Derivatives【 Reading 34】习题精选 management, 2012

karoliukas

Risk management has evolved into:

A) a series of small sets of independent activities.

B) a government mandated set of standards.

C) a broad set of interrelated activities.

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Risk management was once simply thought as hedging risk. Now managers must look at it from several perspectives. Various types of risks must be defined, measured and selectively managed. A desired level of risk must be selected and the actual risk monitored to see if it is in line with that selected level.

mouse123

Which of the following describes the best way to resolve the differences between the stress testing approach to computing capital requirements and the value at risk (VAR) approach?

A) Ignore the VAR approach since it ignores extreme events.

B) Use both approaches and then use the larger of the two capital requirements.

C) Integrate the two approaches by using an optimization algorithm.

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Where the stress testing approach is weak, the VAR approach is strong and vice versa. A possible way to combine the two approaches would be to compute the capital requirements using each method and then use the larger of the two values. This ensures that the capital requirement meets the needs of both approaches.

mouse123

Stress testing approaches are not constrained by many of the constraints associated with the traditional distribution based value at risk (VAR) approaches. Which of the following is an example of a constraint associated with the traditional VAR approach but NOT the stress testing approach? The traditional VAR approach:

A) places too small a probability on extreme events.

B) places too high a probability on extreme events.

C) ignores extreme events.

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Common probability distributions (i.e., normal distributions) tend to place extreme low probabilities on extreme events.

mouse123

Which of the following most accurately describes the relationship between computing internal capital requirements using a stress testing approach versus a value at risk (VAR) capital strength approach? Stress testing approaches:

A) are substitutes for VAR approaches since they better measure the entire spectrum of potential outcomes.

B) complement VAR approaches since they account for scenarios that may not be properly considered in VAR approaches.

C) can never be combined with VAR approaches because they are based on different probability distributions.

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Since VAR often relies on common probability distributions, it may not properly capture extreme, but possible, events. Stress testing involves evaluating the effects that these events would have on the institution and then establishing capital requirement based on the findings. The two approaches are natural complements.

mouse123

In the Sortino ratio, the excess return is divided by the:

A) standard deviation using only the returns below a minimum level

B) maximum drawdown.

C) standard deviation.

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The Sortino ratio examines the downside risk of returns. It is calculated as the portfolio return minus the minimum acceptable return (MAR) divided by a standard deviation that only uses returns below the MAR. It is similar to the target semivariance. Both remaining responses refer to other measures of risk-adjusted performance. The Sharpe ratio divides the excess return above the risk-free rate by the standard deviation. An example of a risk-adjusted return on invested capital (RAROC) measure would be to divide the portfolio’s expected return by the VAR. The RoMAD (return over maximum drawdown) is the average portfolio return divided by the maximum drawdown. Drawdown refers to the percentage difference between the highest and lowest portfolio values during a period.

mouse123

Which of the following risk measures does NOT assume a normal distribution of returns?

A) Standard Deviation.

B) RoMAD.

C) Sortino ratio.

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The RoMAD (return over maximum drawdown) is the average portfolio return divided by the maximum drawdown. Drawdown refers to the percentage difference between the highest and lowest portfolio values during a period. For example, if the maximum portfolio value during a year was $1000 and the minimum was $900, the drawdown would be 10% [($1000 − $900) / $1000]. This measure does not make an assumption of normality in the returns. The Sharpe ratio (which uses the standard deviation in the denominator) assumes a normal distribution of returns. The Sortino ratio examines the downside risk of returns and also assumes a normal distribution of returns.

mouse123

Jenny Rouse has been a portfolio manager for Theta Advisors for the last five years. The performance of her portfolio has had few returns below its benchmarks since its inception. Which of the following risk measures best measures Rouse’s performance?

A) Standard Deviation.

B) Sortino ratio.

C) Sharpe ratio.

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The Sortino ratio examines the downside risk of returns. It is calculated as the portfolio return minus the minimum acceptable return (MAR) divided by a standard deviation that only uses returns below the MAR. It is similar to the target semivariance. Since Rouse’s portfolio has had consistently higher returns, she should not be penalized for any variability on the upside. Standard deviation and the Sharpe ratio (which uses the standard deviation in the denominator) examine all returns, whether they correspond to positive or negative alphas. The use of these measures would result in risk measurements that are unfairly high in Rouse’s case.

mouse123

The practice that imposes current credit risk on a periodic basis to lower potential credit risk is called:

A) netting.

B) marking to market.

C) potentiality.

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Marking to market is the best answer. This reduces potential credit risk by converting what would otherwise be potential credit risk to current credit risk. The credit risk becomes current insofar as the counterparty is required to provide additional collateral immediately (rather than in the future).

mouse123

A subsidiary of a parent company that is capitalized in a way that results in a high credit rating, with the objective of allowing the subsidiary to engage in activities where a high credit rating is an advantage would be called:

A) collateralization.

B) a special purpose vehicle.

C) a collateral mortgage obligation.

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Special purpose vehicles are subsidiaries set up by a parent company to engage in certain transactions. Generally, they are separate from the parent organization and not liable for the debt of the parent company. They are capitalized in a way that results in a high credit rating, and can, therefore, engage in transactions that the parent cannot.

mouse123

When two counterparties have obligations to each other, the process that potentially reduces the credit risk of one counterparty to zero and lowers the credit risk of the other is known as:

A) netting.

B) marking to market.

C) collateralizing.

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Netting is the process of consolidating the exposures between two parties to a single net exposure that one party bears. Marking to market would not apply to a case where two parties have obligations to each other.