Part 2 Full Length Interactive Mock Exam 2

Which of the following is TRUE about the impact of wrong-way risk (WWR) on central counterparties (CCPs)?

Operational resilience is different than traditional business continuity and disaster recovery (BC/DR) planning. In regard to this contrast between resilience and BC/DR, which of the following statements is TRUE about operational resilience?

In regard to asset-liability management and duration techniques, each of the following statements is true EXCEPT which is false?

Volatility is an important risk factor according to Andrew Ang. The strong negative relationship between VIX changes and stock returns is explained by (at least) two dynamics. The first is called the leverage effect. The “second channel is a time-varying risk premium story and is the one the basic CAPM [capital asset pricing model] advocates,” explains Ang.(†)

Assume the riskfree rate is 3.0% while the equity risk premium (EPR; aka, the market’s expected excess return) is 6.0% because the market’s expected return is 9.0%. According to the CAPM, and consistent with Ang’s theory on the transmission channel between volatility and stock returns, which of the following should cause a DECLINE in a stock’s price?

(†) Andrew Ang, Asset Management: A Systematic Approach to Factor Investing (New York: Oxford University Press, 2014).

Consider the following asset over three periods that starts with an initial price of $20.00 and pays a $2.00 dividend each period. In addition to the asset’s price and dividends over three periods, we also show its per-period arithmetic (aka, simple) return:

About this asset’s performance, each of the following statements is true EXCEPT which is not accurate?

Peter approximated the CVA of a collateralized exposure by assuming a 10-day margin period of risk (MRP) and his result is a CVA of -0.20. The uncollateralized CVA would in excess of -1.00; that is, without collateral, the CVA would be less than -1.0. Subsequently, he realizes that he was mistaken and the actual MPR is 40 days. If this is the only change (i.e., ceteris paribus), then what is the revised approximation of the credit value adjustment (CVA)?

According to the Basel Committee on Banking Supervision (BCBS), “given the increase in the frequency, severity and sophistication of cyber-incidents in recent years, a number of legislative, regulatory and supervisory initiatives have been taken to increase cyber-resilience.” Financial institutions also recognize they must build their cyber-resilience capabilities. This is a non-trivial effort that involves governance, culture, strategy, the workforce, information-sharing, and third-party risk. In regard to BCBS’s report on the range of cyber-resilience, each of the following is true EXCEPT which is false?

Peter is a CFA candidate who has been studying covered interest rate parity (CIRP) but he is also reading that “since the Global Financial Crisis (GFC), CIRP has failed to hold.” Peter has assumed CIPR is the closest thing to a physical law in finance. His friend Patricia is an FRM candidate and she offers two explanations for the apparent anomaly:

I. The basis tends to open up because banks, institutional investors, and non-financial firms tend to demand currency hedges; e.g., banks tend to close balance sheet currency mismatches with FX swaps​

Which statement(s) by Patricia explain the violation(s) of CIRP since the GFC?

Janice is preparing to conduct factor regressions in order to discover the factor loadings in her firm’s equity portfolio. She will begin by regressing three explanatory (aka, independent) variables: the market factor (MKT) plus two additional factors. Each of the following pairs of factors are good candidates for these additional factors EXCEPT which of the following pair is NOT a good candidate?

A portfolio with a current value of $171.30 million is allocated between two bonds:

• The first bond is a zero-coupon bond with five years to maturity and it has a value of $71.30 million. Its annual yield to maturity is 7.0% as 1/1.07^5 equals about 0.7130;
• The second bond matures in one year and pays a 4.0% annual coupon. It has a yield of 4.0% such that its market value is $100.00 million

The spot rate term structure is depicted below: 4.00% at one year, 5.00% at two years, 5.50% at three years, 6.00% at four years and 7.00% at five years. Finally, the returns VaR (aka, risk) is based on a yield volatility of 100 basis points at all maturities and a confidence level of 95.0%. In this way, for example, the risk at one year is given by 1.0%*1.645*(1/1.040) = 1.58%, and the risk at two years is given by 1.0%*1.645*(2/1.050) = 3.133%.

