Chapter 09 Testbank Questions

Chapter 09 - Testbank
Student: ___________________________________________________________________________
1. Market risk is defined as the risk related to the uncertainty of an FI's:
A. earnings on its trading portfolio caused by changes in market conditions.
B. reputation caused by changes in market conditions.
C. solvency caused by the default by specific markets (industries).
D. funding capacity in money markets or in capital markets.
2. Reasons why market risk measurement is important include:
A. management information.
B. resource allocation.
C. performance evaluation.
D. All of the listed options are correct.
3. Which of the following statements is true?
A. Since regulators are concerned with the social cost of a failure, regulatory models will normally tend to be more
conservative than private sector models that are concerned only with the private costs of failure.
B. Since regulators are concerned with the social cost of a failure, regulatory models will normally tend to be less
C. Regulators and private firms are both concerned with the social cost of a failure and thus their models do not differ.
D. None of the listed options are correct.
A. The major models used by banks in calculating market risk exposures are RiskMetrics, Monaco simulation and Historic
(back) calculation.
B. The major models used by banks in calculating market risk exposures are CreditMetrics, Monte Carlo simulation and
Historic (back) calculation.
C. The major models used by banks in calculating market risk exposures are RiskMetrics, Monte Carlo simulation and
D. The major models used by banks in calculating market risk exposures are CreditMetrics, Monte Carlo simulation and
Forward calculation.
A. Daily earnings at risk are defined as the dollar market value of a position plus the price sensitivity of the position plus
the potential adverse move in yield.
B. Daily earnings at risk are defined as the dollar market value of a position multiplied by the price sensitivity of the
position multiplied by the potential adverse move in yield.
C. Daily earnings at risk are defined as (the dollar market value of a position plus the price sensitivity of the position)
multiplied by the potential adverse move in yield.
D. Daily earnings at risk are defined as the dollar market value of a position divided by (the price sensitivity of the position
plus the potential adverse move in yield).

A. Daily price volatility is calculated as the price sensitivity to a small change in yield multiplied by the adverse daily yield
move.
B. Daily price volatility is calculated as the negative modified duration of a security multiplied by the adverse daily yield
move.
C. The daily price volatility of a security influences how much an FI might lose in case of adverse market movements.
A. The assumption that yield changes are normally distributed will result in an exact estimation of extreme outcomes.
B. The assumption that yield changes are normally distributed will generally result in overestimating extreme outcomes.
C. The assumption that yield changes are normally distributed will generally result in underestimating extreme outcomes.
D. Assumptions regarding the distribution of yields are not significant in market risk measurement models.
8. Assume that the modified duration of a bond is 2.45 years and that the potential adverse move in yield is 16.5 basis
points. What is the bond's price volatility (round to two decimals)?
A. 2.45  0.00165 = 0.40%.
B. –2.45  0.00165 = –0.40%.
C. 2.45  0.0165 = 4.04%.
D. –2.45  0.0165 = –4.04%.
9. Assume that the dollar market value of a position is $100 000 and the price volatility is 1.50 per cent. What are the daily
earnings at risk for this position (round to two decimals)?
A. $150.00
B. $1500.00
C. $15 000.00
D. Not enough information to solve the question.
10. Assume the market value of a position is $100 000 and that its modified duration is 3.30 years. Further assume that
the potential adverse move in yield is 16.5 basis points. What are the daily earnings at risk for this position (round to two
decimals)?
A. $54.45
B. $544.50
C. $54 450.00
11. The N-day market value at risk (VAR) equals daily earning at risk multiplied by the square root of N if we assume that
yield shocks are:
A. dependent, that daily volatility is approximately constant and that the FI is 'locked in' to holding the asset in question for
N number of days.
B. independent, that daily volatility is approximately constant and that the FI is 'locked in' to holding the asset in question
for N number of days.
C. dependent, that daily volatility is approximately constant and that the FI is 'locked in' to holding the asset in question for
N minus one number of days.
D. independent, that daily volatility is approximately constant and that the FI is 'locked in' to holding the asset in question
for N minus one number of days.

