Financial Risk Management Quiz #5

1. Which of the following statements regarding futures contracts is most likely correct? A business with a long exposure to an asset would hedge
this exposure by either entering into a
A. long futures contract or by buying a call option.
B. long futures contract or by buying a put option.
C. short futures contract or by buying a call option.
D. short futures contract or by buying a put option.
A business with a long exposure to an asset would hedge the exposure by either entering into a short futures contract or by buying a put option.
(LO 28.d)
2. Which of the following statements is an advantage that is specific only to exchange trading compared to over-the- counter (OTC) trading? On an
exchange system
A. terms are not specified.
B. trades are made in such a way as to reduce credit risk.
C. participants have flexibility to negotiate.
D. there is greater anonymity.
Exchanges are organized to reduce credit risk. The other answer choices are advantages of over-the-counter trading. (LO 28.b)
3. An individual that maintains bid and offer prices in a given security and stands ready to buy or sell lots of said security is
A. a hedger.
B. an arbitrageur.
C. a speculator.
D. a dealer.
A dealer maintains bid and offer prices in a security and stands ready to buy or sell lots of the given security. (LO 28.e)
4. Which of the following statements regarding the margining process on an exchange is correct?
A. The initial margin is calculated as a function of the futures price.
B. CCPs pay interest on both the initial margin and the variation margin.
C. The initial margin or a futures contract is negotiated between the two parties directly.
D. When providing noncash margin, the haircut is positively correlated with the price volatility of the underlying asset.
Haircuts increase and decrease accordingly with the price volatility of the underlying asset. The initial margin is calculated as a function of futures
price volatility and is determined by the exchange (not by the two parties). CCPs pay interest on initial margin only. (LO 29.d)

5.A trader sells short 1,000 shares of Stock A, which is currently trading at $40 per share. A margin requirement of 140% applies as well as a
maintenance margin of 125%. If the share price rises to $55, the amount of the margin call is closest to
 A. $0.
B. $1,000.
C. $14,000.
D. $15,000.
The short sale of 1,000 shares of Stock A trading at $40 generates $40,000. Based on a 140% margin requirement, the additional margin to be
posted is $16,000 (= 40% × $40,000) for a total of $56,000. If the stock price rises to $55, then the shorted shares are worth $55,000 and the
maintenance margin becomes $68,750 (= 1.25 × $55,000). The initial margin of $56,000 is insufficient to cover the maintenance margin, which
means there is a $13,750 margin call (= $68,750 – $55,000). (LO 29.g)
6. An investor enters into a short position in a gold futures contract with the following characteristics:
 The initial margin is $3,000.
 The maintenance margin is $2,250.
 The contract price is $1,300.
 Each contract controls 100 troy ounces.
If the price drops to $1,295 at the end of the first day and $1,290 at the end of the second day, which of the following is closest to the variation
margin required at the end of the second day?
A. $0
B. $250
C. $500
D. $1,000
Note that the investor in this question has a short position that profits from price declines. The short position margin account has increased by
$1,000 over the two days, so there is no variation margin required. (LO 31.c)
7. An equity portfolio is worth $100 million with the benchmark of the Dow Jones Industrial Average (Dow). The Dow is currently at 10,000, and
the corresponding portfolio beta is 1.2. The futures multiplier for the Dow is 10. Which of the following is the closest to the number of contracts
needed to double the portfolio beta?
A. 1,100
B. 1,168
C. 1,188
D. 1,200
(2.4 − 1.2) 100,000,000 /( 10,000 × 10) = 1.2 × 1,000 = 1,200
where beta = 1.2, target beta = 2.4, A = 10 × 10,000, P = $100 million (LO 32.f)
8. An investor has an asset that is currently worth $500, and the annually compounded risk-free rate at all maturities is 3%.
Which of the following amounts is the closest to the no-arbitrage price of a three-month forward contract?