Please note that compound frequency is annual, following the annual coupon payment. Under the duration mapping approach, which is nearest to the portfolio value at risk (VaR)?

Your colleague Robert was tasked by the firm’s Chief Risk Officer (CRO) to estimate the credit value adjustment (CVA) charge on a derivative exposure. He was asked to perform a quick calculation and told therefore that a rough approximation is acceptable. His only facts include the following:

• A simplistic assumption that expected exposure (EE) is constant at 5.0% of notional
• Therefore, the expected positive exposure (EPE) is also 5.0% of notional
• A credit spread of 400 basis points
• Recover rate of 50.0%
• Constant hazard rate of 6.7%
• Approximate maturity of 5.0 years

Which of the following is nearest to Robert’s correct estimate of the credit value adjustment (CVA) charge?

Basel III’s Standardized Measurement Approach (SMA) to operational risk multiplies a Business Indicator Component (BIC) by an Internal Loss Multiplier (ILM) in order to generate the operational risk capital. The BIC is a function of the Business Indicator (BI). In turn, the BI is a financial statement-based proxy for operational risk consisting of three components, each calculated as the average over three years. Each of the following is a component of the Business Indicator (BI) EXCEPT which is not?

In regard to the difference between a foreign exchange (FX) swap and a cross-currency swap, each of the following is true (as a difference) EXCEPT which statement is false?

The Fama-French three-factor model is given by the following formula (Ang 7.2)(†):

Which of the following statements about this Fama-French model is TRUE?

(†) Andrew Ang, Asset Management: A Systematic Approach to Factor Investing (NY: Oxford University Press, 2014)

Suppose the volatility is uncertain and positive correlated with the underlying asset price. Relative to prices implied by a constant volatility, which of the following scenarios is most plausible?

The history of various methods of counterparty risk mitigation via intermediation includes special purpose vehicles (SPVs), derivative product companies (DPCs), monolines, and credit derivative product companies (CDPC). Which of the following statements about the lessons learned is TRUE?

The severity of the US dollar shortage during the global financial crisis (GFC) led to an international policy response. European central banks adopted measures to alleviate banks’ funding pressures in their domestic currencies, but by itself this did not provide sufficient US dollar liquidity. As a remedy, the Federal Reserve introduced a system of reciprocal currency arrangements called “swap lines” with other central banks. As McGuire explains, “In providing US dollars on a global scale, the Federal Reserve effectively engaged in international lending of last resort. The swap network can be understood as a mechanism by which the Federal Reserve extends loans, collateralized by foreign currencies, to other central banks, which in turn make these funds available through US dollar auctions in their respective jurisdictions. This made US dollar liquidity accessible to commercial banks around the world, including those that have no US subsidiaries or insufficient eligible collateral to borrow directly from the Federal Reserve System.” (Patrick McGuire, Gotz von Peter, 2009. “The US Dollar Shortage in Global Banking and the International Policy Response,” BIS Working Papers, Bank for International Settlements.)

Such lending of last resort (LOLR) might present two sorts of classic problems: One, Is there enough money to reassure markets, or is the money limited? Two, What sort of moral hazard is created? A successful swap program overcomes these problems with specific benefits:

I. It has the power to create an unlimited amount of money​

According to Ang’s theory of factor risk, which of the following statements is TRUE?

What is a copula function?

Consider the following exposure profile for a five-year credit default swap (CDS):

Given this profile, which of the following statements is TRUE?

Below is a summary balance sheet of Acme Bank, but in addition to the typical accounts (assets, liabilities, and equities), there are four additional columns to assist in ascertaining whether the bank satisfies Basel III’s liquidity risk requirements:

For purposes of estimating the bank’s liquidity coverage rate (LCR), the following columns are included: HQLA factors, HQLA, Runoff rate, and Net cash outflows. For purposes of estimating the net stable funding ratio (NSFR), the following columns are included: RSF factor, required stable funding, ASF factor, and available stable funding. Does Acme Bank meet the LCR and NSFR requirements?