A. DEAR acknowledges that an FI can sell all its bonds tomorrow, as markets are entirely liquid.
B. DEAR assumes that an FI cannot sell all its bonds tomorrow, although in reality this might be possible.
C. DEAR assumes that an FI can sell all its bonds tomorrow, although in reality it might take many days for the FI to
unload its position.
D. DEAR acknowledges that an FI cannot sell all its bonds tomorrow, but that instead it might take many days for the FI to
13. Assume an FI's daily earnings at risk are $5000 and that the FI is required to hold its position for 10 days. What is the
position's VAR (round to two decimals)?
A. $5000  10 = $15 811.39
B. $5000  (10 – 1) = $15 000.00
C. $5000  10 = $707.11
D. $5000  (10 – 1) = $636.40
14. Assume the dollar market value of an FI's position is $200 000 and the calculated price volatility is 1.25 per cent.
What is the VAR of the position if the FI is required to hold the position for 6 days (round to two decimals)?
A. $2 683.28
B. $6 123.72
C. $200 000.00
D. $489 897.95
15. Assume the dollar market value of an FI's position is $200 000 with a modified duration of 4 years. The potential
adverse move in the yield is 16.5 basis points. What is the VAR of the position if the FI is required to hold the position for
6 days (round to two decimals)?
A. $1 320.00
B. $3 233.33
C. $330.00
D. $200 000.00
A. The relative illiquidity of a market reduces an FI's losses.
B. The relative illiquidity of a market exposes an FI to magnified losses.
C. The relative illiquidity of a market does not influence an FI's loss size.
17. Suppose an FI holds a $2 000 000 trading portfolio with an average beta of 1.0. Over the last year, the daily return on
the stock market index was 3 per cent. How much does the FI stand to lose in earnings if adverse stock market returns
materialise tomorrow?
A. $2 000 000  0.03 = $60 000
B. $2 000 000  1.0  0.03 = $60 000
C. $2 000 000  1.65  0.03 = $99 000
D. $2 000 000  2.33  0.03 = $139 800

18. Assume an FI holds a foreign exchange position of EUR 200 000 and further assume that the dollar per unit of EUR
rate is $1.053/EUR. What is the dollar value of the position (round to two decimals)?
A. EUR 200 000  1.053 = $210 600.00
B. EUR 200 000  1.053 = EUR 210 600.00
C. EUR 200 000 / 1.053 = $189 933.52
D. EUR 200 000 / 1.053 = EUR 189 933.52
A. Technically, 90 per cent of the area under a normal distribution lies between +/– 1.65 from the mean.
B. Technically, 90 per cent of the area under a normal distribution lies between +/– 2.33 from the mean.
C. Technically, 99 per cent of the area under a normal distribution lies between +/– 1.65 from the mean.
D. Technically, 99 per cent of the area under a normal distribution lies between +/– 2.33 from the mean.
20. Which of the following statements best describes the relationship between total risk, systematic risk and unsystematic
risk?
A. Total risk is the product of systematic and unsystematic risk.
B. Total risk is the sum of systematic and unsystematic risk.
C. Total risk is the quotient of systematic and unsystematic risk.
D. Total risk is the difference between systematic and unsystematic risk.
A. Systematic risk reflects the co-movement of a stock with the market portfolio, reflected by the stock's vega and the
volatility of the market portfolio.
B. Unsystematic risk reflects the co-movement of a stock with the market portfolio, reflected by the stock's vega and the
C. Systematic risk reflects the co-movement of a stock with the market portfolio, reflected by the stock's beta and the
D. Unsystematic risk reflects the co-movement of a stock with the market portfolio, reflected by the stock's beta and the
A. Unsystematic risk is specific to a particular firm.
B. Unsystematic risk is specific to a particular industry.
C. Unsystematic risk is specific to a particular geographical area.
D. Unsystematic risk relates to the whole market.
23. Consider the following hypothetical foreign exchange portfolio: What are the daily earnings at risk for the portfolio?
A. $200 / 0.45 = $444.44
B. $200  0.45 = $90.00
C. ($200 / 0.45) / 100 = $4.44
D. ($200  0.45) / 100 = $0.90
A. In a well-diversified portfolio, unsystematic risk can be largely diversified away, leaving behind systematic.
B. In a well-diversified portfolio, systematic risk can be largely diversified away, leaving behind unsystematic.
C. In a well-diversified portfolio, both systematic and unsystematic risk can be largely diversified away.
D. No matter how well diversified a portfolio is, unsystematic and systematic are always existent.

25. Which of the following is a measure of systematic risk?
A. alpha
B. beta
C. gamma
D. sigma
A. Beta is a measure of systematic risk reflecting the co-movement of the returns on a specific share with returns on
shares in the same industry
B. Beta is a measure of unsystematic risk reflecting the co-movement of the returns on a specific share with returns on
shares in the same industry.
C. Beta is a measure of unsystematic risk reflecting the co-movement of the returns on a specific share with returns on
the market portfolio.
D. Beta is a measure of systematic risk reflecting the co-movement of the returns on a specific share with returns on the
market portfolio.
A. The All Ordinaries index is Australia's premier market indicator, which represents the 100 largest companies listed on
the Australian Stock Exchange.
B. The All Ordinaries index is Australia's premier market indicator, which represents the 300 largest companies listed on
C. The All Ordinaries index is Australia's premier market indicator, which represents the 500 largest companies listed on
D. The All Ordinaries index is Australia's premier market indicator, which represents all companies listed on the Australian
Stock Exchange.
A. In CAPM, it is assumed that systematic and unsystematic risk are positively correlated.
B. In CAPM, it is assumed that systematic and unsystematic risk are negatively correlated.
C. In CAPM, it is assumed that systematic and unsystematic risk are independent of each other.
29. Assume an FI holds three different positions. The following DEAR information is available for the positions. Position 1
is a five-year zero coupon bonds with DEAR of $12 500, position 2 is a CHF spot contract with DEAR of $9500 and the
third position are Australian equities with DEAR of $34 500. Which of the following statements is true in relation to these
positions?
A. The DEAR of the portfolio can be calculated by simply adding up the individual DEARs.
B. The DEAR of the portfolio can be calculated by simply multiplying the individual DEARs.
C. The DEAR of the portfolio can be calculated by simply adding up the individual DEARs and adjusting the sum by an
error factor gamma.

