Market Risk MCQs for CAIIB BFM (Unit 14) Module B

Correct Answer: B. Market risk. Market risk refers to the possibility of losing money due to changes in overall market conditions.

Correct Answer: C. A decrease in overall stock prices. A fall in stock prices is a market factor that can cause financial losses.

Correct Answer: B. Price risk. Price risk is the chance of losing money because the price of a specific investment goes down.

Correct Answer: C. Asset liquidity risk. Asset liquidity risk is about the difficulty of selling a specific investment quickly without losing value.

Correct Answer: D. Market liquidity risk. Market liquidity risk is when it becomes difficult to buy or sell investments in the broader market.

Correct Answer: C. Both gains and losses are amplified. Leverage increases the potential for both higher profits and bigger losses.

Correct Answer: B. Higher risk of capital depletion. Higher leverage means that losses can quickly reduce an investor’s capital.

Correct Answer: C. To effectively manage market risk. Knowing the potential for losses helps investors make informed decisions and manage risk.

Correct Answer: C. Value at Risk (VaR). VaR is a measure used to estimate the maximum potential loss over a specific time period.

Correct Answer: C. A structured approach. A risk management framework offers a systematic way to identify, assess, and control risks.

Correct Answer: C. Capital loss. A drop in stock price means the investment is worth less than what was paid for it, resulting in a capital loss.

Correct Answer: B. It results in a magnified capital loss. Leverage increases the impact of price changes, leading to larger losses when prices fall.

Correct Answer: B. It can worsen their losses because they might have to sell at lower prices. In an illiquid market, finding buyers at a desired price can be difficult, potentially forcing sellers to accept lower offers.

Correct Answer: B. Trading book. The trading book is where banks record their positions held for trading.

Correct Answer: B. Proprietary positions in debt securities. The trading book includes the bank’s own holdings of debt securities for trading purposes.

Correct Answer: D. Commodities. Commodities are presently not allowed in the trading book in India.

Correct Answer: B. Generating short-term profit from price movements. Trading book positions are typically held to profit from short-term price differences or for hedging.

Correct Answer: B. Market risk. Market risk is one of the key risks identified in the trading book.

Correct Answer: B. Asset liquidity risk and market liquidity risk. These two as components of trading liquidity risk.

Correct Answer: C. The risk of losses from changes in the mark-to-market value of the trading portfolio during liquidation.

Correct Answer: B. The length of the liquidation period. Longer liquidation periods increase the potential for adverse market movements.

Correct Answer: C. Movements in market prices. Market risk is limited to losses from market movements.

Correct Answer: D. Operational risk. Monitoring deficiencies are classified as operational risks, not market risks.

Correct Answer: B. The profit or loss resulting from changes in market value of the trading positions. This is how earnings in the trading book are defined in the context.

Correct Answer: B. The ability to execute transactions freely at reasonable prices. This is the definition provided for trading liquidity risk.

Correct Answer: B. Liquidating positions without significantly impacting market prices. This is one of the components listed for trading liquidity risk.

Correct Answer: B. Higher price volatility and larger adverse price deviations. Poor liquidity can lead to greater fluctuations in prices.

Correct Answer: B. Adverse changes in market prices is a liquidation risk.

Correct Answer: B. Asset liquidation risk. This is the definition provided for asset liquidation risk.

Correct Answer: B. Market liquidation risk. This is the definition given for market liquidation risk.

Correct Answer: B. Because prices can sometimes deviate significantly from their fair value.

Correct Answer: C. Credit risk.

Correct Answer: B. The risk levels associated with a borrower or issuer. Credit ratings are indicators of creditworthiness.

Correct Answer: B. The price is likely to decrease. Reduced credit ratings typically lead to a lower price for financial instruments.

Correct Answer: B. The risk that the other party to the derivative contract will fail to meet their obligations. This is the definition of counterparty risk for OTC derivatives.

Correct Answer: C. Credit risk interacts with market risk as the mark-to-market values of derivatives change.

Correct Answer: B. When the mark-to-market value of the derivative is negative for the bank (representing an amount receivable). This is when the bank is owed money by the counterparty.

Correct Answer: C. Credit risk exposure. Potential future values indicate the potential amount the bank could lose if the counterparty defaults.