In regard to the various approaches to liquidity transfer pricing (LTP), each of the following statements is true EXCEPT which is false?

Sally the risk manager is backtesting her company’s one-day 97.0% value at risk (VaR) model over a two-year horizon. Because there are 250 trading days in a year, the horizon is 500 days. For her two-tailed backtest, the desired confidence is 95.0% If she uses a normal distribution to approximate the binomial, then what is the maximum number of daily losses that can be observed (aka, the “cutoff”) in order to conclude the model is calibrated correctly? (note: inspired by GARP’s 2017 Part 2 Practice Exam, Question 12).

Two counterparties are negotiating the terms of a new Master Agreement in reference to a series of derivative transactions. They are also negotiating the parameters of a credit support annex (CSA) which might be appended to the Master Agreement. There are three approaches: two-way CSA, one-way CSA, or no CSA.

About the possible CSA, which of the following statements is TRUE?

Which of the following statements is TRUE about Basel II?

According to Fung and Hsieh “the majority of managed futures funds pursue trend following strategies.”(†) Therefore, they classify managed future hedge funds as a directional style (as opposed to non-directional or relative or arbitrage-like). Which exotic or option trading strategy most nearly resembles the payoff of a trend-following strategy?

501.1. Below are displayed seven pairs of (A,B) variables, e.g., (3,5), (4,4)…(7,1). The third row shows pairwise products, e.g., 3*5 = 15, 4*4 = 16. Finally, the mean, E(.), and standard deviation, StdDev(.), are displayed; e.g., E(A) = 5.860, E(A*B) = 17.710, Standard Deviation (A*B) = 6.250. Note the StdDev(.) is a population’s standard deviation; we do not require the sample standard deviations (why?).

Which is nearest to the Pearson correlation coefficient between (A) and (B)?

901.1. Freecone Financial LLC entered into an interest rate swap some time ago where it agreed to make semi-annual fixed payments at a rate of 3.0% per annum, in exchange for receiving floating payments on a notional amount of $50.0 million. The floating rate is the six-month secured overnight financing rate (SOFR) and this is also the discount rate used to value the swap. The swap has a remaining life of 1.25 years. The SOFR rate applicable to the exchange in three months was determined three months ago: it was 2.40%. Just as with a LIBOR-based swap, the floating rate is observed at the beginning of each six-month period but paid at the end of the period. Currently, the SOFR term structure is flat at 2.60% per annum with continuous compounding. With respect to its position in this swap, which of the following is nearest to Freecone Financial’s current exposure?

In regard to changes to the regulation of OTC derivatives that occurred after the 2007-2009 financial crisis, which of the following BEST summarizes the rules for standard (aka, standardized) transactions and uncleared trades (i.e., the derivatives not covered by the rules for standardized transactions)?

When Acme Bank engaged its staff to develop a sound contingency funding plan (CFP), the bank explicitly included the following five design considerations?

I. Aligned to business and risk profiles

II. Integrated with broader risk management frameworks

III. Theoretical basis for precoded instruction set

IV. Inclusive of appropriate stakeholder groups

V. Supported by a communication plan

Although there exists no single, universal contingency funding plan (CFP), each of the bank’s above considerations appears to be correct EXCEPT which is likely incorrect?

Your colleague Barbara was tasked to prepare the first draft of your firm’s Risk Plan. The board requested the draft include each of “five guideposts” as the directors were influenced by Rosengarten and Peter Zangari (Litterman), specifically that “the risk plan should be incorporated as a separate section of the organization’s strategic planning document. As such, it should receive all of the vetting and discussion that any other part of the planning document would receive. When in final form, its main themes should be capable of being articulated to analysts, auditors, boards, actuaries, management teams, suppliers of capital, and other interested constituencies. The risk plan should include five guideposts.”[1]

Each of the following is likely to appear in the draft Risk Plan (as one of the five guideposts) EXCEPT which is least likely to appear in the Risk Plan?

