AIM 1: Describe the silo approach used to regulate capital requirements in different financial conglomerates, and critically assess its limitations.

1、The silo approach to capital regulation for financial conglomerates:

aggregates risk across diverse regulated subsidiaries.
sums the capital requirements across diverse regulated subsidiaries.
considers the capital requirements of non-licensed financial operations engaged in lending or leasing.
A) I and II only.
 
B) II only.
 
C) II and III only.
 
D) I, II, and III.

The correct answer is B

The silo approach simply sums each operations capital requirements to arrive at an overall capital figure. It does not consider the capital requirements of non-licensed financial operations engaged in lending or leasing activities. It does not aggregate risk across diverse regulated subsidiaries, which would lower capital requirements through diversification benefits or increase them because of concentration of risk.

2、Focusing on each individual operation of a conglomerate to arrive at a total capital adequacy figure describes the:

A) silo approach.
 
B) legal-based approach. 
 
C) market-based approach.
 
D) building-block approach.

The correct answer is A

The silo approach treats the individual businesses as independent silos to determine total capital adequacy. The building-block approach aggregates risks based on modeling the three levels of a financial conglomerate. The legal-based and market-based approaches are part of the capital regulation of financial conglomerates.

3、Which of the following are NOT limitations of the silo approach of risk measurement for financial conglomerates?

A) The supervision may lack the experience required to monitor risks outside her primary business area.
 
B) It does not consider the capital requirements of non-licensed financial operations engaged in lending or leasing activities.
 
C) The operations’ risk levels could be similar yet regulation would require a different treatment for each unit.
 
D) It does not aggregate risks across diverse regulated subsidiaries.

The correct answer is A

This is a problem of choosing the top risk officer from the risk officers of any division.

AIM 3: Describe the building-block approach and diversification benefits for aggregating risks in a financial conglomerate.

1、Which of the following approaches to the capital regulation of financial conglomerates combine(s) the various risks faced by a financial conglomerate into a single risk measure?

The silo approach.
The building block approach.
The economic capital approach.
A) I, II, and III.
 
B) III only.
 
C) II only.
 
D) II and III only.

The correct answer is D

The economic capital approach and building block approach combine the various risks into a single risk measure. The silo approach does not aggregate risks.

2、The building block approach addresses which of the following special challenges a conglomerate creates for capital management?

The stand-alone risk associated with portfolios.
Different cross-risk factors within business units.
Different risk factors across business units at the holding company level or cross-sector level.
Balancing the problem of over or under capitalization by focusing on the regulatory concern for profitability.
A) II, III, and IV only.
 
B) I, II, and III only.
 
C) II and III only.
 
D) I and IV only.

The correct answer is B

Statement IV is incorrect; statements I, II, and III are correct.

3、Which of the following are TRUE about the diversification benefits achieved at each of the three levels of financial conglomerate organization?

Diversification at the portfolio level is typically 50% or higher.
At the portfolio level, correlation tends to be low, number of positions tends to be high, and concentration of positions tends to be low.
Insurers typically have fewer benefits of diversification of the business unit level as asset risks are highly correlated.
Diversification benefits at the unit and holding company level are similar as correlation between business units is lower than correlation within business units.
A) I, II, and IV only.
 
B) I and II only.
 
C) II and III only.
 
D) I, III, and IV only.

The correct answer is B

Insurers have greater benefits of diversification. The holding company organizational level has the least benefits of diversification.

AIM 4: Describe the special challenges a financial conglomerate creates for capital management and how economic capital can serve as a common risk standard across a financial conglomerate.

1、One of the challenges for capital management includes assessing the single risk factor, which determines risk at the:

A) business unit level.
 
B) holding company level.
 
C) portfolio level.
 
D) financial conglomerate.

The correct answer is C

Capital adequacy is calculated using the single risk factor within the portfolio, cross-risk factors within business units, and risk factors across the business units at the holding company level.

2、Which of the following risks is modeled using extreme value theory?

A) Event risk.
 
B) Market risk.
 
C) Credit risk.
 
D) Insurance risk.