Correct Answer: B. The risk of loss if a party fails to complete their obligations in a market transaction. This is the definition of settlement risk.

Correct Answer: B. To mitigate settlement risk. RTGS helps ensure the timely and final settlement of transactions.

Correct Answer: B. By acting as an intermediary and helping to mitigate settlement risk. Central counterparties stand between the buyer and seller, reducing the risk of one party defaulting.

Correct Answer: C. Risk Identification. Risk Identification involves determining potential market risks.

Correct Answer: B. Risk Measurement. Risk Measurement focuses on determining the quantum of potential losses.

Correct Answer: C. Risk Monitoring and Control. This process involves the ongoing management of market risks.

Correct Answer: C. Risk Mitigation. Risk Mitigation focuses on reducing the level of market risk.

Correct Answer: C. The Board of Directors. The Board holds the overall responsibility for market risk management.

Correct Answer: C. Articulating market risk management policies and procedures. The Board defines the framework for market risk management.

Correct Answer: B. Aggregate risk limits for overall market risk. The Board sets the broad limits for market risk.

Correct Answer: C. Establishing review mechanisms and reporting/auditing systems. The Board ensures oversight through these systems.

Correct Answer: B. Liquidity risk, interest rate risk, foreign exchange risk, and equity-price risk. The Board sets limits for these specific types of market risks.

Correct Answer: C. To set guidelines for market risk management and reporting. The Committee provides the framework for managing market risk.

Correct Answer: B. The Risk Management Committee. This committee ensures policy conformity.

Correct Answer: B. The Risk Management Committee. This committee is responsible for setting and reviewing these limits.

Correct Answer: B. The Risk Management Committee. This committee oversees the adequacy of risk measurement tools.

Correct Answer: B. The Risk Management Committee. This committee ensures proper staffing for market risk management.

Correct Answer: B. The Asset-Liability Management Committee (ALCO). ALCO handles product pricing.

Correct Answer: C. To protect and improve the NIM. ALCO’s actions aim to enhance the bank’s profitability from interest-bearing assets and liabilities.

Correct Answer: B. The Asset-Liability Management Committee (ALCO). ALCO manages the balance sheet structure.

Correct Answer: B. The Asset-Liability Management Committee (ALCO). ALCO formulates the bank’s perspective on interest rates.

Correct Answer: B. The Asset-Liability Management Committee (ALCO). ALCO oversees funding and liquidity.

Correct Answer: B. The Asset-Liability Management Committee (ALCO). ALCO manages these aspects of the bank’s financials.

Correct Answer: B. The Asset-Liability Management Committee (ALCO). ALCO sets operational boundaries and monitors performance.

Correct Answer: B. The ALM Support Group/Market Risk Group. This group provides analytical support to ALCO.

Correct Answer: B. The ALM Support Group/Market Risk Group. This group assesses the impact of market fluctuations.

Correct Answer: B. The ALM Support Group/Market Risk Group. This group advises ALCO on necessary actions.

Correct Answer: C. The Middle Office. The Middle Office provides an independent view of market risk.

Correct Answer: C. The Middle Office. The Middle Office offers an independent evaluation of risk.

Correct Answer: C. The Middle Office. Independent price validation is a key function of the Middle Office.

Correct Answer: C. The Middle Office. Independence from the treasury is crucial for the Middle Office’s objectivity.

Correct Answer: C. Market prices. Market risk encompasses losses from various market price movements.

Correct Answer: B. To ensure unbiased risk assessment. Independence allows for an objective evaluation of risks.

Correct Answer: C. Protecting and improving Net Interest Margin (NIM) and managing liquidity. ALCO aims to balance profitability and risk.

Correct Answer: B. To set the overall risk management tone and policy. The Board establishes the foundation for risk management.

Correct Answer: B. Their risks are generally well-understood. Standard products have known risk profiles.

Correct Answer: C. Product Programs. Product Programs establish the framework for standard products.

Correct Answer: C. Market risk measurement for both individual products and the portfolio. Product Programs detail how risk is measured.

Correct Answer: B. It requires closer and more detailed analysis. Non-standard products have unique or less understood risks.

Correct Answer: C. Product Transaction Memorandum. This document provides initial guidance for non-standard products.

Correct Answer: C. From corporate policy down to the transaction level. Corporate policy sets the overall risk appetite.