[1] Robert Litterman and the Quantitative Resources Group, Modern Investment Management: An Equilibrium Approach (Hoboken, NJ: John Wiley & Sons, 2003)

The table below exhibits Jorion’s[1] stress test of a $200.0 million two-bond portfolio: one bond is a $100.0 million 5-year 6.0% annual coupon issue, and the second bond is a $100.0 million 1-year 4.0% annual coupon issue.

Each of the following statements about this stress test exercise is true EXCEPT which is false?

[1] Philippe Jorion, Value-at-Risk: The New Benchmark for Managing Financial Risk, 3rd Ed. (NY: McGraw Hill, 2006)

In the context of money laundering and financing terrorism (ML/FT) risks, which of the following statements is TRUE about the appropriate role of correspondent banking?

In regard to the variety of types of liquidity risk reports generated by a typical bank, each of the following is a true statement EXCEPT which is inaccurate?

According to Bodie, Kane, and Marcus, EACH of the following make it difficult to evaluate the performance of hedge funds EXCEPT for:

The daily profit/loss (P/L) is given by the following discrete distribution where (a) is a constant:

What is the 95.0% expected shortfall relative to zero (i.e., not relative to the mean or expected value)?

Logistic regression is often used to predict whether a loan will default. For example, the logit function can predict conditional default by the estimation of default probability as a function of several explanatory variables x(1), x(2) … x(n), where X(i) for example could be income or loan-to-value. Here is the general form:

In reference to this logistic regression model, each of the following is a true statement EXCEPT which is false?

Which of the following statements is TRUE about risk culture?

In regard to the design of liquidity stress test(s), each of the following is true EXCEPT which is inaccurate?

The following data compares a Portfolio (P) to the Market (M):

What is Modigliani-squared (M^2) measure of the portfolio?

502.1. Your colleague Mary conveys to you that she has computed a Pearson correlation coefficient of 0.20 between two variables, but she is not yet specific about the variables. Each of the following statements must be true EXCEPT which is false?

According to De Laurentis (†) among the following approaches, which is the LEAST LIKELY to meet the criteria of Measurability and Verifiability?

(†) Giacomo De Laurentis, Renato Maino, and Luca Molteni, Developing, Validating and Using Internal Ratings (West Sussex, United Kingdom: John Wiley & Sons, 2010)

After years of progress on improving banking culture and conduct, industry leaders have reported eight important lessons they learned during the process. Among these lessons learned, which of the following is TRUE?

Which of the following best describes the term structure of expected liquidity, TSL(e)?

Consider the following performance date for a sample period:

If the Portfolio (P) is one sub-portfolio that is combined with several other portfolios into a large investment fund, which is the appropriate risk-adjusted performance measure (RAPM) and what is its value for Portfolio (P)?

Consider the following amortization schedule for a $1.0 million mortgage loan that fully amortizes in ten years:

Each of the following statements is true EXCEPT which is false?

In regard to the challenges in modeling a bank’s revenues, losses, and its balance sheet over a stress test horizon period, which of the following statements is TRUE?

Which of the following is a USE of intraday liquidity?

The current short-term rate, r(0) is 4.00%. Under a Ho-Lee Model with time-dependent drift, the time step is monthly and the annualized drifts are as follows: +100 basis points in the first month and +80 basis points in the second month. The annual basis point volatility (sigma) is 200 bps.

What is the value of the missing node [2,0] in this Ho-Lee interest rate tree?

Each of the following statements is true about sovereign credit default swaps (SCDS) EXCEPT which is false?

