Mock exam Market Risk (answers)

Q1 : Answer 1 (Asset revaluation reserves are part of Tier 2 Capital)

Q2 : Answer 4 (I only) (Remark : II and III are not part of capital. IV is part of Tier 2 or Tier 3)
Q3 : Answer 1 (Remark : The puttable feature of a bond reduces the VaR figure of the portfolio if
the portfolio is having a long position in the bond as it reduces the maximum loss by allowing to
sell it back to the bond issuer.)
Q4 : Answer 4 (Remark : Return = Yearly raw return * Market value of asset = 1% * 4m = 40 000 $.
According to BIS regulations the capital is 3 times the average VaR. So the capital is = 3*$200,000
= $600,000. RAROC = Revenues-Costs / Capital = $40,000/$600,000 = 0.0666 = 6,66%
The RAROC on the asset is less than the Threshold RAROC of the institution and the asset is
rejected.
Q5 Answer 3
Q6 Answer 1 (Variance / covariance) (Remark : Delta/Gamma is better than Variance / covariance
for options and last 2 methods are usually full revaluations, which handle perfectly options)
Q7 Answer 4 (Remark : It is a tricky question : It is a spread VaR meaning that a long position in
one instrument is always associated with a short position in the other instrument, so the correlation
must be used with a negative sign !)
Q8 Answer 2 (Remark : Most markets have fatter tails than normal, so the same percentile break in
the two different distributions will have more probability in the historical distribution and less in the
parametric normal)
Q9 Answer 3 (Remark : Definition of VaR)
Q10 Answer 3 (Remark 60 / 2.33 *1.64 = 42.23 42.43 [99% => 2.33 SD, 95% => 1.64 SD [Slide
21, Course 1])
Q11 Answer 3 (Remark : loi statistique des grands nombres. If returns were not normally
distributed, 3 would be false)

Q12 Answer 3 (Remark :

Q13 Answer 3 (Remark : 1 is wrong (there are some cases when it is not true), 2 is wrong (if
perfectly correlated, then VaR (A+B)=Var(A)+Var(B), 4 is too common (most assets are skewed
and therefore most loss distribution also). Only 3 remains (in the example, the VaR was zero except
at the end so the loss distribution was not monotonically decreasing in its tails)
Q14 Answer 3 (both 1 and 2)
Q15 Answer 3 (Single, Multiple)

Q16 Answer 4 (Remark : 2 is wrong (stress scenarios are not for EL, but for UL), 3 is wrong (it
concerns the VaR). 1 is true but not related to VaR, so 4 is better)
Q17 Answer 1 (Remark : Extreme events occur when a risk takes values from the tail of its
distribution. Extreme value theory (EVT) is a statistical discipline to describe and understand
quantifiable rare events. It is especially well suited to describe the heavy tails of loss distributions.
Answer 2 is almost always right whether extreme events occur as per EVT or not, 3 is almost never
right whether extreme events occur as per EVT or not, 4 is more a definition of an extreme events
than anything else, so 1 is the better answer, even if I consider this question to be badly written but
some questions are badly written so you must encounter a few of them)
Q18 Answer 2 (Central banks and financial regulators use stress tests to more effectively monitor
broad patterns of risk-taking and risk intermediation in financial markets. It is another example of a
tricky to answer question : the wrong answers all refer to valid uses of stress tests but these stress
tests are done by banks then shared with regulators. The only time central banks do directly stress
tests is for answer 2).
Q19 Answer 4 (Supervisory Capital Assessment Program (SCAP) allowed US supervisors to
measure how much of an additional capital buffer, if any, each institution would need to establish
today to ensure that it would have sufficient capital if the economy weakens more than expected)
Q20 Answer 1 (The liquidity risk pricing must take into account not only the normal scenarios but
also the stressed scenarios in order to ensure accurate liquidity pricing)
Q21 Answer 4 (This is one of the drawbacks of stress testing. They are difficult to back test.
Hypothetical stress scenarios cannot be validated based on actual market events. Even if these
events actually occur, there is usually no way to apply what was right or wrong in the scenario to
other hypothetical scenarios to improve them)