Correct Answer: C. Corporate approval. New products require authorization at the corporate level.

Correct Answer: B. Corporate approval. Deviations from standard procedures need corporate authorization.

Correct Answer: B. To ensure appropriate safeguards and exposure limits are in place. Corporate approval aims to control risk.

Correct Answer: C. Based on the risk-return characteristics and quantification of risks. Corporate decisions consider both potential gains and associated risks.

Correct Answer: B. The impact of transaction-level risk on the overall portfolio. The corporate level focuses on the aggregate risk.

Correct Answer: C. To identify potential risks at an early stage. Early identification is crucial for effective risk management.

Correct Answer: B. To mitigate identified risks. Safeguards are implemented to reduce the likelihood or impact of risks.

Correct Answer: B. To control potential losses from specific products. Exposure limits help manage potential downsides.

Correct Answer: C. The size and probability of potential losses. Risk quantification helps understand the magnitude and likelihood of losses.

Correct Answer: B. The change in market value for a unit change in a single market parameter. Sensitivity focuses on how value changes with one market factor.

Correct Answer: C. It ignores simultaneous changes in other parameters. Sensitivity looks at one factor at a time.

Correct Answer: C. It varies with the parameter’s value. Sensitivity is not always a fixed measure.

Correct Answer: C. Interest rate-sensitive instruments. Instruments like bonds are highly sensitive to interest rate changes.

Correct Answer: C. The change in value for a 1 basis point (0.01%) change in market yield. BPV quantifies the impact of small yield changes.

Correct Answer: C. Bonds. BPV is a standard measure for interest rate risk in bonds.

Correct Answer: C. By determining the price change for a 0.01% yield shift. BPV directly reflects this price sensitivity.

Correct Answer: B. It quickly estimates the potential profit or loss for small changes in yield. BPV provides a quick way to assess yield sensitivity.

Correct Answer: C. It decreases. As maturity approaches, the bond’s price becomes less sensitive to yield changes.

Correct Answer: C. A bond’s price sensitivity to yield changes and the average time to receive the present value of cash flows. Duration combines price sensitivity and time to cash flow.

Correct Answer: C. (Cumulative Present value of time adjusted cash flows) / (Current bond price). This formula represents the weighted average time to receive cash flows.

Correct Answer: C. Macaulay’s duration adjusted for yield to maturity, measuring the percentage change in bond price for a 1% yield change. Modified duration provides a direct measure of price sensitivity.

Correct Answer: C. Macaulay’s Duration / (1 + yield). This formula adjusts Macaulay’s duration for the impact of yield.

Correct Answer: C. The percentage price change is equal to the modified duration. Modified duration directly quantifies this percentage change.

Correct Answer: C. Longer duration means higher price sensitivity. Bonds with longer durations are more sensitive to interest rate fluctuations.

Correct Answer: B. -2.5%. Approximate % change in price = – Modified Duration × Yield Change = -5 × 0.5% = -2.5%.

Correct Answer: B. The potential losses when earnings perform worse than expected. Downside potential specifically looks at negative deviations.

Correct Answer: B. The predicted worst-case loss at a specific confidence level over a defined period under normal trading conditions. VaR provides an estimate of potential losses under typical conditions.

Correct Answer: C. “How much can we expect to lose?”. VaR is a measure of potential downside risk.

Correct Answer: C. The period over which the potential loss is estimated. The time horizon defines the duration for the VaR calculation.

Correct Answer: C. The probability that losses will not exceed the VaR. The confidence level indicates the certainty of the VaR estimate.

Correct Answer: C. Normal trading conditions, excluding extreme market events. VaR is not designed for black swan events.

Correct Answer: C. The volatility of asset prices. Higher volatility generally leads to a higher VaR.

Correct Answer: B. The correlation between the prices of different assets. Correlation affects the overall portfolio risk.

Correct Answer: C. Price Volatility = (Yield volatility × BPV × Yield) / Price. This formula shows how price volatility is derived from yield volatility and bond characteristics.

Correct Answer: C. Correlation (Variance/Covariance) Method. This method uses statistical relationships between asset returns.

Correct Answer: C. Historical Simulation. This method uses past data to simulate potential future losses.

