Vignette: As a department head for a large financial institution, risk management is one of your primary responsibilities. This includes managing both credit and liquidity risk on the firm's investment portfolio as well as the various derivative instruments used by the company.
Question: One of the ways that credit risk associated with derivative instruments may be mitigated is by having a clause that automatically forces a settlement when the credit rating of one of the parties drops below a certain threshold.
Such a credit risk mitigation strategy is known as which of the following?
Select an Answer: margin calls credit triggers credit guarantee position limits
Rationale:
A credit trigger forces settlement when the credit rating of one of the parties drops below a certain threshold. They are often used with longer term derivatives.
2024-03-27
Vignette: Casey Alright has been assigned the task of evaluating global risk management issues for his employer. His employer, GBG Global Capital, is involved with investing on a global basis and has recently decided to examine the global risk management issues of the firm to see if they are missing anything.
GBG is concerned about the risk factors that it may not be taking into consideration when analyzing its risk. The following are issues that management has brought up to Casey that they want examined.
Question: Casey is evaluating the usefulness of variance and correlation measures in financial markets during periods of financial crisis versus during periods of normalcy.
Which statement best describes correlation and variance in times of financial crisis?
Select an Answer: There are only marginal changes in correlation and variance in times of crisis; therefore, they do not need to be factored into risk management. The diversification benefits decrease when correlations rise; therefore, your risk level increases. The diversification benefits increase when correlations rise; therefore, your risk level decreases. The VAR estimates provide for the effects of increased correlations during periods of crisis; therefore, the effects are factored into current positions.
Rationale:
During crisis situations the correlation between global markets increases. The implication of this increased correlation is that the maximum amount that you can lose for a given probability over a given time period increases. The diversification benefits decrease when correlations rise; therefore, your risk level increases. Stress testing can be used to evaluate the effects of increased correlations.
2024-03-26
Vignette: Natasha Jorgen is a financial engineer with the firm CDC Analytics Inc. Her main task is to assist in the modeling of credit derivatives.
Her boss, Toshi Yamato, has asked her to put together a presentation on credit risk for several of their top institutional clients.
Question: In Natasha's presentation, she outlines the benefits of using total return credit swaps to the payer and to the receiver.
Which of the following statements best describes the benefits to both the receiver and the payer?
Select an Answer: The receiver benefits by eliminating credit risk and not having to finance the underlying assets. The payer benefits by locking in a fixed margin and by not having to finance the underlying assets. The receiver benefits by not having to finance the underlying assets and by having the credit analysis performed by the payer. The payer benefits by eliminating credit risk for a relatively small fee. The receiver benefits by not having to finance the underlying assets and by having the credit analysis performed by the payer. The payer benefits by eliminating credit risk and locking in a fixed margin. The receiver benefits by not having to finance the underlying assets and by locking in a fixed margin. The payer benefits by eliminating credit risk for a relatively small fee.
Rationale:
The receiver is essentially taking on the credit risk while the payer is eliminating or reducing risk. For example, a lending institution has a portfolio of loans that cost them LIBOR + 50bps to finance. The institution enters into a swap with an investor as the total return credit swap payer and the investor agrees to pay LIBOR + 75bps. Thus, the payer locks in a margin of 25bps, eliminating its risk.
2024-03-25
Vignette: Natasha Jorgen is a financial engineer with the firm CDC Analytics Inc. Her main task is to assist in the modeling of credit derivatives.
Her boss, Toshi Yamato, has asked her to put together a presentation on credit risk for several of their top institutional clients.
Question: Natasha points out the reasons why a seller of credit protection would be willing to assume the credit risk of an underlying financial asset or institution.
All of the following are reasons why a seller of credit protection would be willing to assume credit risk except:
Select an Answer: the prospect of a rating agency upgrade for an issue. the issuing firm is acquired by a larger firm of higher financial quality. an expected rise in inflation rates. an income enhancement of their current portfolio by writing covered call options.
Rationale:
An expected rise in inflation rates would not be desirable for a firm assuming credit risk as it would likely result in a rise in interest rates. This would reduce the value of the bonds which would be good for the buyer of credit risk derivatives but not good for the seller - the one assuming the credit risk.
2024-03-24
Vignette: Guy Pappas is responsible for value at risk measurements within the firm he works for and wants to take a closer look at the uses and abuses of VAR. Guy is reviewing a variety of issues related to VAR.
Question: Which of the following describes the difference between a value risk manager and a cash flow risk manager?
Select an Answer: Value risk managers are concerned with the increase in value of the portfolio or firm under management. A cash flow manager is primarily focused on portfolio investment of any cash balances in the portfolio. Value risk managers are concerned with the value of VAR of the portfolio or firm under management. A cash flow manager is primarily focused on a portfolio or firm's cash balance in the portfolio. Value risk managers are concerned with the value of the portfolio or firm under management. A cash flow manager is primarily focused on portfolio or firm cash flows and the volatility of these cash flows. Value risk managers are concerned with the value of downside risk of the portfolio or firm under management. A cash flow manager is primarily focused on portfolio investment of any cash balances in the portfolio.
Rationale:
Value risk managers are concerned with the value of the portfolio or firm under management. A cash flow manager is primarily focused on portfolio or firm cash flows
and the volatility of these cash flows.