(ii)Yield curve risk(iii)Embedded option risk(iv)Mismatch riskEmbedded option risk

Answers to Terminal QuestionsA.(iv), B.(iv), C.(i), D.(iv), E.(iii)

********************************************************************* Unit 10Terminal Questions(A) Systemic risk is the risk of(i)Failure of a bank, which is not adhering to regulations(ii)Failure of two banks simultaneously due to bankruptcy of one bank(iii)Where a group of banks fail due to contagion effect(iv)Failure of entire banking systemFailure of entire banking system

(B) Central Bank Governors of G-10 countries participate in the Basel Committee on Banking Supervision. Total number of members:

(i) 10 (ii) 11 (iii) 12 (iv) 1313

(C)1988 Capital Accord framework accounted for1.Credit risk2.Market Risk3.Operational risk4.Defined capital componentWhich of the following is true?(i)All of them(ii)1,2 and 4(iii)1, 3 and 4(iv)1,2 and 31,2 and 4

(D)Back testing is done to(i)Test a model

(ii)Compare model results and actual performance(iii)Record performance(iv)None of the aboveCompare model results and actual performance

(E) Under Basel II, capital requirement under the accord is(i)The maximum capital that is required to be maintained(ii)The minimum capital that is required to be maintained(iii)The capital as specified by the regulatory authority is required to be maintained(iv)None of the aboveThe capital as specified by the regulatory authority is required to be maintained

(F) Capital charge for credit risk requires input for PD, LGD, HAD and M. Under advanced IRB approach, who provides the input for LGD.

(i)Bank(ii)Supervisor(iii)Function provided by BCBS(iv)None of the aboveBank

Answers to Terminal Questions1. (iv), 2.(iv), 3.(ii), 4.(ii), 5.(iii), 6.(i)

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Unit 111. A bank expects fall in price of a security if it sells it in the market. What is the risk

that the bank is facing?(a) Market risk (b) Operational risk(c) Asset liquidation risk (d) Market liquidity riskAsset liquidation risk

2. An 8-year 8% semi-annual bond has a BPV of Rs 125. The yield on the bond has increased by 5 basis points. What is the profit or loss suffered due to increase in yield?

(a) A profit of Rs 1000 (c) A profit of Rs 625(b) A loss of Rs 1000 (d) A loss of Rs 625A loss of Rs 625

3. 1 day VaR of a portfolio is Rs 500.000 with 95% confidence level. In a period of six months (125 working days) how many times the loss on the portfolio may exceed Rs 500.000?(a) 4 days (c) 6 days(b) 5 days (d) 7 days6 days

4. A bank suffers loss due to adverse market movement of a security. The security was how ever held beyond the defeasance period. What is the type of the risk that the bank has suffered?

(a) Market risk (b) Operational risk (c) Market liquidation risk (d) Credit risk

5. A bank holds a security that is rated A+. The rating of the security migrates to A. What is the risk that the bank has faced?

(a) Market risk (c) Market liquidation risk(b) Operational risk (d) Credit riskCredit risk

6. A bond with remaining maturity of 5 years is presently yielding 6%. Its modified duration is 5 years. What is its McCauley's duration?

(a) 5.05% (c) 5.30%(b) 3.77% (d) 6.00%5.30%

7. VaR is not enough to assess market risk of a portfolio. Stress testing is desirable because(a)It helps in calibrating VaR module(b)It helps as an additional risk measure(c)It helps in assessing risk due to abnormal movement of market parameters(d)It is used as VaR measure is not accurate enoughIt helps in assessing risk due to abnormal movement of market parameters

Answers to Terminal Questions1. (c), 2. (d), 3. (c), 4. (b),5. (d), 6. (c), 7. (c)

UNIT 12

Terminal Questions1.Which of the following is not a type of credit risk?

(i)Default risk (ii)Credit spread risk (iii) Intrinsic risk (iv) Basis risk2.Risk of a portfolio with over exposure in steel sector will be(i)More than systematic risk(ii)Equal to intrinsic risk(iii)Less than intrinsic risk(iv)None of these

3.

4.The risk that arises due to worsening of credit quality is(i)Intrinsic risk(ii)Credit spread risk(iii)Portfolio risk(iv)Counterparty risk

5.In order to develop our capability to actively manage our credit portfolio one must have in place thefollowing:(a)Credit Rating Model (or models for different categories of loans and advances)

(b)Develop and maintain necessary data on defaults of borrowers rating category-wise, i.e.. 'Rating Migration'(i)Both 1 and 2 are required(ii)Only 1 is required(iii)Only 2 is required(iv)None of the above

6. The model that combines five financial ratios using reported accounting information and equityvalues to produce an objective measure of borrower's financial health is(i)Altman's Z Score(ii)'CreditMetrics'(iii)CreditRisk+(iv)None of the above.

7. A transaction where financial securities are issued against the cash flow generated from a pool ofassets is called(i)Securitization(ii)Credit Default Swaps(iii)Credit Linked Notes(iv)Total Return Swaps

Answers to Questions1. iv, 2. i, 3. 21, 4. ii, 5. i, .6. i, 7. I

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Unit 13

1.Operational Risk arises from(a)Inadequate or failed internal processes(b)People and systems(c)External events(d)Defaults(e)Market price fluctuationsWhich of the following is true(i) All of them(ii) None of them(iii) (a), (b) and (c)(iv) (a), (b) and (e)

2.The third Consultative Paper recommended for(a)Cause based classification (b)Effect based classification (c)Event based classificationFor operational risk.Which of the following is true(i) (a)(ii)None of them

(iii)(c)(iv)(b)

3.Benefits of integrated risk framework are(a)To relate capital and reserves more effectively to their actual level of risk exposure.(b)To evaluate pricing decisions and product profitability(c)In making risk transfer decisionsWhich of the following is true(i)All of them(ii)None of them(ii) (a )and(b)(iv) (b) and (c)

4.Rewards of proper management of operational risks are(a)Lesser risk capital(b)Cost reductions in operations(c)Competitive edgeWhich of the following is true(i)All of them(ii)None of them(iii)(a), (b) and (c)(iv)(a) and (b)

5.Given the followingProbability of occurrence = 4Potential financial impact = 4Impact of internal controls = 0%What is the estimated level of operational risk?(a)3(b)2(c)0(d)4

6.What is the beta factor for corporate finance under Standardised approach?(a)15%(b)18%(c)12%(d)None of the above Answers to Terminal Questions1. (iii), 2. (iii), 3. (i), 4. (i), 5. (d), 6. (b)

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