third position are Australian equities with DEAR of $34 500. The five-year zero coupon bonds and the CHF spot position
have a negative correlation of 0.5, the correlation between the zero coupon bonds and the Australian equities is positive
0.5 and the correlation between the CHF spot contract and the Australian equities is positive 0.2. What is the DEAR of the
portfolio?
A. 12 500 + 9500 + 34 500 = $56 500.
B. 12 500(–0.5) + 9500(0.5) + 34 500(0.2) = $5400.
C. [12 5002 + 95002 + 34 5002 – 2(–0.5)(12 500)(9500) – 2(0.5)(12 500)(34 500) – 2(0.2)(9500)(34 500)]1/2 = $31 514.
D. [$12 5002 + $95002 + $34 5002 + 2(–0.5)(12 500)(9500) + 2(0.5)(12 500)(34 500) + 2(0.2)(9500)(34 500)]1/2 = $43 363.
31. How can basis risk arise in an FI's operations?
A. Basis risk arises because loan rates and deposit rates are inversely related in their movements over time.
B. Basis risk arises because loan rates and deposit rates are perfectly correlated in their movements over time.
C. Basis risk arises because loan rates and deposit rates are not correlated in their movements over time.
D. Basis risk arises because loan rates and deposit rates are not perfectly related in their movements over time.
A. There are no major flaws associated with VAR models like RiskMetrics.
B. One problem associated with VAR models such as RiskMetrics is the assumption of a normal distribution, that is, a
skew of 1.
C. One problem associated with VAR models such as RiskMetrics is that these models ignore the risk in the payments of
accrued interest on an FI's debt securities.
33. Which of the following is an advantage of the back simulation approach?
A. simplicity
B. assumption of normally distributed asset returns
C. calculation of correlations of asset returns
34. Which of the following is an adequate definition of the term general market risk charge?
A. A charge reflecting the risk of the decline in the liquidity of the trading portfolio.
B. A charge reflecting the modified duration and interest rate shocks for each maturity.
C. A charge reflecting the risk of the decline in the credit risk quality of the trading portfolio.
D. A charge reflecting the duration and interest rate gaps for each maturity.
35. What is meant by vertical offset?
A. The deduction of capital charges because long and short positions in the same maturity bucket but in different
instruments more than offset each other.
B. The assignment of additional capital charges because long and short positions in the same maturity bucket but in
different instruments cannot perfectly offset each other.
C. The deduction of capital charges because long and short positions in different maturity buckets but in the same
instrument more than offset each other.
D. The assignment of additional capital charges because long and short positions in different maturity buckets but in the
same instrument cannot perfectly offset each other.

36. What is meant by horizontal offset?
A. The deduction of capital charges because long and short positions of the same maturities have durations that more
than perfectly hedge each other.
B. The assignment of additional capital charges because long and short positions of the same maturities have durations
that do not perfectly hedge each other.
C. The deduction of additional capital because long and short positions of different maturities more than perfectly hedge
each other.
D. The assignment of additional capital charges because long and short positions of different maturities do not perfectly
hedge each other.
A. The BIS charges for unsystematic risk by adding the long and short positions in any given share and applying a 4 per
cent charge against the gross position in the share.
B. The BIS charges for unsystematic risk by adding the long and short positions in any given share and applying an 8 per
C. The BIS charges for unsystematic risk by adding the long and short positions in any given share and applying a 4 per
cent charge against the net position in the share.
D. The BIS charges for unsystematic risk by adding the long and short positions in any given share and applying an 8 per
A. Under BIS, the capital charge is calculated as DEAR multiplied by the square root of 10 multiplied by 3.
B. The idea of a minimum multiplication factor of 3 is to create a scheme that is 'incentive compatible'.
C. Regulators can punish FIs that underestimate their capital charges by raising the multiplication factor to as high as 5.
D. Under BIS, the capital charge is calculated as DEAR multiplied by the square root of 10 multiplied by 3 and the idea of
a minimum multiplication factor of 3 is to create a scheme that is 'incentive compatible'.
A. The BIS requires banks to define an adverse change in rates as being the 95th percentile.
B. The BIS requires banks to define an adverse change in rates as being the 97.5th percentile.
C. The BIS requires banks to define an adverse change in rates as being the 99th percentile.
D. The BIS requires banks to define an adverse change in rates as being the 99.5th percentile.
40. Which of the following are problems associated with the BIS approach to calculating capital requirements for
equities?
A. The approach assumes the same systematic risk factor for every stock.
B. The approach assumes the same unsystematic risk factor for every stock.
C. The approach does not fully consider the benefits from portfolio diversification.
D. The approach assumes the same systematic risk factor for every stock and the approach does not fully consider the
benefits from portfolio diversification.
41. Market risk is defined as the risk related to the uncertainty of an FI's earnings on its trading portfolio caused by
changes in market conditions.
True False

42. In sequential order, the steps involved in back simulation are as follows: measure exposures, measure sensitivity,
measure risk, measure risk again, rank days by risk from worst to best, VAR.
True False
43. A major advantage is that RiskMetrics directly provides a worst-case scenario number, while this is not the case for
back simulation.

