Question 1

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.

Accepted Answer

RiskMetrics uses an exponentially weighted moving average, which assigns greater weight to more recent observations in the calculation of volatility. This allows for more recent news and market movements to have a greater impact on the overall measure of risk.

Question 2

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.

Accepted Answer

The answer of Define the following terms within the context...

Question 3

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.

Accepted Answer

The correct sequential order for back simulation is: measure exposures, measure risks, measure sensitivity, rank days by risk from worst to best, measure risk again, and VAR.

Question 4

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

Accepted Answer

The answer of Explain the basic concept of the RiskMetric...

Question 5

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.

Accepted Answer

The historic or back simulation approach uses actual historical data and therefore does not require any assumptions about distribution or calculation of standard deviations and correlations.

Question 6

A major advantage is that RiskMetrics directly provides a worst-case scenario number, while this is not the case for back simulation.

Accepted Answer

RiskMetrics provides a value-at-risk (VaR) measure, which quantifies the worst-case scenario in terms of potential losses over a given time horizon and confidence level. Back simulation, on the other hand, involves simulating many different scenarios and their resulting outcomes, and it may be more difficult to directly compare and interpret the worst-case scenario from these simulations.

Question 7

Vertical offsets are calculated using the sum of the general market risk charges from long and short positions in each time zone.

Accepted Answer

The answer of Vertical offsets are calculated using the sum...

Question 8

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

Accepted Answer

The specific risk charge is indeed a charge that takes into account the risk of a decline in liquidity or credit risk quality of a trading portfolio.

Question 9

Daily earnings at risk (DEAR) is the market risk exposure over the next 72 hours.

Accepted Answer

Daily Earnings at Risk (DEAR) measures the potential loss in value of a portfolio due to market movements over a specified time period, typically one day, not 72 hours.

Question 10

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.

Accepted Answer

This is a correct definition of market risk, which is a type of financial risk that is associated with the potential losses resulting from changes in market variables. These variables may include interest rates, exchange rates, commodity prices, stock prices, and other market factors that affect the value of a financial institution's investments or trading positions. Market risk can arise from various sources, such as foreign exchange risk, interest rate risk, equity risk, and credit spread risk. Therefore, financial institutions use various tools and techniques, like hedging strategies and risk management frameworks, to control and manage their exposure to market risk.

Question 11

Monte Carlo simulations address the problems imposed by a limited number of actual observations, by generating additional observations.

Accepted Answer

Monte Carlo simulations use random sampling techniques to generate additional observations, addressing the problem of limited data.

Question 12

Why is market risk measurement important?

Accepted Answer

The answer of Why is market risk measurement important?...

Question 13

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.

Accepted Answer

The VAR only provides information on the potential loss for a certain confidence level. It does not provide information on the maximum potential loss.

Question 14

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.

Accepted Answer

The market risk capital requirement was not uniformly a large proportion of the total risk capital requirements for Australian banks during this period, as credit risk typically constituted a larger portion. Additionally, while market risk losses were significant during the global financial crisis, they did not uniformly increase post-crisis.

Question 15

The general market risk charges reflect the product of the modified durations and interest rate shocks expected for each maturity.

Accepted Answer

This is true, as the general market risk charges for interest rate risk in a bank's trading book are usually calculated based on a Value-at-Risk (VaR) framework, where the VaR calculation involves the use of modified durations and interest rate shocks at different maturities.

Quiz 9: Market Risk