A. $496
B. $500
C. $502
D. $504
Using Equation 1: $500 × 1.030.25 = $503.71 where S = 500, T = 0.25, r = 0.03 (LO 34.f)
9. A bond pays a semiannual coupon of $40 and has a current value of $1,109. The next payment on the bond is in four months, and the annual
interest rate is 6.50%. Using an annual compounding assumption, the price of a six- month forward contract on this bond is closest to
A. $1,103.
B. $1,104.
C. $1,145.
D. $1,185.
Use the formula F = (S − I) × (1 + r)T, where I is the present value of $40 to be received in 4 months, or 0.333 years. At a discount rate of 6.50%: I =
$40 / 1.065 0.333 = $39.17; F = ($1,109 − 39.17) × 1.065 0.5 = $1,104.05 (LO 34.f)
10. A company has a $20 million portfolio with a beta of 1.2. It would like to use futures contracts on the S&P 500 to hedge its risk. The index
futures price is currently standing at 1080, and each contract is for delivery of $250 times the index. What is the hedge that minimizes risk? What
should the company do if it wants to reduce the beta of the portfolio to 0.6?
The formula for the number of contracts that should be shorted gives
1.2 (20,000,000/(1080x250)) = 88.9
Rounding to the nearest whole number, 89 contracts should be shorted. To reduce the beta to 0.6, half of this position, or a short position in 44
contracts, is required.
11. Explain what is meant by a perfect hedge. Does a perfect hedge always lead to a better outcome than an imperfect hedge? Explain your answer.
A perfect hedge is one that completely eliminates the hedger’s risk. A perfect hedge does not always lead to a better outcome than an imperfect
hedge. It just leads to a more certain outcome. Consider a company that hedges its exposure to the price of an asset. Suppose the asset’s price
movements prove to be favorable to the company. A perfect hedge totally neutralizes the company’s gain from these favorable price movements.
An imperfect hedge, which only partially neutralizes the gains, might well give a better outcome.
Financial Risk Management Quiz #6
1. Which of the following statements regarding options is correct?
A. Stock options are typically American-style options.
B. All options expire on the third Wednesday of the expiration month.
C. American-style options are less valuable than European-style options.
D. Index options are typically American-style options and are cash settled.
Stock options are typically exchange-traded, American-style options. Options expire after the third Friday of the month. American-style options
are at least as valuable as European-style options. Index options are typically European-style (not American-style) options and are cash settled.
(LO 36.a)
2. If the stock experiences a 4-to-1 split, the strike price becomes.
A. $20.
B. $25.
C. $50.
D. $100.
a/b= ¼ x100$= 25$ (LO 36.b)
3. Consider a European put option on a stock trading at $50. The put option has an expiration of six months, a strike price of $40, and a risk-
free rate of 5%. The lower bound and upper bound on the put are closest to
A. $10, $40.00.
B. $10, $39.00.
C. $0, $40.00.
D. $0, $39.00.
The upper bound is the present value of the exercise price: $40 / 1.025 = $39.02. Because the put is out-of-the-money, the lower bound is zero. (LO
37.b)
4. According to put-call parity for European options, purchasing a put option on ABC stock would be equivalent to
A. buying a call, buying ABC stock, and buying a zero-coupon bond.
B. buying a call, selling ABC stock, and buying a zero-coupon bond.
C. selling a call, selling ABC stock, and buying a zero-coupon bond.
D. buying a call, selling ABC stock, and selling a zero-coupon bond.
The formula for put-call parity is p + S0 = c + PV(X). Rearranging to solve for the price of a put, we have p = c − S0 + PV(X). (LO 37.c)
5. Consider an American call and put option on the same stock. Both options have the same one- year expiration and a strike price of $45.
The stock is currently priced at $50, and the annual interest rate is 10%. Which of the following amounts could be the difference in the two
option values?
A. $4.95
B. $7.95
C. $9.35
D. $12.50
The upper and lower bounds are: S0 − X ≤ C − P ≤ S0 − PV(X) or $5 ≤ C − P ≤ $9.09. Only $7.95 falls within the bounds. (LO 37.d)
6. A covered call position is
A. the simultaneous purchase of a call and the underlying asset.
B. the purchase of a share of stock with a simultaneous sale of a call on that stock.
C. the purchase of a share of stock with a simultaneous sale of a put on that stock.
D. the short sale of a stock with a simultaneous sale of a call on that stock.
The covered call is a stock plus a short call. The term covered means that the stock covers the inherent obligation assumed in writing the call.
