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P1.T1.501. What is risk? (Crouhy, Galai & Mark)

Nicole Seaman

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Learning Objectives: Explain the concept of risk and compare risk management with risk taking. Describe the risk management process and identify problems and challenges which can arise in the risk management process. Evaluate and apply tools and procedures used to measure and manage risk, including quantitative measures, qualitative assessment, and enterprise risk management.

Questions:

501.1. You are having lunch with a client who suddenly asks you, "I noticed that you studied risk. To me, risk is when bad stuff can happen. Can you tell me, what is your definition of risk?" As far as the financial risk manager (FRM) is concerned--at least among the following potential responses to your client's question--which of the following definitions of risk is best?

a. Risk is the source or cause of a financial loss or cost
b. Risk is a condition that increases the probability of a loss
c. Risk is the size of a loss or cost: if a cost is greater, then its risk is greater
d. Risk is the variability of adverse outcomes that are unexpected


501.2. According to Crouhy, Galia and Mark, which of the following is TRUE about the 2007 to 2009 global financial crisis (GFC) and its implication on risk management?

a. Soft factors--e.g., corporate governance structures and risk cultures--did NOT cause the GFC; instead, the GFC was effectively caused by hard factors and, in particular, technical deficiencies in risk measurement
b. Since the GFC, risk managers have--to at least some degree--shifted away from historical-statistical treatments of risk and toward scenario analysis and stress testing
c. Contrary to the popular mainstream narrative, financial engineering and derivatives helped mitigate losses during the GFC due to their innate ability to disperse risk; for example, "without credit derivatives, financial risk would have been far more concentrated and the consequences of the crisis would have almost certainly been worse."
d. Although risk management was narrowly responsible for minor failures leading up to (and during) the GFC, these failures were small exceptions to the general rule that risk management has consistently and successfully prevented market disruptions and accounting scandals for over three decades


501.3. According to Crouhy et al, each of the following statements about the numerical measurement of risk is true EXCEPT which is false?

a. Merely judgmental rankings of risk (e.g., Risk Rating 3 versus Risk Rating 2) can help us make more rational in-class comparative decisions
b. If we can put an absolute cost or price on a risk, then we can make rational economic decisions about risks; at this point, risk management decisions become fungible with other management decisions
c. The best numerical measure of risk during abnormal markets, over longer periods, or for illiquid portfolios is value at risk (VaR)
d. All risk measures depend on a robust control environment; for example, in many rogue-trading case studies (debacles) traders found some way of circumventing trading controls and suppressing risk measures

Answers here:
 

David Harper CFA FRM

David Harper CFA FRM
Staff member
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It's funny how, after nine (9, yikes!) years of studying/learning/teaching the FRM, I still have to pause at the question (501.1) above: what is risk? Sometimes i start by reminding myself what "risk" is not:
  • Risk is not "loss" itself, or the realized loss; risk is the potential for (unexpected) loss
  • Risk is not "peril" which is technically the cause or source of a loss; e.g., among the Basel III operational risk event types are internal fraud and external frauds; fraud is technically a peril. It's cause-effect: the peril creates a risk (effect = potential loss with some probability and severity)
  • Risk is not "hazard" which is a condition that increases the probability of a loss
We could do worse than to define risk as ([probability of loss] * [severity of loss]) because that avoids the above definitional traps ...
 
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brian.field

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@Nicole Manley, Can I expect to see a Part 2 question every monday (generally?) I have not seen one today and I think you mentioned that the questions were returning today.

Thanks,

Brian
 

Nicole Seaman

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Hello @brianhfield,

We post a daily practice question each day Monday through Thursday. We rotate between part 1 and part 2 each day. For example, today we posted a part 1 question, tomorrow we will post a part 2 question, Wednesday we will post a part 1 question and so on.

Thanks!

Nicole
 

Nicole Seaman

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Hello @prash2015,

The answers to the daily practice questions are only available to paid members. When you purchase one of our packages, you gain access to the full forum, along with study materials that can help tremendously in your studies. You can view all of our packages, along with their features and pricing HERE.

Thank you,

Nicole
 

David Harper CFA FRM

David Harper CFA FRM
Staff member
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@CK2015 Thank you, we always appreciate this sort of feedback. But I can't find the typo to which you refer. Sorry to ask you to be more specific, but I'd love to fix it? Thanks!
 

CK2015

New Member
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It's a minor typo. In the second paragraph below, (C) below should have been (D) like " In regard to (A), (B), and (D), each is TRUE"

501.3. C. False, "the VaR measure works well as a risk measure only for markets operating under normal conditions and only over a short period, such as one trading day. Potentially, it’s a very poor and misleading measure of risk in abnormal markets, over longer time periods, or for illiquid portfolios."

In regard to (A), (B), and (C), each is TRUE.
 
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