Kingstreet Savings is attempting to determine its liquidity requirement. The bank has classified its checking, savings, and nonperson time deposits (which total $380.0 million in deposits) into three categories: hot money, vulnerable, and stable (aka, core) funds:

The total liquidity requirement is the sum of the liability and loan requirements, but we are here ignoring the loan liquidity requirement; further, the reserve requirements are not necessarily realistic but instead are rounded for the sake of more convenient calculations. Management has elected to hold an 80.0% reserve in liquid assets or borrowing capacity for each dollar of hot money deposits, a 50.0% reserve behind vulnerable deposits, and a 20.0% reserve for its holdings of core funds. The legal reserve requirement is 10.0% for both checkable and savings deposits; nonpersonal time deposits have zero legal reserve requirements.

Kingstreet Savings is using the Structure of Funds approach to estimating its liquidity requirement. What is Kingstreet’s net deposit liquidity requirement for the (total of) vulnerable funds?

Analyst Steven is building a short-term interest rate tree according to the Vasicek Model which is characterized by mean reversion, and where the time step is monthly (dt = 1/12). The current short-term rate, r(0) is 8.00%. The annual basis point volatility is 200 basis points. Theta is the long-run value (or central tendency) of the short-term rate; in Steven’s model theta is 3.00%. Finally, the constant (k) which denotes the speed of mean reversion is equal to 0.60. In brief, Steven’s Vasicek model is given by dr = 0.60*(3.0% – r)*dt + sigma*dw.

What is the value in the Vasicek tree at node [2,1]?

According to Crouhy, Galai and Mark, best practice in the implementation of a RAROC system should include each of the following elements EXCEPT which is incorrect?

First City Bell Bank has forecast its checkable deposits, time and saving deposits, and commercial and household loans over the next six months; aka, semester.

If we employ the sources and uses of funds method to estimate the bank’s liquidity needs over the semester, which of the following statements is TRUE?

Jerry the analyst estimates a stock’s current volatility is 34.0% per annum. Using this as an input to price a European call option on the stock, the output price of the Black-Scholes-Merton (BSM) model is $6.95. However, the market price of the call option is $7.23. He prices a European put option (on the same stock) with the same strike price and maturity and the BSM model price output is $5.12. Which is nearest to the likely market price of the put option?

Golin and Delhaise(†) divide credit analysis into four areas according to borrower type:

1. Consumer credit analysis is the evaluation of the creditworthiness of individual consumers;
2. Corporate credit analysis is the evaluation of nonfinancial companies such as manufacturers, and nonfinancial service providers;
3. Financial institution credit analysis is the evaluation of financial companies including banks and nonbank financial institutions (NBFIs), such as insurance companies and investment funds; and
4. Sovereign /municipal credit analysis is the evaluation of the credit risk associated with the financial obligations of nations, subnational governments, and public authorities, as well as the impact of such risks on obligations of nonstate entities operating in specific jurisdictions.

According to Golin and Delhaise, each of the following is TRUE about key features of credit analysis with respect to borrower type, EXCEPT which is not true?

(†) Jonathan Golin and Philippe Delhaise, The Bank Credit Analysis Handbook (Hoboken, NJ: John Wiley & Sons, 2013)

Rankcon is a repo investor in the money market mutual fund industry with the exclusive motive of cash management. As Tuckman explains, “Investors holding cash for liquidity or safekeeping purposes often find investing in repo to be an ideal solution. The most significant example of this is the money market mutual fund industry, which invests on behalf of investors willing to accept relatively low returns in exchange for liquidity and safety.” (Source: Bruce Tuckman, Angel Serrat, Fixed Income Securities: Tools for Today’s Markets, 3rd Edition (New York: Wiley, 2011)). Note: a money market fund would lend money while taking collateral and then, at maturity, collect the loan plus interest and return the collateral.

Given this motivation, Rankcon understandably employs each of the following criteria (or preference) with respect to its repo investments EXCEPT which is the LEAST likely preference?