Why would you write a covered call? You feel the stock’s price will not go up anytime soon, and you want to increase your income by collecting
some call option premiums. To add some insurance that the stock won’t get called away, the call writer can write out-of-the money calls. You
should know that this strategy for enhancing one’s income is not without risk. The call writer is trading the stock’s upside potential for the call
 premium. The desirability of writing a covered call to enhance income depends upon the chance that the stock price will exceed the exercise price
at which the trader writes the call. (LO 38.a)
7. Consider an option strategy where an investor buys one call option with an exercise price of
$55 for $7, sells two call options with an exercise price of $60 for $4, and buys one call option with an exercise price of $65 for $2. If the stock
price declines to $25, what will be the profit or loss on the strategy?
A. −$3
B. −$1
C. $1
D. $2
The strategy described is a butterfly spread where the investor buys a call with a low exercise price, buys another call with a high exercise price,
and sells two calls with a price in between. In this case, if the option moves to $25, none of the call options will be in-the-money, so the profit is
equal to the net premium paid, which is −$7 + (2 × $4) − $2 = −$1. (LO 38.b)
8. An investor is very confident that a stock will change significantly over the next few months; however, the direction of the price change is
unknown. Which strategies will most likely produce a profit if the stock price moves as expected?
I. Short butterfly spread
II. Bearish calendar spread
A. I only
B. II only
C. Both I and II
D. Neither I nor II
A short butterfly spread will produce a modest profit if there is a large amount of volatility in the price of the stock. A bearish calendar spread is a
play using options with different expiration dates. (LO 38.c)
9. An investor constructs a straddle by buying an April $30 call for $4 and buying an April $30 put for $3. If the price of the underlying shares
is $27 at expiration, what is the profit on the position?
A. −$4
B. −$2
C. $2
D. $3
The sum of the premiums paid for the position is $7. With the underlying stock at $27, the put will be worth $3, while the call option will be
worthless. The value of the position is (−$7 + $3) = −$4. (LO 38.d)
10. An investor believes that a stock will either increase or decrease greatly in value over the next few months but believes a down move is more
likely. Which of the following strategies will be most appropriate for this investor?
A. A protective put
B. An at-the-money strip
C. An at-the-money strap
D. A straddle
An at-the-money strip bets on volatility but is more bearish because it pays off more on the downside. A straddle is possible, but a strip is even
more appropriate. (LO 38.d)
11. 4-month European call option on a dividend-paying stock is currently selling for $5. The stock price is $64, the strike price is $60, and a
dividend of $0.80 is expected in 1 month. The risk-free interest rate is 12% per annum for all maturities. What opportunities are there for an
arbitrageur?
The present value of the strike price is 60e -0.12x4/12 =$57.65.
The present value of the dividend is 0.80e -0.12x1/12 =0.79.
Because 5< 64-57.65-0.79 the condition in equation (10.8) is violated. An arbitrageur should buy the option and short the stock. This
generates 64 – 5=$59 . The arbitrageur invests $0.79 of this at 12% for one month to pay the dividend of $0.80 in one month. The remaining
$58.21 is invested for four months at 12%. Regardless of what happens a profit will materialize. If the stock price declines below $60 in four
months, the arbitrageur loses the $5 spent on the option but gains on the short position. The arbitrageur shorts when the stock price is $64,
has to pay dividends with a present value of $0.79, and closes out the short position when the stock price is $60 or less. Because $57.65 is the
present value of $60, the short position generates at least 64 – 57.65 – 0.79= $5.56 in present value terms. The present value of the
arbitrageur’s gain is therefore at least 5.56 – 5.00 = $0.56.
If the stock price is above $60 at the expiration of the option, the option is exercised. The arbitrageur buys the stock for $60 in four months
and closes out the short position. The present value of the $60 paid for the stock is $57.65 and as before the dividend has a present value of
$0.79. The gain from the short position and the exercise of the option is therefore exactly equal to 64 – 57.65 – 0.79 = $ 5.56 . The
arbitrageur’s gain in present value terms is exactly equal to 5.56 – 5.00 = $ 0.56 .
12. A 1-month European put option on a non-dividend-paying stock is currently selling for
$2.50. The stock price is $47, the strike price is $50, and the risk-free interest rate is 6% per annum. What opportunities are there for an arbitrageur?
