Learning Outcomes: Distinguish between expected loss and unexpected loss, and provide examples of each. Interpret the relationship between risk and reward. Describe and differentiate between the key classes of risks, explain how each type of risk can arise, and assess the potential impact of each type of risk on an organization.
Questions:
502.1. Crouhy writes that "understanding [the difference between expected loss and unexpected loss] is the key to understanding modern risk management concepts such as economic capital attribution and risk-adjusted pricing." Which of the following statements is TRUE about unexpected loss (UL)?
a. Unexpected loss levels tend to be higher for a consumer credit card portfolio than a corporate loan portfolio
b. In a credit portfolio, higher default correlation implies lower portfolio unexpected losses
c. Unexpected loss (UL) it typically priced into the products or services offered to customers, while expected loss is the denominator of risk-adjusted return on capital (RAROC)
d. Market risk value at risk (MVaR) can be expressed as either relative MVaR or absolute MVaR but it is "relative MVaR" that matches (better captures) unexpected losses (UL)
502.2. Crouhy's risk typology is consistent with Jorion's. This typology includes the three major financial risks (market, credit and operational risk) and includes liquidity risk as a key financial risk. Non-financial risks are either business or non-business risks. Non-business risks include reputation and political risks; business risks include strategy and technological innovation. For FRM purposes, however, the domain is financial risks, primarily: market risk, liquidity risk, credit risk, and operational risk. According to this risk typology, each of the following is true but which statement is false?
a. Basis risk is a context-specific form of market risk
b. There are four major types of market risk: interest rate risk, equity price risk, foreign exchange risk, and commodity price risk; interest rate risk parses into trading risk and the special case of gap risk (gap risk relates to the risk that arises in the balance sheet of an institution as a result of the different sensitivities of assets and liabilities to changes of interest rates).
c. Credit risk can be decomposed into four main types: default risk, bankruptcy risk, downgrade (credit deterioration) risk, and settlement risk.
d. Because legal and regulatory risk are classified as business risks rather than financial risks, many of the large losses from derivatives trading case studies (debacles) over the last decade are technically business risk failures not financial risk failures
502.3. According to Crouhy, at least among the given choices, which of the following is probably the most important current and future challenge to the wider risk management profession as it seeks to improve the efficacy of the risk manager's job?
a. In the extended wake of the financial crisis and ensuing confidence loss in many quantitative approaches, restore the reputation of financial engineering by building better mathematical measures of risk
b. Build a wider risk culture and promote risk literacy in which key staff members understand how they can affect the risk profile of the organization; i.e., "put down deeper risk management roots in each organization."
c. Improve the ability of firms to predict the expected future value (i.e., the expected mean) of financial variables with better accuracy; e.g., "dispersions won't matter if we can't find a more accurate crystal ball for forecasting"
d. Promote the continual "upgrading" from naive, simple metrics (e.g., notional limits) toward more sophisticated methods which are almost universally more robust and automatically comparable
Answers here:
Questions:
502.1. Crouhy writes that "understanding [the difference between expected loss and unexpected loss] is the key to understanding modern risk management concepts such as economic capital attribution and risk-adjusted pricing." Which of the following statements is TRUE about unexpected loss (UL)?
a. Unexpected loss levels tend to be higher for a consumer credit card portfolio than a corporate loan portfolio
b. In a credit portfolio, higher default correlation implies lower portfolio unexpected losses
c. Unexpected loss (UL) it typically priced into the products or services offered to customers, while expected loss is the denominator of risk-adjusted return on capital (RAROC)
d. Market risk value at risk (MVaR) can be expressed as either relative MVaR or absolute MVaR but it is "relative MVaR" that matches (better captures) unexpected losses (UL)
502.2. Crouhy's risk typology is consistent with Jorion's. This typology includes the three major financial risks (market, credit and operational risk) and includes liquidity risk as a key financial risk. Non-financial risks are either business or non-business risks. Non-business risks include reputation and political risks; business risks include strategy and technological innovation. For FRM purposes, however, the domain is financial risks, primarily: market risk, liquidity risk, credit risk, and operational risk. According to this risk typology, each of the following is true but which statement is false?
a. Basis risk is a context-specific form of market risk
b. There are four major types of market risk: interest rate risk, equity price risk, foreign exchange risk, and commodity price risk; interest rate risk parses into trading risk and the special case of gap risk (gap risk relates to the risk that arises in the balance sheet of an institution as a result of the different sensitivities of assets and liabilities to changes of interest rates).
c. Credit risk can be decomposed into four main types: default risk, bankruptcy risk, downgrade (credit deterioration) risk, and settlement risk.
d. Because legal and regulatory risk are classified as business risks rather than financial risks, many of the large losses from derivatives trading case studies (debacles) over the last decade are technically business risk failures not financial risk failures
502.3. According to Crouhy, at least among the given choices, which of the following is probably the most important current and future challenge to the wider risk management profession as it seeks to improve the efficacy of the risk manager's job?
a. In the extended wake of the financial crisis and ensuing confidence loss in many quantitative approaches, restore the reputation of financial engineering by building better mathematical measures of risk
b. Build a wider risk culture and promote risk literacy in which key staff members understand how they can affect the risk profile of the organization; i.e., "put down deeper risk management roots in each organization."
c. Improve the ability of firms to predict the expected future value (i.e., the expected mean) of financial variables with better accuracy; e.g., "dispersions won't matter if we can't find a more accurate crystal ball for forecasting"
d. Promote the continual "upgrading" from naive, simple metrics (e.g., notional limits) toward more sophisticated methods which are almost universally more robust and automatically comparable
Answers here:
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