REVIEW QUESTION FROM BIONIC TURTLE – BOOK1

502.1. D. Market risk value at risk (MVaR) can be expressed as either relative MVaR or absolute
MVaR but it is "relative MVaR" that matches (better captures) unexpected losses (UL)

504.1. B. False. "The crisis reignited a long-term debate about how to ensure that bank boards
contain the right balance of independence, engagement and financial industry expertise. However,
analysis of failed banks do not show any clear correlation between a predominance of 'expert
insiders' or 'independents' and either failure or success. The first large
failure of the crisis, the U.K.'s Northern Rock in 2007, had a number of banking experts on its
board."

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

506.3. B. Line Management

600.2. A. TRUE: If the Modigliani-Miller theorem is strictly true, then banks do not need to exist

601.2. B. TRUE: Less granularity might be advisable in order to capitalize on opportunities

702.3. A. TRUE: Repo haircuts shocked (increased) for many assets that had no direct connection
to subprime securities

703.3. B. BEST EVIDENCE: Syndicated lending started to fall in mid‐ 2007 and the fall accelerated
during the banking panic that began in September 2008

48.1 D. Counterparty risks

 The CDS hedges default risk. Or, at least the default risk is not ignored.
 The interest rate swap hedges market risk.
 The forward contract intends to hedge currency risk.
 But without collateral, the forward contract is exposed to counterparty risk.

REVIEW BOOK 1:

602.1 A. Expected loss (EL) is the least likely because "financial risk" primarily concerns
unexpected losses (UL). Further, expected credit losses will be priced into loan products rather
than buffered by capital cushions

605.1. C. Unlike valuation (pricing) where precision is important, risk measurement neither requires
nor realistically expects a high degree of precision

605.3. B. FALSE: Value at risk (VaR) is optimal for market risk but is poorly designed for credit
and operational risk; and VaR cannot realistically play a role in enterprise risk and economic capital
metrics, where elliptical properties are desirable

609.1. D. Kintech is overvalued and Zimit is undervalued

 β(Kintech) = ρ(k,M)*σ(k)/σ(M) = 0.70*60%/30% = 1.40 and its CAPM required rate of
return = 1% + 1.40*7.0% = 10.80%; compared to 10.0% forecast, it is overvalued
 β(Zimit) = COV(z,M)/σ^2(M) = 0.0540/30%^2 = 0.60 and its CAPM required rate of
return = 1% + 0.60*7.0% = 5.20%; compared to 6.0% forecast, it is undervalued
Key definitions include:
 Risk Appetite: The types and amount of risk, on a broad level, an organization is willing to accept
in pursuit of value.

 Risk Capacity: The maximum amount of risk that an entity is able to absorb in the pursuit of
strategy and business objectives.

 Internal Control: A process, effected by an entity’s board of directors, management, and other
personnel, designed to provide reasonable assurance regarding the achievement of objectives
relating to operations, reporting, and compliance.

 Risk Profile: A composite view of the risk assumed at a particular level of the entity, or aspect
of the business model that positions management to consider the types, severity, and
interdependencies of risks, and how they may affect performance relative to its strategy and
business objectives.

 Enterprise Risk: The culture, capabilities, and practices, integrated with strategy-setting and its
execution, that organizations rely on to manage risk in creating, preserving, and realizing value.

Also of potential interest is the oft-cited difference between inherent and residual risk:

 Inherent risk is the risk to an entity in the absence of any direct or focused actions by
management to alter its severity.

 Target residual risk is the amount of risk that an entity prefers to assume in the pursuit of its
strategy and business objectives, knowing that management will implement, or has implemented,
direct or focused actions by management to alter risk severity

 Actual residual risk is the risk remaining after management has taken action to alter its severity.
Actual residual risk should be equal to or less than the target residual risk, as is illustrated in Figure
8.5. Where actual residual risk exceeds target risk, additional actions should be identified that allow
management to alter risk severity further.