Reading 40: Risk Management Los h~Q1-7

contrast, following, describes, statements, advantages

LOS h: Compare and contrast alternative types of stress testing and discuss the advantages and disadvantages of each.

Q1. Which of the following statements best describes the uses of stress analysis?

A) Scenario analysis, which is a special case of stress analysis, suffers from limitations on implementing a consistent and manageable approach.

B) Stress analysis can be used to enhance VAR analysis by focusing on the extent of loss in an extreme event.

C) Stress analysis has several advantages over a value at risk (VAR) only approach that includes: highlighting inappropriate assumptions, hidden vulnerabilities, and the ability to be able to forecast probability of rare but damaging events.

Q2. John Nicholson is in charge of the risk management committee for Beta Portfolio Managers. Beta has a variety of bonds in their portfolio of differing durations, call features, and coupons. He is worried about the impact on the firm’s bond portfolio from simultaneous changes in interest rates, the shape of the yield curve, and interest rate volatilities. Which of the following forms of stress testing is he most likely to utilize?

A) Stylized scenarios.

B) Factor push analysis.

C) Worst-case scenario analysis.

Q3. Which of the following describes the form of stress testing referred to as factor push analysis?

A) All factors are examined at levels that inflict the most damage on the portfolio.

B) The effect on the portfolio from simultaneous changes in several factors is examined.

C) The impact on the portfolio is measured by examining an input at an extreme level.

Q4. Which of the following is NOT a disadvantage of using stress testing? Stress testing:

A) reflects the analyst’s intentional and unintentional misspecification of the model.

B) reflects only normal circumstances.

C) fails to include the simultaneous adverse movements of risk factors.

Q5. Which of the following is NOT a use of stress testing?

A) Stress testing complements value at risk (VAR).

B) It enables the risk manager to eliminate all risk from a portfolio.

C) It can be used for capital allocation across business units.

Q6. Paula Flox, global risk manager for Green Asset Management, wants to implement a stress testing program. She asks Richard Volk, a junior analyst, to prepare a report on stress testing. When she receives the completed report, Flox is extremely unhappy because it includes only one true conclusion. Which of Volk’s conclusions regarding stress testing is TRUE? Stress analysis:

A) is weak when it comes to highlighting effects of inappropriate assumptions.

B) can incorporate delta risks, but fails to account for gamma risks.

C) is not useful for determining the probability of an expected loss.

Q7. Which of the following is NOT a damaging consequence of not conducting proper stress analysis?

A) Inability to proactively alter assumptions about correlation structures.

B) Exposure to risk of being taken over.

C) Risk of exposure to potential big hits to a portfolio due to second order (gamma) effects of large market moves.