True False
44. Specific risk charge is a charge reflecting the risk of the decline in the liquidity or credit risk quality of the trading
portfolio.
True False
45. The general market risk charges reflect the product of the modified durations and interest rate shocks expected for
each maturity.
True False
46. Vertical offsets are calculated using the sum of the general market risk charges from long and short positions in each
time zone.
True False
47. Monte Carlo simulations address the problems imposed by a limited number of actual observations, by generating
additional observations.
True False
48. Consider a VAR of $100 000 for a 95 per cent confidence level. A problem with this information is that while we know
that we will lose more than the VAR amount on 5 days out of every 100, we do not know the maximum amount we can
lose.
True False
49. RiskMetrics weights more recent observations more highly than past observations, which allows more recent news to
be more heavily reflected in the calculation of the standard deviation.
True False
50. Daily earnings at risk (DEAR) is the market risk exposure over the next 72 hours.
True False
51. One benefit of the historic or back simulation approach is that it does not need calculation of standard deviations and
correlations (or assume normal distributions for asset returns) to calculate the portfolio risk figures.
True False

52. From 1998 to 2010 the market risk capital requirement was uniformly a large proportion of the total risk capital
requirements for Australian banks, and losses due to market risk continued to increase during and post the global
financial crisis.
True False
53. Why is market risk measurement important?

54. Explain the basic concept of the RiskMetric model. What are the major disadvantages? How can the major
disadvantages be addressed?

55. Define the following terms within the context of the BIS standardised framework:
a. specific risk charge
b. general market risk charge
c. vertical offsets
d. horizontal offset.

