Foundations of Risk Management

In a multifactor model of returns, what does an asset's factor beta measure?

The risk-free rate is 2%. Under the Fama-French three-factor model, the market risk premium is 6%, the SMB premium is 2.5% and the HML premium is 3%. A growth stock has loadings of 1.1 on the market, 0.4 on SMB and −0.3 on HML. Its expected return is closest to:

In the Fama-French three-factor model, the HML factor is the return on:

A three-factor model has a risk-free rate of 2%. The factor risk premiums are 5% for the market factor, 2% for a size factor and −1% for an inflation factor. A portfolio has sensitivities of 1.1 to the market, 0.4 to size and 0.5 to inflation. Its expected return is closest to:

The risk-free rate is 3%. The market portfolio has an expected return of 9% and a volatility of 16%. An efficient portfolio on the capital market line has a volatility of 12%. Its expected return is closest to:

A stock has a beta of 1.2 and a total volatility of 30%. The market's volatility is 18%. Under a single-index model, the stock's idiosyncratic (firm-specific) volatility is closest to:

A stock with a beta of 1.25 is fairly priced under the CAPM with an expected return of 11%. The risk-free rate is 2.5%. The expected return on the market implied by these figures is closest to:

An analyst forecasts a return of 12% for a stock with a beta of 1.2. The risk-free rate is 4% and the expected market return is 10%. Relative to the security market line, the stock is:

The risk-free rate is 3% and the expected market return is 10%. Stock A has a beta of 0.8 and a forecast return of 9%. Stock B has a beta of 1.5 and a forecast return of 13%. Using the security market line, which trade does the analyst's forecast support?

A portfolio holds 60% in asset A, with a volatility of 20%, and 40% in asset B, with a volatility of 10%. The correlation between their returns is 0.3. The portfolio's volatility is closest to:

A portfolio with a beta of 0.8 returned 10%. The market returned 9% and the risk-free rate was 2%. Which statement about the portfolio's performance is correct?

A fund returned 10.4% against its benchmark's 8.9%. Its tracking error against the benchmark was 2.5%, its volatility was 16% and the risk-free rate was 3%. The fund's information ratio is closest to:

A portfolio has an expected excess return of 8% over the 3% risk-free rate and a volatility of 20%. An investor borrows at the risk-free rate to hold 150% of her wealth in the portfolio. The Sharpe ratio of her leveraged position is closest to:

Which performance measure divides excess return over a minimum acceptable return by the deviation of returns below that minimum?

A fund's annual active returns against its benchmark over four years were 1.2%, −0.6%, 2.0% and 0.2%. Using the sample standard deviation (dividing by n - 1), its tracking error is closest to:

A portfolio returned 12.5% with a beta of 1.25 and a volatility of 20%. The risk-free rate was 2.5%. The portfolio's Treynor ratio is closest to:

An investor puts all of her wealth into a single actively managed fund. Which measure best captures the risk-adjusted performance relevant to her?

At Barings, a trader was able to hide large and growing losses for a long period. Which control failure is most associated with this case?

A fund holds $125 billion of assets financed with $5 billion of equity, with the rest borrowed. If the value of its assets falls by 2%, the percentage loss on its equity is closest to:

Which risk was central to the failure of the UK mortgage lender Northern Rock?

How can a bank whose assets are worth more than its liabilities still fail?

Which model risk lesson is commonly drawn from losses on mortgage-backed securities and their senior tranches in the global financial crisis?

A desk running a supposedly low-risk arbitrage strategy has reported profits far above those of its peers for several quarters. What is the appropriate risk management response?

A protection buyer holds a credit default swap with a notional of $20 million and a spread of 200 basis points a year, paid quarterly in arrears. The reference entity defaults two months after the last premium date, and the recovery rate is set at 35%. The buyer must pay the premium accrued since the last payment date. The buyer's net cash receipt at settlement is closest to:

Default correlation among the loans in a securitized pool rises while the expected loss on the pool stays the same. What happens to the values of the equity and senior tranches?

Rules that require the sponsor of a securitization to retain part of the credit risk of the pool are mainly intended to:

During a crisis, a supervisor asks a bank for its exposures broken down by a new industry grouping. The bank's systems cannot produce the breakdown for several weeks. Which attribute of risk data aggregation is most clearly lacking?

A bank's group credit exposure report leaves out loans held by a recently acquired subsidiary whose systems are not yet connected. Which attribute of risk data aggregation is most clearly lacking?

Which statement best describes good governance of a bank's risk data aggregation and reporting?

A bank's market risk and credit risk systems use different identifiers for the same counterparties, so exposures to one corporate group cannot be combined. Which principle addresses this problem most directly?

Some steps in a bank's risk data aggregation still rely on spreadsheets. Which practice best supports the accuracy of the resulting reports?

A bank's risk system shows total loan exposure of $48.6 billion, while the general ledger shows $50.4 billion. The gap between the two, as a percentage of the general ledger figure, is closest to:

Which of the following is a benefit commonly cited for enterprise risk management compared with managing each risk in a separate silo?

Which of the following best describes enterprise risk management?

A bank's stand-alone economic capital is $250 million for market risk, $500 million for credit risk and $150 million for operational risk. Market and credit losses have a correlation of 0.4; operational losses are uncorrelated with both. With square-root aggregation of the three amounts, the diversification benefit is closest to:

A proposed business line would earn revenue of $45 million a year with operating costs of $15 million and an expected loss of $5 million. It needs $200 million of economic capital. The firm's hurdle rate on economic capital is 14%. Ignoring taxes, which conclusion is correct?

A firm sets its total economic capital equal to the simple sum of the stand-alone economic capital of its business units. What does this implicitly assume?

Which body is ultimately responsible for approving a bank's risk appetite statement?

A bank estimates it could absorb losses of up to $800 million before it breaches its minimum capital requirement. Its board states that it will accept a 1-in-20-year loss of no more than $300 million. Which statement is correct?

Which feature most strengthens the independence of a bank's chief risk officer?

A bank's one-year credit loss distribution has a 99.9th percentile of $48 million and a mean of $6 million. The bank holds economic capital for unexpected loss at the 99.9% level and covers expected loss through pricing. Its economic capital is closest to:

A bank has given a borrower a $10 million credit line, of which $6 million is drawn. The bank expects 75% of the undrawn amount to be drawn by the time of any default. The one-year probability of default is 1.5% and the loss given default is 40%. The one-year expected loss is closest to:

A loan has an exposure at default of $10 million. The borrower's one-year probability of default is 2% and the loss given default is 45%. The one-year expected loss is closest to:

In perfect capital markets, hedging cannot raise a firm's value because shareholders can manage risk themselves. Which of the following is a reason hedging can add value when markets are imperfect?

Risk managers sometimes distinguish between risk and uncertainty in the sense used by Frank Knight. Which of the following describes uncertainty?

A hedge fund finds that it can sell a large block of corporate bonds only at a price well below the last quoted price. Which type of risk does this illustrate?