In this case the present value of the strike price 50e -0.06x1/12 =$49.75 . Because
2.5< 49.75 – 47.00 .
the condition in equation (10.5) is violated. An arbitrageur should borrow $49.50 at 6% for one month, buy the stock, and buy the put option. This
generates a profit in all circumstances.If the stock price is above $50 in one month, the option expires worthless, but the stock can be sold for at
least $50. A sum of $50 received in one month has a present value of $49.75 today. The strategy therefore generates profit with a present value of
at least $0.25.
If the stock price is below $50 in one month the put option is exercised and the stock owned is sold for exactly $50 (or $49.75 in present value
terms). The trading strategy therefore generates a profit of exactly $0.25 in present value terms.
13. The price of a non-dividend-paying stock is $19 and the price of a 3-month European call option on the stock with a strike price of $20 is $1.
The risk-free rate is 4% per annum. What is the price of a 3-month European put option with a strike price of $20?
By the put - call parity we obtain
P – c = p – 1 = e -rT K – S0= e -4%x3/12 $20 - $19 ≈ $0.8
 hence the put price equals p ≈ $1.8.
14. Give an intuitive explanation of why the early exercise of an American put becomes more attractive as the risk-free rate increases and
volatility decreases.
The early exercise of an American put is attractive when the interest earned on the strike price is greater than the insurance element lost.
When interest rates increase, the value of the interest earned on the strike price increases making early exercise more attractive. When
volatility decreases, the insurance element is less valuable. Again, this makes early exercise more attractive.
Financial Risk Management Quiz 7
1. For a $200,000,000 portfolio, the expected 1-week portfolio return and standard deviation are 0.0025 and 0.0155, respectively. Calculate the
1-week VaR and expected shortfall with a 95% confidence level.
VaR= (µ- z σ) x portfolio value
= [0.0025- 1.65(0.0155)] x $200,000,000= $-4,615,000
The manager can be 95% confident that the maximum 1-week loss will not exceed $4,615,000.

ES= 0.0025+ 0.0155x (e-(1.65^2/2)/[(1-0.95)x căn (2pi)])= 6340417,912

2. A bank reports a daily 95% VAR as $15 million. Assuming daily and 10-day returns follow a normal distribution, the 99% 10-day VAR is
(a) $15 mil
(b) $47 mil
(c) $212 mil
(d) $67 mil
95% 10-days= $15mill x căn 10=$47.43 mill
99% VaR= (2.33/1.65)x95% VaR
=>99% 10-days VaR= (2.33/1.65) X $47.43mill= 66.69mill (66,690,000)
3. Consider a portfolio manager who manages a portfolio which consists of a single asset. The return of the asset (r) is normally distributed
with annual mean return μ=10% and annual standard deviation σ=30%. The value of the portfolio today is $100 million.
a. What is the probability of a loss of more than $20 million dollars by year end (i.e., what is the probability that the end-of-year value is less
than $80 million)?
b. What is the VAR at the 99% confidence level?
Return (x)=-20%(20mill/100mill)
Z=(x-mean)/Stdve= (-20%-10%)/30%= -1
a. P(X<-20% or loss > 20%)= 0.1587 or 15.87% ( kobit)

b. VaR at 99% level= (10%-2.33 x 30%)/100000000= -59900000

4. Suppose that an investment has a 4% chance of a loss of $10 million, a 2% chance of a loss of $1 million, and a 94% chance of a profit of
$1 million. Calculate the Expected Shortfall for these investments when the confidence level is 95%. Assume normal distributions.
A B A+B
94% 1 1
2% -1 -1
4% -10 -10 4%x4%= 0.1600%
expected shortfall là phần còn lại nằm ngoài VaR tức là Var 95% thì ES sẽ là 5% còn lại.
thì trong 5% còn lại đấy có 4% là loss 10mill 1% loss 1mill
nma 4% với 1% này là xét trên cả đồ thị 100%, nên phải quy đổi về %/5% kia
nên là 4%/5% và 1%/5%là 20% và 80%
ES= 20% x -1mill+ 80%x -10mill= -8.2mill
The expected shortfall for one of the investments is the expected loss conditional that the loss is in the 5 percent tail. Given that we are in the
tail there is a 20% chance than the loss is $1 million and an 80% chance that the loss is $10 million. The expected loss is therefore $8.2
million. This is the expected shortfall.