Chapter 09 - Testbank Key

1. Market risk is defined as the risk related to the uncertainty of an FI's:
A. earnings on its trading portfolio caused by changes in market conditions.
B. reputation caused by changes in market conditions.
C. solvency caused by the default by specific markets (industries).
D. funding capacity in money markets or in capital markets.
Difficulty: Medium
Learning Objective: 09-01 Understand why market risk is important.
2. Reasons why market risk measurement is important include:
A. management information.
B. resource allocation.
C. performance evaluation.
Difficulty: Easy
A. Since regulators are concerned with the social cost of a failure, regulatory models will normally tend to be more
B. Since regulators are concerned with the social cost of a failure, regulatory models will normally tend to be less
C. Regulators and private firms are both concerned with the social cost of a failure and thus their models do not differ.
Difficulty: Medium
Learning Objective: 09-07 Understand how regulators measure market risk exposures for capital adequacy purposes.
A. The major models used by banks in calculating market risk exposures are RiskMetrics, Monaco simulation and Historic
(back) calculation.
B. The major models used by banks in calculating market risk exposures are CreditMetrics, Monte Carlo simulation and
C. The major models used by banks in calculating market risk exposures are RiskMetrics, Monte Carlo simulation and
D. The major models used by banks in calculating market risk exposures are CreditMetrics, Monte Carlo simulation and
Forward calculation.
Difficulty: Medium
Learning Objective: 09-02 Learn about the concept of value at risk and its use in measurement of market risk.
Learning Objective: 09-03 Understand how to measure market risk exposure of a FI.
A. Daily earnings at risk are defined as the dollar market value of a position plus the price sensitivity of the position plus
the potential adverse move in yield.
B. Daily earnings at risk are defined as the dollar market value of a position multiplied by the price sensitivity of the
position multiplied by the potential adverse move in yield.
C. Daily earnings at risk are defined as (the dollar market value of a position plus the price sensitivity of the position)
multiplied by the potential adverse move in yield.
D. Daily earnings at risk are defined as the dollar market value of a position divided by (the price sensitivity of the position
plus the potential adverse move in yield).
Difficulty: Medium
Learning Objective: 09-04 Learn the measurement techniques of the RiskMetrics model.
A. Daily price volatility is calculated as the price sensitivity to a small change in yield multiplied by the adverse daily yield
move.
B. Daily price volatility is calculated as the negative modified duration of a security multiplied by the adverse daily yield
move.
C. The daily price volatility of a security influences how much an FI might lose in case of adverse market movements.
Difficulty: Medium
A. The assumption that yield changes are normally distributed will result in an exact estimation of extreme outcomes.
B. The assumption that yield changes are normally distributed will generally result in overestimating extreme outcomes.
C. The assumption that yield changes are normally distributed will generally result in underestimating extreme outcomes.
D. Assumptions regarding the distribution of yields are not significant in market risk measurement models.
Difficulty: Medium
8. Assume that the modified duration of a bond is 2.45 years and that the potential adverse move in yield is 16.5 basis
points. What is the bond's price volatility (round to two decimals)?
A. 2.45  0.00165 = 0.40%.
B. –2.45  0.00165 = –0.40%.
C. 2.45  0.0165 = 4.04%.
D. –2.45  0.0165 = –4.04%.
Difficulty: Medium
9. Assume that the dollar market value of a position is $100 000 and the price volatility is 1.50 per cent. What are the daily
earnings at risk for this position (round to two decimals)?
A. $150.00
B. $1500.00
C. $15 000.00
Difficulty: Medium
10. Assume the market value of a position is $100 000 and that its modified duration is 3.30 years. Further assume that
the potential adverse move in yield is 16.5 basis points. What are the daily earnings at risk for this position (round to two
decimals)?
A. $54.45
B. $544.50
C. $54 450.00
Difficulty: Hard
11. The N-day market value at risk (VAR) equals daily earning at risk multiplied by the square root of N if we assume that
yield shocks are:
A. dependent, that daily volatility is approximately constant and that the FI is 'locked in' to holding the asset in question for
N number of days.
B. independent, that daily volatility is approximately constant and that the FI is 'locked in' to holding the asset in question
for N number of days.
C. dependent, that daily volatility is approximately constant and that the FI is 'locked in' to holding the asset in question for
N minus one number of days.
D. independent, that daily volatility is approximately constant and that the FI is 'locked in' to holding the asset in question
for N minus one number of days.
Difficulty: Hard
A. DEAR acknowledges that an FI can sell all its bonds tomorrow, as markets are entirely liquid.
B. DEAR assumes that an FI cannot sell all its bonds tomorrow, although in reality this might be possible.
C. DEAR assumes that an FI can sell all its bonds tomorrow, although in reality it might take many days for the FI to
D. DEAR acknowledges that an FI cannot sell all its bonds tomorrow, but that instead it might take many days for the FI to
Difficulty: Medium
13. Assume an FI's daily earnings at risk are $5000 and that the FI is required to hold its position for 10 days. What is the
position's VAR (round to two decimals)?
A. $5000  10 = $15 811.39
B. $5000  (10 – 1) = $15 000.00
C. $5000  10 = $707.11
D. $5000  (10 – 1) = $636.40
Difficulty: Hard
14. Assume the dollar market value of an FI's position is $200 000 and the calculated price volatility is 1.25 per cent.
What is the VAR of the position if the FI is required to hold the position for 6 days (round to two decimals)?
A. $2 683.28
B. $6 123.72
C. $200 000.00
D. $489 897.95
Difficulty: Hard
15. Assume the dollar market value of an FI's position is $200 000 with a modified duration of 4 years. The potential
adverse move in the yield is 16.5 basis points. What is the VAR of the position if the FI is required to hold the position for
6 days (round to two decimals)?
A. $1 320.00
B. $3 233.33
C. $330.00
D. $200 000.00
Difficulty: Hard
A. The relative illiquidity of a market reduces an FI's losses.
B. The relative illiquidity of a market exposes an FI to magnified losses.
C. The relative illiquidity of a market does not influence an FI's loss size.
Difficulty: Medium
17. Suppose an FI holds a $2 000 000 trading portfolio with an average beta of 1.0. Over the last year, the daily return on
the stock market index was 3 per cent. How much does the FI stand to lose in earnings if adverse stock market returns
materialise tomorrow?
A. $2 000 000  0.03 = $60 000
B. $2 000 000  1.0  0.03 = $60 000
C. $2 000 000  1.65  0.03 = $99 000
D. $2 000 000  2.33  0.03 = $139 800
Difficulty: Hard
18. Assume an FI holds a foreign exchange position of EUR 200 000 and further assume that the dollar per unit of EUR
rate is $1.053/EUR. What is the dollar value of the position (round to two decimals)?
A. EUR 200 000  1.053 = $210 600.00
B. EUR 200 000  1.053 = EUR 210 600.00
C. EUR 200 000 / 1.053 = $189 933.52
D. EUR 200 000 / 1.053 = EUR 189 933.52
Difficulty: Hard
A. Technically, 90 per cent of the area under a normal distribution lies between +/– 1.65 from the mean.
B. Technically, 90 per cent of the area under a normal distribution lies between +/– 2.33 from the mean.
C. Technically, 99 per cent of the area under a normal distribution lies between +/– 1.65 from the mean.
D. Technically, 99 per cent of the area under a normal distribution lies between +/– 2.33 from the mean.
Difficulty: Hard
20. Which of the following statements best describes the relationship between total risk, systematic risk and unsystematic
risk?
A. Total risk is the product of systematic and unsystematic risk.
B. Total risk is the sum of systematic and unsystematic risk.
C. Total risk is the quotient of systematic and unsystematic risk.
D. Total risk is the difference between systematic and unsystematic risk.
Difficulty: Easy
A. Systematic risk reflects the co-movement of a stock with the market portfolio, reflected by the stock's vega and the
B. Unsystematic risk reflects the co-movement of a stock with the market portfolio, reflected by the stock's vega and the
C. Systematic risk reflects the co-movement of a stock with the market portfolio, reflected by the stock's beta and the
D. Unsystematic risk reflects the co-movement of a stock with the market portfolio, reflected by the stock's beta and the
Difficulty: Medium
A. Unsystematic risk is specific to a particular firm.
B. Unsystematic risk is specific to a particular industry.
C. Unsystematic risk is specific to a particular geographical area.