Which of the following is insured, at least up to some amount?

Peter is a Risk Analyst who has collected a dataset and seeks to fit a relatively simple univariate distribution to the data. He hopes the data is approximately normal. To test this hypothesis, he generates a quantile-quantile plot (QQ plot) using a standard normal distribution as the reference. This QQ plot is displayed below:

Based on the QQ plot, which statement is most likely to be TRUE about this distribution?

According to Malz, “The default01 measures the impact of an increase of one (1) basis point in the default probability. It is analogous to the DV01 and the spread01 and is calculated numerically in a similar way. To compute the default01, we increase and decrease default probability 10bps and revalue each tranche at these new [default probability] values … Each default01 is expressed as a positive number and expresses the decline in value or increase in loss resulting from a 1-basis point rise in default probability.”(†)

Each of the following is true about default01 EXCEPT which is false?

(†) Allan Malz, Financial Risk Management: Models, History, and Institutions (Hoboken, NJ: John Wiley & Sons, 2011)

The bid-ask spread is USD 0.350 on an asset with a current price of USD 50.00 per share. The spread itself is normally distributed with volatility of 20 basis points (0.20%). Which is nearest to the 99 percent confidence interval on the transaction costs?

Which of the following Basel liquidity ratios includes regulatory capital in the numerator?

In comparison to Basel III, which itself essentially incorporated the previous quantitative requirements for backtesting under the internal models approach (IMA) to market risk, which of the following BEST summarizes the change(s), if any, to the backtesting requirements under the fundamental review of the trading book (FRTB; aka, Basel IV)?

Let’s assume the same three-tier securitization structure illustrated by Malz section 9.2(†) with identical assumptions for convenience:

• The loans in the collateral pool and the liabilities are assumed to have a maturity of five (5) years
• Assets consist of 100 identical leveraged loans with par value of $1.0 million each, priced at par, paying a fixed 8.5%, i.e., 350 bps over LIBOR flat at 5.0%
• Senior debt (senior bonds) of $85.0 million paying a coupon of LIBOR + 50 bps
• Mezzanine debt (junior bonds) of $10.0 million paying a coupon of LIBOR + 500 bps
• This scenario assumes a default rate of 2.0% per annum and the recovery rate is 40%
• The money market rate is 5.0%

Here is the five-year scenario given by these assumptions:

Each of the following is true about this structure EXCEPT for which is not?

(†) Allan Malz, Financial Risk Management: Models, History, and Institutions (Hoboken, NJ: John Wiley & Sons, 2011)

According to Malz(†), each of the following statements is true about the mapping of risk factors to positions EXCEPT which is incorrect?

(†) Allan Malz, Financial Risk Management: Models, History, and Institutions (Hoboken, NJ: John Wiley & Sons, 2011)​

A position with a value of $1.0 million consists of 50,000 shares of an asset. The asset is quoted bid $19.00, offer $21.00. The asset has an expected return of 14.0% per annual and an annual volatility of 26.0%. We are interested in the lognormal value at risk (aka, lognormal VaR) over a one-year horizon; that is, we assume geometric returns are normally distributed. If our confidence level is 95.0%, which is NEAREST to the one-year liquidity-adjusted lognormal VaR (LVaR)?

Donald the analyst is employing the Cox-Ingersoll-Ross (CIR) model for the short-term rate process:(†)

His assumptions include (see above):

• The time-step is monthly, dt = 1/12
• Today’s initial rate, r(0) = 1.00%
• The annual basis point volatility, sigma = 2.50%
• The long-run rate, theta = 8.00%
• The strength of reversion, k = 0.60

For the first month, the random uniform value is 0.71 such that the random standard normal is 0.5534 and dw = 0.5534*SQRT(1/12) = 0.160. What is the short-rate in the first month under this CIR process, r(1/12)?