Correct Answer: C. Monte Carlo Simulation. This method uses computer simulations to model potential outcomes.

Correct Answer: B. It protects stakeholders by translating portfolio exposures into potential profit and loss. VaR helps understand potential financial impact.

Correct Answer: B. By aggregating the exposures into a single potential loss figure. VaR provides a consolidated view of risk.

Correct Answer: C. It is not a worst-case scenario and doesn’t measure losses under abnormal market conditions. VaR has limitations in extreme situations.

Correct Answer: C. Back testing, model calibration, scenario analysis, and stress testing. These techniques complement VaR.

Correct Answer: C. Management Information Systems (MIS). VaR provides valuable data for risk analysis in MIS.

Correct Answer: B. By informing decisions based on the potential for losses. VaR helps in making risk-aware strategic choices.

Correct Answer: B. A process of comparing model-based VaR with actual portfolio performance to validate accuracy. Back testing checks the reliability of the VaR model.

Correct Answer: B. Arithmetical moving average and exponential moving average. These are common statistical techniques for volatility estimation.

Correct Answer: B. The variability in historical data periods and the failure to capture “event risk”. Past data may not always predict future volatility, especially during unexpected events.

Correct Answer: C. VaR’s inability to measure risk under abnormal market conditions is a key limitation. VaR is less reliable during crises.

Correct Answer: C. Severe losses that go beyond the VaR estimate (captures tail risk). CVaR focuses on the extreme tail of the loss distribution.

Correct Answer: C. It is the average of losses exceeding VaR. CVaR provides an estimate of the expected magnitude of losses beyond VaR.

Correct Answer: B. To evaluate the accuracy of new or existing VaR models. Back testing helps determine if the VaR model is performing as expected.

Correct Answer: B. To determine the impact of non-normal market parameter movements and assess potential losses in extreme conditions. Stress testing examines resilience to severe shocks.

Correct Answer: B. Isolating the impact of predefined moves in a single risk factor. This test focuses on the effect of one variable at a time.

Correct Answer: C. Applying simultaneous shocks to multiple risk factors based on historical or hypothetical events. Scenario analysis considers the combined impact of several factors.

Correct Answer: C. The most damaging combination of risk factor moves. This technique seeks to find the worst-case scenario.

Correct Answer: B. To capture risk in extreme circumstances and accommodate skewed distributions. EVT is specifically designed for tail risk analysis.

Correct Answer: C. It is relevant to the current position and considers all relevant market rates. A good stress test is tailored to the current situation.

Correct Answer: B. Potential regime shifts in the market. Stress tests should consider fundamental changes in market behavior.

Correct Answer: B. Market illiquidity. Difficulty in trading during stressed conditions can amplify losses.

Correct Answer: B. The interplay between market and credit risk. These two types of risk can be interconnected, especially in stressed scenarios.

Correct Answer: C. Forward-looking, considering potential future events. Stress tests should anticipate potential future shocks.

Correct Answer: C. To summarize exposure to extreme scenarios and inform senior management about risk-taking. Stress tests provide insights into potential severe impacts.

Correct Answer: B. By highlighting potential vulnerabilities in funding under stressed conditions. Stress tests help assess funding adequacy in crises.

Correct Answer: B. By revealing potential weaknesses or limitations in the models under extreme conditions. Stress tests can expose flaws in model design or assumptions.

Correct Answer: B. By informing the setting of limits based on the potential for losses under extreme scenarios. Stress test results can guide the establishment of appropriate trading boundaries.

Correct Answer: B. By highlighting the need for additional capital buffers to absorb potential losses in extreme scenarios. Stress tests can indicate if current capital levels are sufficient.

Correct Answer: C. Lack of transparency, subjectivity in choosing parameters, absence of probabilities, and cost. These are known challenges associated with stress testing.

Correct Answer: C. To keep portfolio value variations within defined boundaries using risk limits. Risk monitoring and control aims to manage fluctuations within acceptable levels.

Correct Answer: C. Simultaneously applying risk and business policies and setting market risk limits based on economic risk measures. Policy implementation balances risk and business objectives.

Correct Answer: B. By maintaining portfolio value variations within defined boundaries by using limits as upper bounds on risks. Risk control uses limits to manage potential losses.

Correct Answer: C. Roles and authority in risk management. Clear guidelines ensure accountability and proper decision-making.