5. A company uses an EWMA model for forecasting volatility. It decides to change the parameter λ from 0.95 to 0.85. Explain the
likely impact on the forecasts.
Reducing λ from 0.95 to 0.85 means that more weight is given to recent observations of Ri and less weight is given to older
observations. Volatilities calculated with λ = 0.85 will react more quickly to new information and will bounce around much more
than volatilities calculated with λ = 0.95.
6. Consider a position consisting of a $100,000 investment in asset A and a $100,000 investment in asset B. Assume that the daily volatilities of
both assets are 1% and that the coefficient of correlation between their returns is 0.3. What is the 5-day 99% value at risk for the portfolio?
(b1 answer)
7. The most recent estimate of the daily volatility of the U.S. dollar–sterling exchange rate is 0.6%, and the exchange rate at 4 p.m. yesterday
was 1.5000. The parameter λ in the EWMA model is 0.9. Suppose that the exchange rate at 4 p.m. today proves to be 1.4950. How would the
estimate of the daily volatility be updated?
The proportional daily change is −0.005∕1.5 = −0.003333. The current daily variance estimate is 0.0062 = 0.000036. The new daily variance
 estimate is 0.9 × 0.000036 + 0.1 × 0.0033332 = 0.000033511. The new volatility is the square root of this. It is 0.00579 or 0.579%.
8. A call option and a mortgage-backed security are good examples of
A. a linear and nonlinear derivative, respectively.
B. a nonlinear and linear derivative, respectively.
C. linear derivatives.
D. nonlinear derivatives.
A nonlinear derivative’s value is a function of the change in the value of the underlying asset and is dependent on the state of the underlying
asset. (LO 46.a)
9. Which of the following statements regarding the measurement of risk for nonlinear derivatives is true?
I. A disadvantage of the delta-normal approach is that it is highly computational.
II. The full revaluation approach is most appropriate for portfolios containing mortgage-backed securities or options with embedded features.
A. I only
B. II only
C. Both I and II
D. Neither I nor II
Both the delta-normal and full revaluation methods measure the risk of nonlinear securities. The full revaluation approach can be highly
computational; therefore, it does not work well for portfolios of more complex derivatives such as mortgage-backed securities, swaptions, or
options with embedded features. The delta-normal approach calculates the risk using the delta approximation, which is linear or the delta-gamma
approximation, which adjusts for the curvature of the underlying relationship. This approach simplifies the calculation of more complex securities
by approximating the changes. (LO 46.g)
10. ρ(X + Y) ≤ ρ(X) + ρ(Y) is the mathematical equation for which property of a coherent risk measure?
A. Monotonicity
B. Subadditivity
C. Positive homogeneity
D. Translation invariance
The property of subadditivity states that a portfolio made up of subportfolios will have equal or less risk than the sum of the risks of each individual
subportfolio. (LO 45.f)
11. Which of the following is not a reason that expected shortfall (ES) is a more appropriate risk measure than value at risk (VaR)?
A. For normal distributions, only ES satisfies all the properties of coherent risk measurements.
B. For nonelliptical distributions, the portfolio risk surface formed by holding period and confidence level is more convex for ES.
C. ES gives an estimate of the magnitude of a loss.
 D. ES has less restrictive assumptions regarding risk/return decision rules than VaR.
VaR and ES both satisfy all the properties of coherent risk measures for normal distributions. However, only ES satisfies all the properties of
coherent risk measures when the assumption of normality is not met. (LO 45.g)
12. Which of the following is true about stress testing?
(a) It is used to evaluate the potential impact on portfolio values of unlikely, although plausible, events or movements in a set of financial
variables.
(b) It is a risk management tool that directly compares predicted results to observed actual results. Predicted values are also compared
with historical data.
(c) Both a) and b) above are true.
(d) None of the above are true.
Stress Testing in finance basically means testing how well will banks be able to operate and resist the effect that may be experienced if the market
conditions turn adverse and the economy experiences a negative shock.