D. Unsystematic risk relates to the whole market.
Difficulty: Easy
23. Consider the following hypothetical foreign exchange portfolio: What are the daily earnings at risk for the portfolio?
A. $200 / 0.45 = $444.44
B. $200  0.45 = $90.00
C. ($200 / 0.45) / 100 = $4.44
D. ($200  0.45) / 100 = $0.90
Difficulty: Hard
A. In a well-diversified portfolio, unsystematic risk can be largely diversified away, leaving behind systematic.
B. In a well-diversified portfolio, systematic risk can be largely diversified away, leaving behind unsystematic.
C. In a well-diversified portfolio, both systematic and unsystematic risk can be largely diversified away.
D. No matter how well diversified a portfolio is, unsystematic and systematic are always existent.
Difficulty: Medium
25. Which of the following is a measure of systematic risk?
A. alpha
B. beta
C. gamma
D. sigma
Difficulty: Easy
A. Beta is a measure of systematic risk reflecting the co-movement of the returns on a specific share with returns on
shares in the same industry
B. Beta is a measure of unsystematic risk reflecting the co-movement of the returns on a specific share with returns on
shares in the same industry.
C. Beta is a measure of unsystematic risk reflecting the co-movement of the returns on a specific share with returns on
the market portfolio.
D. Beta is a measure of systematic risk reflecting the co-movement of the returns on a specific share with returns on the
market portfolio.
Difficulty: Medium
A. The All Ordinaries index is Australia's premier market indicator, which represents the 100 largest companies listed on
B. The All Ordinaries index is Australia's premier market indicator, which represents the 300 largest companies listed on
C. The All Ordinaries index is Australia's premier market indicator, which represents the 500 largest companies listed on
D. The All Ordinaries index is Australia's premier market indicator, which represents all companies listed on the Australian
Stock Exchange.
Difficulty: Easy
A. In CAPM, it is assumed that systematic and unsystematic risk are positively correlated.
B. In CAPM, it is assumed that systematic and unsystematic risk are negatively correlated.
C. In CAPM, it is assumed that systematic and unsystematic risk are independent of each other.
Difficulty: Hard
third position are Australian equities with DEAR of $34 500. Which of the following statements is true in relation to these
positions?
A. The DEAR of the portfolio can be calculated by simply adding up the individual DEARs.
B. The DEAR of the portfolio can be calculated by simply multiplying the individual DEARs.
C. The DEAR of the portfolio can be calculated by simply adding up the individual DEARs and adjusting the sum by an
error factor gamma.
Difficulty: Hard
third position are Australian equities with DEAR of $34 500. The five-year zero coupon bonds and the CHF spot position
have a negative correlation of 0.5, the correlation between the zero coupon bonds and the Australian equities is positive
0.5 and the correlation between the CHF spot contract and the Australian equities is positive 0.2. What is the DEAR of the
portfolio?
A. 12 500 + 9500 + 34 500 = $56 500.
B. 12 500(–0.5) + 9500(0.5) + 34 500(0.2) = $5400.
C. [12 5002 + 95002 + 34 5002 – 2(–0.5)(12 500)(9500) – 2(0.5)(12 500)(34 500) – 2(0.2)(9500)(34 500)]1/2 = $31 514.
D. [$12 5002 + $95002 + $34 5002 + 2(–0.5)(12 500)(9500) + 2(0.5)(12 500)(34 500) + 2(0.2)(9500)(34 500)]1/2 = $43 363.
Difficulty: Hard
Learning Objective: 09-06 Learn the Monte Carlo simulation approach.
31. How can basis risk arise in an FI's operations?
A. Basis risk arises because loan rates and deposit rates are inversely related in their movements over time.
B. Basis risk arises because loan rates and deposit rates are perfectly correlated in their movements over time.
C. Basis risk arises because loan rates and deposit rates are not correlated in their movements over time.
D. Basis risk arises because loan rates and deposit rates are not perfectly related in their movements over time.
Difficulty: Medium
A. There are no major flaws associated with VAR models like RiskMetrics.
B. One problem associated with VAR models such as RiskMetrics is the assumption of a normal distribution, that is, a
skew of 1.
C. One problem associated with VAR models such as RiskMetrics is that these models ignore the risk in the payments of
accrued interest on an FI's debt securities.
Difficulty: Medium
Learning Objective: 09-05 Learn the back simulation approach of measuring value at risk.
33. Which of the following is an advantage of the back simulation approach?
A. simplicity
B. assumption of normally distributed asset returns
C. calculation of correlations of asset returns
Difficulty: Easy
34. Which of the following is an adequate definition of the term general market risk charge?
A. A charge reflecting the risk of the decline in the liquidity of the trading portfolio.
B. A charge reflecting the modified duration and interest rate shocks for each maturity.
C. A charge reflecting the risk of the decline in the credit risk quality of the trading portfolio.
D. A charge reflecting the duration and interest rate gaps for each maturity.
Difficulty: Medium
35. What is meant by vertical offset?
A. The deduction of capital charges because long and short positions in the same maturity bucket but in different
instruments more than offset each other.
B. The assignment of additional capital charges because long and short positions in the same maturity bucket but in
different instruments cannot perfectly offset each other.
C. The deduction of capital charges because long and short positions in different maturity buckets but in the same
instrument more than offset each other.
D. The assignment of additional capital charges because long and short positions in different maturity buckets but in the
same instrument cannot perfectly offset each other.
Difficulty: Hard
36. What is meant by horizontal offset?
A. The deduction of capital charges because long and short positions of the same maturities have durations that more
than perfectly hedge each other.
B. The assignment of additional capital charges because long and short positions of the same maturities have durations
that do not perfectly hedge each other.
C. The deduction of additional capital because long and short positions of different maturities more than perfectly hedge
each other.
D. The assignment of additional capital charges because long and short positions of different maturities do not perfectly
hedge each other.
Difficulty: Hard
A. The BIS charges for unsystematic risk by adding the long and short positions in any given share and applying a 4 per
B. The BIS charges for unsystematic risk by adding the long and short positions in any given share and applying an 8 per
C. The BIS charges for unsystematic risk by adding the long and short positions in any given share and applying a 4 per
D. The BIS charges for unsystematic risk by adding the long and short positions in any given share and applying an 8 per
Difficulty: Hard
A. Under BIS, the capital charge is calculated as DEAR multiplied by the square root of 10 multiplied by 3.
B. The idea of a minimum multiplication factor of 3 is to create a scheme that is 'incentive compatible'.
C. Regulators can punish FIs that underestimate their capital charges by raising the multiplication factor to as high as 5.
D. Under BIS, the capital charge is calculated as DEAR multiplied by the square root of 10 multiplied by 3 and the idea of
a minimum multiplication factor of 3 is to create a scheme that is 'incentive compatible'.
Difficulty: Hard
A. The BIS requires banks to define an adverse change in rates as being the 95th percentile.
B. The BIS requires banks to define an adverse change in rates as being the 97.5th percentile.
C. The BIS requires banks to define an adverse change in rates as being the 99th percentile.
D. The BIS requires banks to define an adverse change in rates as being the 99.5th percentile.
Difficulty: Medium
40. Which of the following are problems associated with the BIS approach to calculating capital requirements for
equities?
A. The approach assumes the same systematic risk factor for every stock.
B. The approach assumes the same unsystematic risk factor for every stock.
C. The approach does not fully consider the benefits from portfolio diversification.
D. The approach assumes the same systematic risk factor for every stock and the approach does not fully consider the
benefits from portfolio diversification.
Difficulty: Medium
41. Market risk is defined as the risk related to the uncertainty of an FI's earnings on its trading portfolio caused by
changes in market conditions.
TRUE
Difficulty: Medium
42. In sequential order, the steps involved in back simulation are as follows: measure exposures, measure sensitivity,
measure risk, measure risk again, rank days by risk from worst to best, VAR.
TRUE
Difficulty: Medium
43. A major advantage is that RiskMetrics directly provides a worst-case scenario number, while this is not the case for
back simulation.