Correct Answer: B. A defined process with clear steps and responsibilities. A structured process ensures proper oversight and approval.

Correct Answer: C. They unbundle products and transactions to analyze their individual risk components. This allows for a detailed understanding of the underlying risks.

Correct Answer: C. Portfolio management practices. These guidelines help control overall portfolio risk.

Correct Answer: C. Systems for estimating portfolio risk under both normal and stressed conditions. A comprehensive view requires assessment under various scenarios.

Correct Answer: C. That assets are valued at their current market prices. Mark-to-market provides a realistic view of asset values.

Correct Answer: B. Continuous monitoring and reporting of risk limits. Regular oversight is crucial for timely action.

Correct Answer: B. They aid in performance reviews and resource allocation. Risk measurements provide insights for decision-making.

Correct Answer: B. Approved market risk limits for factor sensitivities and Value at Risk (VaR). These are specific measures for controlling risk.

Correct Answer: C. Daily. Frequent measurement allows for timely identification of potential issues.

Correct Answer: B. Management triggers or stop-loss limits. These help prevent large losses.

Correct Answer: B. Basis risk. Basis risk arises from imperfect correlation between hedging instruments and the hedged item.

Correct Answer: C. Verification of transaction execution and revaluation at prevailing market rates. This ensures accuracy and reflects current market conditions.

Correct Answer: B. Independent personnel not involved in the initial rate setting. Independence ensures objectivity and reduces the risk of manipulation.

Correct Answer: B. Independent testing and certification. This ensures the reliability and accuracy of the models.

Correct Answer: C. Quarterly. Regular stress testing helps assess the portfolio’s resilience to adverse market conditions.

Correct Answer: B. An approved model control and certification policy. This ensures proper governance and oversight of the models.

Correct Answer: B. Full documentation of the financial models, including their assumptions and limitations. Comprehensive documentation is essential for understanding and validating the models.

Correct Answer: B. Designated personnel validate financial models for algorithm accuracy. Specialized skills are needed for this task.

Correct Answer: C. Annually. External validation provides an independent assessment of the models’ reliability.

Correct Answer: B. Implementing strict access controls and change management procedures. This helps maintain the integrity of the models.

Correct Answer: B. Periodic review of model assumptions is conducted. Regular review ensures that the assumptions remain valid in the current market environment.

Correct Answer: B. Avoid holding a large portion of the market in any single asset type. Holding a significant market share can make it difficult to liquidate positions quickly without impacting prices.

Correct Answer: B. It enhances the portfolio’s liquidity by making it easier and faster to execute trades. Instruments that are not frequently traded can be challenging to sell quickly at a fair price.

Correct Answer: C. They may have a limited number of participants in the market, making them harder to trade efficiently. Instruments with unusual maturities might lack sufficient buyers or sellers.

Correct Answer: C. It can be challenging to find counterparties willing to take the opposite side of a trade, thereby increasing the risk of not being able to execute or having to accept unfavorable prices. In markets lacking balanced buy and sell orders, executing trades at the desired price can be difficult.

Correct Answer: C. Through a combination of the number of shares, the price per share, or the total monetary value of the holdings. These are standard ways to quantify a market position.

Correct Answer: B. By stating the overall monetary value that the investor’s position represents. This provides a clear indication of the investment’s size.

Correct Answer: B. By determining the degree to which the position’s value is likely to change in response to fluctuations in relevant market factors. This highlights the potential volatility and risk associated with the position.

Correct Answer: C. The price at which shares of stock ‘A’ are trading in the market. The stock’s price is the most direct market factor affecting its investment value.

Correct Answer: C. The Market Factor Sensitivity of Mr. X’s position to the price of stock ‘A’. This figure indicates how sensitive the portfolio value is to changes in the stock price.

Correct Answer: C. The degree of fluctuation or uncertainty in the price of stock ‘A’ on a daily basis. Volatility measures the dispersion of returns.

Correct Answer: C. The defeasance period. This term refers to the time needed to unwind a position.

Correct Answer: B. By multiplying the 3% volatility by the z-score that corresponds to a 99% confidence level (which is approximately 2.326). The defeasance factor scales the volatility based on the desired confidence.

