Kingpin804

Peter Weatherford and Paul Washington are discussing the characteristics of an effective enterprise risk management system for their firm, Supra Portfolio Managers. Weatherford states that Supra should have a committee in place to respond to violations of risk management guidelines. Washington adds that each asset Supra holds must be investigated thoroughly in isolation so that management can better understand the asset’s risk and return characteristics. Which of the following regarding Weatherford’s and Washington’s statements is CORRECT?

A) Weatherford is incorrect; Washington is incorrect.

B) Weatherford is correct; Washington is correct.

C) Weatherford is correct; Washington is incorrect.

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Weatherford is correct. There should be a committee or team at the highest reaches of management to respond quickly to violations of risk guidelines.
Washington is incorrect because, although each asset’s risk and return characteristics should be investigated thoroughly, each asset should be examined from a portfolio perspective, not in isolation. The correlations between assets should be examined in order to determine the risk of the firm as a whole.

Kingpin804

Tom Andrews is in charge of the risk management committee for Sigma Portfolio Managers. Interest rates have recently increased and the firm’s model has predicted a substantial decline in the value of the firm’s bond portfolio. However, the actual value of the bond portfolio has not decreased as much as expected because the firm has large holdings of callable bonds. Which of the following is the best action for Andrews to take? Andrews should advise the risk management committee that they should:

A) revise the model in light of its shortcomings.

B) take no action at all.

C) hedge the position by buying a series of interest rate call options (caps).

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Andrews should advise the risk management committee that they should revise the model. Recall that callables will outperform noncallables when interest rates rise and the callable bonds were previously priced to call. In this case, Sigma should revise their model so it accounts for the option-like features of their bonds and provides a more realistic assessment of bond performance in various interest rate scenarios.

Kingpin804

Frank Meinrod is in charge of the risk management committee for Alpha Portfolio Managers. Recently, the value of one of the company’s bond positions has decreased due to a potential steep rate hike by the Federal Reserve. Meinrod believes that the rate hike will be moderate and that the decline in the bond portfolio value is temporary. Which of the following is the best action for Meinrod to take? Meinrod should advise the risk management committee that they should:

A) take no action at all.

B) hedge the position by selling interest rate futures.

C) hedge the position by buying interest rate futures.

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Meinrod should advise the risk management committee that they should take no action at all. In most cases, when there is a risk management problem that is viewed as temporary, the best course of action is often to take no action at all.

Kingpin804

Which of the following would NOT be a characteristic of an effective enterprise risk management system?

A) Allocating capital according to the returns generated.

B) Using a model that accounts for changing risk factor sensitivities.

C) Identifying all relevant external and internal risk factors.

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An effective enterprise risk management system would allocate capital on a risk-adjusted basis. Capital should not be allocated solely according to returns without accounting for risk. Both remaining responses above are all components of an effective enterprise risk management system.

Kingpin804

Which of the following would NOT be a characteristic of an effective enterprise risk management system?

A) Allowance for all potential combinations of risk factors facing the firm.

B) Allocation of capital on a risk-adjusted basis.

C) Decentralization of risk monitoring and control procedures.

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An effective enterprise risk management system should provide for performance monitoring by a risk management committee that reports directly to upper management. Both remaining responses above are all components of an effective enterprise risk management system.

Kingpin804

Which of the following regarding an effective risk management model is least accurate?

A) When a risk management problem is viewed as a long-run change in fundamentals, corrective action is required.

B) When a risk management problem is viewed as temporary, the best course of action is often to take no action at all.

C) Duration and delta are sufficient for modeling the risk of bonds and options.

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Duration and delta by themselves are not sufficient measures of bond and option risk. Second order effects (convexity and gamma) must also be considered. Risk managers should consider asset sensitivities to factors as well as how those sensitivities change. Both remaining responses are correct.

Kingpin804

A manager wishes to lower the financial risk of a portfolio. She looks at the risks of her portfolio associated with currencies and commodities. In attempting to lower the financial risk associated with her portfolio, she should hedge:

A) the risk of neither currencies nor commodities because neither are associated with financial risk.

B) the risk associated with currencies, but not commodities since commodities are unrelated to financial risk.

C) the risk associated with both currencies and commodities.

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Market risk is a subset of financial risk. Market risk includes commodities, currencies, equity prices, and interest rates.

Kingpin804

A company has a portfolio composed of several securities with large bid/ask spreads. This is an indication that the portfolio has:

A) low liquidity risk, but the financial risk is not affected.

B) high liquidity risk, which means high financial risk.

C) high liquidity risk, but the financial risk is not affected.

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The bid/ask spread is a good measure of liquidity. The larger the spread the greater the liquidity risk. Liquidity risk is a subset of financial risk—the larger the liquidity risk, the larger the financial risk.

Kingpin804

Increasing the relative weight on OTC derivatives relative to the weight on exchange-traded derivatives in a portfolio will:

A) have no affect on credit risk or financial risk.

B) increase credit risk but decrease financial risk.

C) increase credit risk and financial risk.

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OTC derivatives have much more credit risk than exchange-traded derivatives, so the credit risk will increase. Credit risk is a part of financial risk; therefore, financial risk increases too.

Kingpin804

All of the following are sources of non-financial risk EXCEPT:

A) regulations.

B) accounting practices.

C) commodity prices.

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Commodity prices are a source of financial risk.