AIM 1: Identify the similarities across past major financial shocks.

1、Which of the following is NOT one of the three traits common to past major financial shocks?

A) Reliance on overly complex pricing models. 

B) A lack of market liquidity. 

C) A sharp decline in asset prices due to a triggering event. 

D) Leverage concerns.

The correct answer is A

The three common traits associated with past major financial shocks are:

1、a triggering event leads to a sharp decline in asset prices.

2、liquidity pressures.

3、leverage concerns.

2、Which of the following are common traits of past financial shocks?

      I. There is an event that sets off a sharp decline in asset prices.

     II. A large number of firms fail or go out of business.

    III. Institutions become reluctant to grant credit.

    IV. A large number of firms seek to sell risky assets, leading to an excess supply of liquidity.

A) I, II, and III. 

B) II, III, and IV.  

C) I, II, and IV. 

D) I and III.

The correct answer is D

There are three common traits among past financial shocks: a triggering event sets off a sharp decline in asset prices, firms sell risky assets, causing market liquidity to effectively dry up, and institutions question previously granted margin, and become reluctant to grant additional margin. Note that a financial crisis does not necessitate a large number of firms going out of business (it may only be one or two major firms), and it is excessive d

AIM 2: List and discuss fundamental approaches that anticipate financial shocks and limit their severity.

1、The single most important factor in determining whether a financial disturbance becomes a systematic financial shock is:

A) credit risk. 

B) the dependence across institutions on similar valuation models. 

C) the evaporation of market liquidity.

D) the failure of most risk measures to capture tail events. 

 The correct answer is A

Credit risk is the single most important factor in determining whether a financial disturbance becomes a systematic financial shock. Lack of liquidity is the second most important factor.

AIM 3: List and discuss recommendations and guiding principles concerning risk management and risk related disclosure practices, financial infrastructure, complex financial products, and other emerging issues in financial markets.

1、Which of the following is the most effective way to address differences in counterparty credit quality?

A) Including a force majeure provision in a derivative transaction.  

B) Using netting arrangements.  

C) Using sophisticated credit pricing models.  

D) Establishing initial margin requirements. 

The correct answer is D

Using collateral is an effective way to address differences in counterparty transparency and credit quality, and initial margin requirements are one of the key forms of collateral (see Recommendation 5 in CRMPG II report). Note that using credit pricing models and netting arrangements are also important credit risk mitigants, however, the models will help determine credit exposure, while netting arrangements will match payments to reduce exposure – neither addresses credit quality differences. A force majeure provision addresses contract terms in the event of an earthquake, war, terrorist attack, or other disaster.

2、Which of the following describes the most effective means to address the industry-wide problem of unsigned confirmations for credit derivatives?

A) Eliminate the practice of trade assignments.  

B) Pre-trade reviews.  

C) Use of collateral. 

D) Straight-through processing. 

The correct answer is D

Unsigned confirmations refer to the operational breakdown where transactions are not agreed to or recognized in writing. It is an industry wide problem that represents a major operational risk. Straight-through processing (STP) refers to the automation of trading systems where confirmation matching would be automatic.

3、The use of straight-through processing (STP) of over-the-counter derivatives transactions is expected to:

decrease risk in the financial markets.

integrate the trading, reporting, and control functions.

require increased manual processing of transaction and confirmation processing.

A) I, II, and III. 

B) II and III only. 

C) I and II only. 

D) II only.

The correct answer is C

The use of STP integrates trading, reporting, and control functions, and includes the replacement of outdated manual systems with automated trade and confirmation matching. It should ultimately reduce market-wide risk by enabling firms to improve their management of trading volume, reducing trade disputes, increasing netting capabilities, and eliminating redundant operations.

4、According to the Report of the Counterparty Risk Management Policy Group (CRMPG) II, the overriding guiding principle for its recommendations concerning complex financial products is:

A) sound judgment and experience.

B) accountability. 

C) standardization of procedures. 

D) the use of sophisticated financial models.

The correct answer is A

According to the CRMPG II, the overriding guiding principle is that management must rely on sound judgment based on familiarity and knowledge of the fundamentals of risk management.

5、Which of the following risks is most likely to be greater when selling a complex product to a retail investor instead of an institutional investor?

A) Liquidity risk. 

B) Reputational risk.  

C) Legal risk.  

D) Credit risk. 

The correct answer is B

Selling complex products to retail investors increases the potential for reputational risks. Retail investors are generally less sophisticated than institutional investors and may not fully understand the risks involved with a complex product. Retail investors who buy a product that “blows up” are more likely to blame the selling institution, thus damaging its reputation. Note that other risks may also increase, but reputational risk is the biggest factor that changes when dealing with retail investors.

AIM 4: List and discuss supervisory challenges identified by the CRMPG.

1、The supervisory challenges identified by the CRMPG II are designed to:

A) encourage the creation of rules to govern potential contingencies a firm may face. 

B) foster a balance between rules that protect clients and ones that prevent them from achieving their financial goals.

C) eliminate overlap between financial statement and regulatory accounting.

D) create clear lines of demarcation between regulatory jurisdictions.

The correct answer is B

One of the key tenets of the four supervisory challenges identified by the CRMPG II is to balance the responsibilities of institutions and clients so that regulations do not impede the ability of an institution to meet a client’s financial goals. Other tenets encourage a principle-based supervisory approach as opposed to a rules approach and encourage uniform accounting practices as well as coordination among regulators in different jurisdictions.