TRUE
Difficulty: Medium
44. Specific risk charge is a charge reflecting the risk of the decline in the liquidity or credit risk quality of the trading
portfolio.
TRUE
Difficulty: Medium
45. The general market risk charges reflect the product of the modified durations and interest rate shocks expected for
each maturity.
TRUE
Difficulty: Medium
46. Vertical offsets are calculated using the sum of the general market risk charges from long and short positions in each
time zone.
FALSE
Difficulty: Medium
47. Monte Carlo simulations address the problems imposed by a limited number of actual observations, by generating
additional observations.
TRUE
Difficulty: Medium
Learning Objective: 09-06 Learn the Monte Carlo simulation approach.
48. Consider a VAR of $100 000 for a 95 per cent confidence level. A problem with this information is that while we know
that we will lose more than the VAR amount on 5 days out of every 100, we do not know the maximum amount we can
lose.
TRUE
Difficulty: Hard
49. RiskMetrics weights more recent observations more highly than past observations, which allows more recent news to
be more heavily reflected in the calculation of the standard deviation.
TRUE
Difficulty: Medium
50. Daily earnings at risk (DEAR) is the market risk exposure over the next 72 hours.
FALSE
Difficulty: Easy
51. One benefit of the historic or back simulation approach is that it does not need calculation of standard deviations and
correlations (or assume normal distributions for asset returns) to calculate the portfolio risk figures.
TRUE
Difficulty: Medium
52. From 1998 to 2010 the market risk capital requirement was uniformly a large proportion of the total risk capital
requirements for Australian banks, and losses due to market risk continued to increase during and post the global
financial crisis.
FALSE
Difficulty: Medium
53. Why is market risk measurement important?
Market risk is related to the uncertainty of an FI's earnings on its trading portfolio caused by changes in market conditions
such as interest rate risk and foreign exchange risk. Measurement of market risk is important because it can help an FI
manager in the following ways:
1. provide information on the risk positions taken by individual traders.
2. establish limit positions on each trader based on the market risk of their portfolios.
3. help allocate resources to departments with lower market risks and appropriate returns.
4. evaluate performance based on risks undertaken by traders in determining optimal bonuses.
5. help develop more efficient internal models so as to avoid using standardised regulatory models that may overprice
some risks and lead to the potential misallocations of resources.