Financial Risk Management Quiz 8
1. XYZ Bank is trying to forecast the expected loss on a loan to a mid-size corporate borrower. It determines that there will be a 75% loss if the
borrower does not perform the financial obligation. This risk measure is
A. the probability of default.
B. the loss rate.
C. the unexpected loss.
D. the exposure at default.
Current measures used to evaluate credit risk include the firm’s probability of default, which is the likelihood that a borrower will default, the
loss rate (loss given default), which represents the likely percentage loss if the borrower defaults, the exposure amount (exposure at default),
and the expected loss. The stated 75% loss if the borrower defaults is the loss rate. (LO 50.b)
2. Which of the following statements about expected loss (EL) and unexpected loss (UL) is true?
A. Expected loss always exceeds unexpected loss.
B. Unexpected loss always exceeds expected loss.
C. Expected loss requires quantifying the actual loss.
D. Expected loss is directly related to the exposure amount.
EL increases with increases in the exposure amount. UL typically exceeds EL, but they are both equal to zero when probability of default is
zero. UL, not EL, requires quantifying actual loss. (LO 50.c)
3. The relationship between expected loss (EL), unexpected loss (UL), and actual loss can be best described as
A. actual loss = EL + UL.
B. actual loss = EL – UL.
C. actual loss = EL × UL.
 D. actual loss = UL – EL.
Since UL can be defined as the difference between the actual loss and expected loss, actual loss = EL + UL. (LO 50.d)
4. Calculate expected loss if a bank expects a 1.8% default rate on its loans assuming the recovery rate in the event of default is 60%.
EL = PD × LGD × EAD = PD × (1 − RR) × EAD=1.8% x (1-60%)= 0.72%
PD = probability of default LGD = loss given default
EAD = exposure at default RR = recovery rate (RR = 1 − LGD)
5. Suppose bank TDA made a loan of 1,000 million VND to a borrower, of which 800 million VND is currently outstanding. The bank has
assessed an internal credit rating equivalent to a 2% default probability over the next year. The bank has additionally estimated a 30% loss given
default if the borrower defaults. The standard deviation of PD and LR is 6% and 20%, respectively. Calculate the expected and unexpected loss
for TDA bank.
EL=EA x PD x LR= $800mill x 0.02 x 0.3= $4,8mill
UL=EA x căn(PD x σ2 LR+LR2 x σ2 PD ) = $800mill x căn(0.02x0.22+0.32x0.062) = $26,82mill
The unexpected loss represents 3.35% of the exposure amount: ( $26,820,000/$800000000)
6. Suppose that a bank has a portfolio with 5,000 loans, and each loan is $2 million and has a 0.5% PD in a year. Also assume that the recovery
rate is 50% and correlation between losses is 0.3. Calculate the standard deviation of the loss from the loan portfolio and the standard deviation of the
loss as a percentage of its size.
7. Bank XYZ has three assets outstanding with the following features. Assume the correlation between assets are 0.2. Calculate the expected
loss ELP and unexpected loss ULP for the portfolio as well as the contribution of each asset to the portfolio risk.

Loan A Loan B Loan C

Outstanding loan balance $ 2,000,000 $3,000,000 $1,500,000
Probability of default 1% 0.8% 1.5%
Loss rate 40% 30% 50%
𝜎PD 3% 2% 4%
𝜎LR 25% 20% 30%
ELA= EA x PD x LR= $ 2,000,000 x 0.01 x 0.4 = $8000
ELB= EA x PD x LR= $ 3,000,000 x 0.008 x 0.015= $360
ELC= EA x PD x LR= $ 1,500,000 x 0.015 x 0.5= $11250
UL=EA x căn ( PD x σ2 LR +LR2 x σ2 PD )
ULA= $ 2,000,000 x căn ( 0.01 x 0.252 + 0.42x0.032 )=$55,462( 55461.6985)
ULB= $ 3,000,000 x căn ( 0.008 x 0.202 + 0.32x0.022 )= $56,604 ( 56603.88679)
ULC= $ 1,500,000 x căn ( 0.015 x 0.32 + 0.52x0.042 )= $62,750 (62749.50199)

ELP= $8000 + $360+ $11250= $19610

ULP = căn (ULA2 +ULB2 + ULC2 +2 p(A,B) x ULA x ULB +2 p(A,C)x ULA x ULC+ 2p(B,C)x ULB x ULC)
= căn ((55,462)2+ (56,604)2 + (62,750)2 + 2x0.2x55,462x56,604 + 2x0.2x55,462x62,750 + 2x0.2x56,604x62,750 ) = $119,432