(†) Bruce Tuckman, Fixed Income Securities, 3rd Edition (Hoboken, NJ: John Wiley & Sons, 2011)

Employing a single-factor model for the Credit VaR of a portfolio, Malz(†) relates the market factor return (m) to a stated level of portfolio loss, in this case, 0.010:

If the default probability is 1.0%, such that k = N[-1](1.0%) = -2.33, and the correlation is 0.64, such that beta = 0.80, which is nearest to the probability that the portfolio loss is 0.01 or worse; i.e., the probability that the market factor ends up at a quantile, or worse, associated with a portfolio loss of 0.01?

As the strategic context for cyber risk, Coburn et al. (†) refer to resilience engineering as a progression from traditional safety engineering where the advantage of a resilience perspective is that it views social-technical systems (e.g., social and cultural factors) rather than only technical systems. This perspective informs various cyber resilience objectives; for example, analytical monitoring, coordinated defense, deception, privilege restriction, and random changes. In regard to resilient security approaches, which of the following is TRUE (according to Coburn et al. (†))?

(†) Andrew Coburn, Eireann Leverett, and Gordon Woo, Solving Cyber Risk: Protecting Your Company and Society (Hoboken, NJ: Wiley, 2019)

Illiquidity risk premiums compensate investors for the inability to access capital immediately and/or for the market’s withdrawal of liquidity during a crisis. Andrew Ang(†) details four different ways that an investor (asset owner) might capture or “harvest” the illiquidity premium. However, among these four, which has the greatest impact on portfolio returns (and is generally superior in Andrew Ang’s(†) opinion)?

(†) Andrew Ang, Asset Management: A Systematic Approach to Factor Investing (New York: Oxford University Press, 2014).

Which of the following is the chief drawback or limitation of the standard (aka, unmodified) bootstrap procedure?

According to Malz(†), each of the following is true about the CDS spread curve and spread risk EXCEPT which is not?

(†) Allan Malz, Financial Risk Management: Models, History, and Institutions (Hoboken, NJ: John Wiley & Sons, 2011)

In regard to the incremental risk charge (IRC) in Basel 2.5, each of the following is true EXCEPT which is false?

Consider the following non-parametric and/or semi-parametric approaches to historical simulation:

I. Basis historical simulation
II. Bootstrapped historical simulation
III. Age-weighted historical simulation
IV. Volatility-weighted historical simulation
V. Correlation-weighted historical simulation
VI. Filtered historical simulation

Which of these above approaches naturally allow us to obtain value at risk (VaR) and expected shortfall (ES) estimates that might EXCEED the maximum loss in our historical dataset?

Peter the municipal bond analyst observes that in recent years there have occurred only about 6.0 U.S. municipal defaults per year. If he makes the highly simplifying assumption that 6.0 defaults per year is the average in a Poisson process (distribution), what is the probability that the next municipal default will occur within one month?

In regard to the original Basel I accord, each of the following is true EXCEPT which is false?

An investor holds two positions:

• Short shares worth $10,000 where the proportional bid-offer spread is 0.030, and
• Long shares worth $17,000 where the proportional bid-offer spread is 0.040

What is the approximate cost to the investor to unwind this two-position portfolio?

Malz gives us a single-factor credit risk model, where a(T) is the log asset return. This single-factor model is sum of systemic risk contribution plus an idiosyncratic risk contribution:

If a firm’s systemic risk contributes 70% to its total risk (i.e., idiosyncratic risk therefore contributes 30%) and if the firm’s unconditional default probability is 2.0%, what are the implied beta and (k) parameters?

Which of the following is the BEST guiding principle for managing model risk?

Venkat(†) writes that “The EWI framework can be summarized as M.E.R.I.T” where the (M) refers to measures. Which of the following is a TRUE characteristic (or feature) of good Early Warning Indicator (EWI) measures?

(†) Shyam Venkat, Stephen Baird, Liquidity Risk Management (Hoboken, NJ: John Wiley & Sons, 2016)