Correct Answer: C. ₹6,000 multiplied by 3 multiplied by 2.326. The VaR is calculated as Sensitivity per one percent change multiplied by Volatility multiplied by Defeasance Factor, which equals ₹6,000 multiplied by 3 multiplied by 2.326, resulting in ₹41,868.

Correct Answer: B. The volatility of financial instruments. Market risk is fundamentally linked to the unpredictable price movements of financial assets.

Correct Answer: C. To reduce portfolio volatility in order to limit potential losses. Mitigation aims to dampen the fluctuations in portfolio value, especially on the downside.

Correct Answer: B. It also limits the potential for upside gains or profits. Risk reduction often involves sacrificing some potential for high returns.

Correct Answer: C. Counterparty risk. When relying on other entities for mitigation, there’s a risk they might not fulfill their obligations.

Correct Answer: C. Exchanges or central counterparties. These entities act as intermediaries, reducing the risk of one party defaulting.

Correct Answer: B. OTC deals generally have higher counterparty risk. OTC transactions are often bilateral agreements without the guarantees of an exchange.

Correct Answer: C. The weighted average of the Basis Point Values of the individual bonds in the portfolio. Portfolio BPV gives an overall measure of interest rate sensitivity.

Correct Answer: C. Bonds with a BPV lower than the portfolio average. Adding lower BPV bonds will reduce the overall portfolio’s sensitivity to yield changes.

Correct Answer: C. The sensitivity of the portfolio’s value to changes in interest rates. Duration is a key measure of interest rate risk.

Correct Answer: C. By adding instruments with higher durations or reducing holdings of instruments with lower durations. Duration is increased by shifting towards longer-term or more interest-rate-sensitive bonds.

Correct Answer: B. Their prices tend to move in opposite directions. Negative correlation means when one goes up, the other tends to go down.

Correct Answer: C. Their prices move in opposite directions with exactly the same magnitude. This represents a perfect offset in price movements.

Correct Answer: B. It reduces the overall portfolio volatility. When assets move in opposite ways, the overall fluctuations of the portfolio are dampened.

Correct Answer: C. A long position in a stock and a short position in its futures contract. These positions are designed to offset each other’s price movements.

Correct Answer: B. By entering into a long position in a variable-rate IRS. The variable payments of the IRS can offset the fixed payments of the bond as interest rates change.

Correct Answer: B. The right, but not the obligation, to buy an asset at a specific price (strike price). This gives the holder potential upside with limited downside.

Correct Answer: C. It limits the potential loss to the premium paid for the option if the asset price falls below the strike price. The buyer can choose not to exercise the option if the price is unfavorable.

Correct Answer: B. To limit the potential loss when selling an asset. The put option gives the holder the right to sell at a specific price, protecting against price declines.

Correct Answer: C. The payment of a premium to acquire the option. Options are not free and require an upfront payment.

Correct Answer: A. Initial number of shares = 20000 / 200 = 100 shares. Price drop = 10% of Rs. 200 = Rs. 20. New price per share = 200 – 20 = Rs. 180. New investment value = 100 * 180 = Rs. 18,000.

Correct Answer: D. Total value of shares with leverage = 5 * 50,000 = Rs. 2,50,000. Loss in value = 2% of Rs. 2,50,000 = 0.02 * 250000 = Rs. 5,000.

Correct Answer: B. Loss per share = Rs. 50 – Rs. 45 = Rs. 5. Total capital loss = 50 shares * Rs. 5/share = Rs. 250.

Correct Answer: C. Total investment = Rs. 30,000 + Rs. 60,000 = Rs. 90,000. Total loss = 3% of Rs. 90,000 = 0.03 * 90000 = Rs. 2,700. Percentage loss on initial capital = (2700 / 30000) * 100 = 9%.

Correct Answer: C. Profit = BPV * Change in yield = Rs. 1,500 * 5 = Rs. 7,500.

Correct Answer: A. Approximate % change in price = – Modified Duration × Yield Change = -3.2 * 0.5 = -1.6%.

Correct Answer: A. Modified Duration = Macaulay’s Duration / (1 + yield) = 4 / (1 + 0.10) = 4 / 1.10 = 3.64.

Correct Answer: C. Loss = BPV * Change in yield = Rs. 2,500 * 3 = Rs. 7,500.