The correct answer is A

Extreme value theory assesses risks of highly unusual events.

3、Which of the following statements about economic capital in financial conglomerates are CORRECT? I. Economic capital establishes a common currency for risk measurement. II. Economic capital is defined in terms of a confidence interval in the cumulative loss distribution over a similar time horizon. III. A separate standard is needed for each of the three levels of a financial conglomerate to accurately determine the overall risk level. IV. The unique risk problems of a financial conglomerate are at the business unit level.

A) I and III. 
 
B) II and III.
 
C) I and II.
 
D) I, III, and IV. 

The correct answer is C

Only by using a common standard can the financial conglomerate’s risk be evaluated. The unique risk problems are at the holding company level.

4、The risk of losses to a hotel chain due to a terrorist act is best described as:

A) political risk.
 
B) sovereign risk.
 
C) event risk.
 
D) financial risk.

The correct answer is C

Event risk refers to risks beyond the control of the management. A terrorist act would be considered a disaster, which is a form of event risk. Political risk and sovereign risk are components of country risk, which is the risk of operating in a foreign country. Financial risk deals with the use of leverage.

5、The yield on corporate bonds is currently 7.50 percent and the yield on comparable maturity Treasury bonds is currently 6.75 percent. The risk of an increase in corporate bond yield caused by uncertainty over upcoming presidential elections with no change in the Treasury yield, is called:

A) business risk.
 
B) credit risk.
 
C) political risk.
 
D) country risk.

The correct answer is B

The increase in the yield of corporate bonds with no change in the yield of the Treasury bonds is due to the credit spread risk component of credit risk. Business risk is the risk measured using earnings volatility analysis. Country risk is the result of doing business outside the home country. Political risk is a component of country risk.

6、Which of the following factors determines the diversification benefits of any specific level within a financial conglomerate?

A) Capital adequacy.
 
B) Number of risk factors.
 
C) Double leverage.
 
D) Market forces.

The correct answer is B

The factors that determine diversification benefits are correlation, number of risks (positions), and concentration of risk factors (positions).

7、Which level generates the greatest diversification benefits?

A) Portfolio level.
 
B) Financial conglomerate level.
 
C) Business unit level.
 
D) Holding company level.

The correct answer is A

The portfolio level has the greatest diversification benefits, decreasing at the business unit level, with the least amount of diversification occurring at the holding company level.

8、Which of the following factors determine the benefits from risk aggregation at any level within a financial conglomerate?

Size of positions
Number of positions
Correlations among risk factors
A) II and III only.
 
B) I and III only.
 
C) I and II only.
 
D) I, II, and III.

The correct answer is D

Low correlations, a large number of positions, and low weightings of individual portfolio positions combine to maximize the benefits of diversification.

AIM 6: Discuss, in accordance with the New Basel Accord, the 3+1 pillars approach for capital regulation of financial conglomerates.

1、The proposed 3+1 framework for capital regulation of financial conglomerates proposes policy modifications to the new Basel Accord (Basel II) to better address the unique needs of conglomerates. The suggested modification that focuses on preventing the contagion risk of financial conglomerates is the:

A) legal-based approach.
 
B) supervisory-based approach.
 
C) market-based approach.
 
D) rules-based approach.

The correct answer is A

The legal-based approach develops legal firewalls to prevent potential contagion risk from imploding the financial conglomerate.

2、The policy recommendation that focuses on internal risk and capital management is the:

A) market-based approach.
 
B) supervisory-based approach. 
 
C) legal-based approach. 
 
D) rules-based approach. 

The correct answer is B

The supervisory-based approach focuses on internal risk and capital management. The rules-based approach implements current standards for capital adequacy. The market-based approach provides greater transparency of risk and financial structure. The legal-based approach focuses on contagion risk.

3、Which of the following policy recommendations for the implementation of the new Basel Accord required non-financial or unregulated divisions to be independently capitalized?

A) Market-based approach.
 
B) Legal-based approach.
 
C) Supervisory-based approach.
 
D) Rules-based approach.

The correct answer is B

Legal-based approach may require a non-financial firm to be independently capitalized.