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P1.T1.602. Basic financial risk types (Topic Review)

Nicole Seaman

Director of FRM Operations
Staff member
Subscriber
Questions:

602.1. Sallly Smith is developing an economic capital model for her bank. Her economic capital model will determine the target level of equity (i.e., on the balance sheet) at the firm based on a risk appetite articulated by the board of directors and capital at risk across the business units. Each of the following is a financial risk that directly determines her model's output EXCEPT among these which is the LEAST likely to directly impact her economic capital model?

a. The $1.5 million loss that is expected on a $100.0 million bond portfolio with a default probability (PD) of 1.5%
b. The value at risk (VaR) of certain operational processes that Sally has quantified; e.g., model risk, transaction risk
c. The value at risk (VaR) of the bank's portfolio of public securities and debt instruments, 70% of which are actively managed
d. The high exposure of the bank's credit portfolio to macroeconomic conditions; i.e., asset correlation of 20% to systemic risk factors


602.2. Betacare Bank is a United States (U.S.) commercial bank that primarily invests in long-term projects. It is a market leader in commercial real estate loans and business loans. For its sources of funds, the bank mostly issues short-term liabilities, including short-term repurchase agreements (repos), six-month commercial paper and certificates of deposit (CDs) with maturities of less than one year. Each of the following correctly specifies a financial risk to which the bank is exposed EXCEPT which is incorrectly specified?

a. Credit risk due to unexpected losses (UL) in credit assets
b. Liquidity risk due to sudden surge of withdrawals from repo counterparties
c. Market risk due maturity mismatch between long-term assets and short-term liabilities
d. Off-balance-sheet risk due to loans made to companies in the United Kingdom that are denominated in pounds sterling


602.3. Your colleague Peter is drafting a proposed operational risk (OpRisk) taxonomy to be presented to the board. The risk taxonomy will categorize OpRisk in different risk types. He expresses the following four opinions about operational risk. Which of his following statements about operational risk is TRUE?

a. If a risk is not already defined as either a credit, market or liquidity risk, then by definition it is an operational risk
b. In many firms, "operational risk" can be safely renamed "technology risk" because they have increasingly become synonyms
c. In order to be measured and managed, operational risk should exclude external events such as terrorism or criminal hackers breaching the firm's computer systems
d. Although it includes legal risk, operational risk concerns many activities and factors that are not contractual, in contrast to credit and market risk which are based mostly on financial contracts

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