54. Explain the basic concept of the RiskMetric model. What are the major disadvantages? How can the major
disadvantages be addressed?
RiskMetrics model (or the variance/covariance approach) developed by JPMorgan Chase, concentrates on measuring the
market risk exposure of an FI on a daily basis. That is, how much the FI will potentially lose if market conditions move
adversely tomorrow. More specifically, the RiskMetrics model calculates the daily earnings at risk (DEAR) in three trading
areas—fixed income, foreign exchange (FX) and equities—and then it estimates the aggregate risk of the entire trading
portfolio. Measuring the risk exposure for periods longer than a day (Value at risk—VAR) is, under certain assumptions,
simply the transformation of the daily risk exposure number.
Most FIs establish limits for value at risk, daily earnings at risk, position limits and dollar trading loss limits for their trading
portfolios. Actual activity compared with these limits is then monitored daily. Should a risk exposure level exceed
approved limit levels, management must provide a strategy for bringing risk levels within approved limits.
A major criticism of RiskMetrics is the need to assume a symmetric (normal) distribution for all asset returns.Clearly, for
some assets, such as options and short-term securities (bonds), this is highly questionable. For example, the most an
investor can lose if he or she buys a call option on an equity is the call premium; however, the investor's potential upside
returns are unlimited. In a statistical sense, the returns on call options are non-normal since they exhibit a positive skew.
Another disadvantage is that the model assumes that the correlations of asset returns be observed and calculated.
One way of addressing these disadvantages is to use the Historic or Back simulation approach which does not require
that asset returns be normally distributed and does not require that the correlations or standard deviations of asset returns
be calculated. Implementation requires the calculation of the value of the current portfolio of assets based on the prices or
yields that were in place on each of the preceding 500 days (or some large sample of days). These data are rank-ordered
from worst to best case and percentile limits are determined. For example, the five per cent worst case scenario provides
an estimate with 95 per cent confidence that the value of the portfolio will not fall more than this amount.
55. Define the following terms within the context of the BIS standardised framework:
a. specific risk charge
b. general market risk charge
c. vertical offsets
d. horizontal offset.
a. Specific risk charge: a charge reflecting the risk of the decline in the liquidity or credit risk quality of the trading

portfolio over the FI's holding period.
b. General market risk charge: a charge reflecting the modified duration and interest rate shocks for each maturity.
c. Vertical offsets: the assignment of additional capital charges because long and short positions in the same maturity
bucket but in different instruments cannot perfectly offset each other.
d. Horizontal offsets: the assignment of additional capital charges because long and short positions of different maturities
do not perfectly hedge each other.
Chapter 09 - Testbank Summary
Category # of Question
s
Difficulty: Easy 7
Difficulty: Hard 17
Difficulty: Medium 28
Learning Objective: 09-01 Understand why market risk is important. 5
Learning Objective: 09-02 Learn about the concept of value at risk and its use in measurement of market risk. 1
Learning Objective: 09-03 Understand how to measure market risk exposure of a FI. 1
Learning Objective: 09-04 Learn the measurement techniques of the RiskMetrics model. 32
Learning Objective: 09-05 Learn the back simulation approach of measuring value at risk. 5
Learning Objective: 09-06 Learn the Monte Carlo simulation approach. 2
Learning Objective: 09-07 Understand how regulators measure market risk exposures for capital adequacy purpose 14
s.

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Chapter 09 - Testbank

Learning Objective: 09-01 Understand why market risk is important.

a. Specific risk charge: a charge reflecting the risk of the decline in the liquidity or credit risk quality of the trading

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