Deck 2: Risk Measurement and Metrics

Question 1

The calculation and interpretation of VaR and Maximal Probable Annual Loss (MPAL) is the same.

Answer 1

True

Question 2

The use of frequency and severity data is very important to both insurers and firm managers concerned with judging the risk of various endeavors.

Answer 2

True

Question 3

The Capital Asset Pricing Model (CAPM) model assumes that investors in assets expect to be compensated for both the time value of money and the systematic or nondiversifiable risk they bear.

Answer 3

True

Question 4

In repeated games of chance involving uncertainty, relative frequencies are both stable over time and individuals can calculate them by simply counting the total number of equally likely possible outcomes divided by the number of ways that the outcome can occur.

Question 5

Fair value is also referred to as "expected value."

Question 6

The more an observation deviates from what we expected, the more risky we deem the outcome to be.

Question 7

In uncertain economic situations involving possible financial gains or losses, the mean value represents the expected return from an endeavor and expresses the risk involved in the uncertain scenario.

Question 8

Larger standard deviations represent greater risk, everything else being the same.

Question 9

VaR models provide an accurate measure of the losses that occur in extreme events.

Question 10

Severity is the number of times the event is expected to occur in a specified period of time.

Question 11

Standard deviation is the square of variance.

Question 12

Market risk is the change in market value of bank assets and liabilities resulting from changing market conditions.

Question 13

Semivariance, as a measure of risk, gives the same attention to both positive and negative deviations from the mean or expected value.

Question 14

Expected value is calculated by multiplying each probability or relative frequency by its respective gain or loss.

Question 15

The reason that uncertainty is unsettling is not the outcomes of uncertainty but the uncertainty itself.

Question 16

The asset-specific idiosyncratic risk is generally ignored when making decisions concerning the additional amount of risk involved when acquiring an additional asset to be added to an already well-diversified portfolio of assets.

Question 17

In a normal distribution, the probability of any range of profitability values is calculated by finding the standard deviation under the curve in between the desired range of profitability values.

Question 18

Pascal and Fermat were the first to model the exhibited regularity of chance or uncertain events and apply it to solve a practical problem.

Question 19

The notions of "equally likely outcomes" include situations in which the number of possible outcomes is infinite.

Question 20

The normal distribution or bell-shaped curve from statistics provides an example of a continuous probability distribution curve.

Question 21

Identify the model used to explicitly show the trade-off between risk and return of assets in a capital market.

A)Value at Risk Model
B)Absolute Return Model
C)Modigliani-Miller Model
D)Capital Asset Pricing Model
E)Discounted Cash Flow Model

Question 22

A contracting party may not be able to live up to the terms of a financial contract, usually due to total ruin or bankruptcy.Identify this risk.

A)Interest rate risk
B)Default risk
C)Prepayment risk
D)Extension risk
E)Reinvestment risk

Question 23

If we roll two dice, what is the probability of rolling a 6 or a 7?

A)7/36
B)8/36
C)9/36
D)10/36
E)11/36

Question 24

Identify the Greek symbol that denotes variance.

A)δ
B)β
C)σ²
D)δ²
E)σ

Question 25

Inaccuracies in our abilities to create a correct distribution arise from:

A)the nondiversifiable nature of risks.
B)our risk averse nature.
C)our inability to predict future outcomes accurately.
D)our inability to distinguish between hazards and perils.
E)the inability of insurers to insure all risks.

Question 26

Which of the following is defined as the numerical average of the experience of all possible outcomes if you played the game over and over?

A)Unbiased value
B)Unfair value
C)Continuous outcome value
D)Fair value
E)Rational value

Question 27

A problem with the _____ as a measure of risk is that by squaring the individual deviations from the mean, you end up with a measure that is in squared units.

A)standard deviation
B)range
C)mode
D)confidence level
E)variance

Question 28

The normal distribution or bell-shaped curve from statistics provides an example of a continuous probability distribution curve.While calculating the probability of the occurrence of an event, we find that the area under the curve in between the desired range of profitability values is 0.562.What does this mean?

A)The probability of the occurrence of the event is 0.562 percent.
B)The probability of the occurrence of the event is 56.2 percent.
C)The probability of the occurrence of the event is 43.8 percent.
D)The probability of the occurrence of the event is 0.438 percent.
E)The probability of the occurrence can now be calculated by multiplying this number with the standard deviation.

Question 29

"If I flip a coin, I have a 50 percent chance that it will land on heads." In this statement, even after the first coin flip, we still have a 50 percent chance that the next flip will result in a head.This statements interprets "probability" as:

A)the severity of occurrence in repeated trials.
B)a relative frequency of occurrence in repeated trials.
C)an absolute severity of occurrence in a single trial.
D)an absolute frequency of occurrence in a single trial.
E)a relative severity of occurrence in a single trial.

Question 30

According to the model of equally likely outcomes, the relative frequency of occurrence of events in a long sequence of repeated trials corresponds with the theoretical calculation of:

A)the total number of expected outcomes divided by the actual outcomes.
B)the total number of expected outcomes divided by the number of ways an event could occur.
C)the actual outcomes divided by the expected outcomes.
D)the number of ways an event could occur divided by the total number of possible outcomes.
E)the actual outcomes divided by the total number of expected outcomes.

Question 31

The total number of fire claims for the two locations A and B is the same.What does this mean?

A)The frequency and severity of fire claims in locations A and B is the same.
B)The frequency of fire claims in locations A and B differ.
C)The severity of fire claims in locations A and B is the same.
D)Both frequency and severity of fire claims in locations A and B differ.
E)The frequency of fire claims in locations A and B is the same.

Question 32

Identify the distance between the highest possible outcome value to the lowest in a distribution.

A)Standard deviation
B)Mode
C)Variance
D)Skewness
E)Range

Question 33

By taking the "best-case scenario minus the worst-case scenario" we define the potential breadth of outcomes that could arise in the uncertain situation.Which of the following provides an idea about the "worst-case" dispersion of successive surprises?

A)Confidence
B)Standard deviation
C)Range
D)Mode
E)Variance

Question 34

_____ is the notion of how often a certain event will occur.

A)Likelihood
B)Severity
C)Forecasting
D)Plausibility
E)Backcasting

Question 35

A problem with the variance as a measure of risk is that by squaring the individual deviations from the mean, you end up with a measure that is in squared units.To get back to the original units of measurement we commonly take the square root and obtain a risk measure known as:

A)the confidence interval.
B)standard deviation.
C)co-efficient of variation.
D)kurtosis.
E)the root mean square.

Question 36

The reason that uncertainty is unsettling is not the uncertainty itself but the:

A)consequences of different outcomes.
B)expected outcomes.
C)unpredictability of outcomes.
D)lack of accurate tools to measure it.
E)variability of predictable outcomes.

Question 37

If we roll two dice, what is the probability of rolling number 8?

A)3/36
B)4/36
C)5/36
D)1/6
E)1/18

Question 38

Range as a risk measure leaves the picture incomplete because:

A)it cannot distinguish in riskiness between two distributions of situations where the possible outcomes are bounded.
B)it does not take into account the frequency or probability of the extreme values.
C)it measures the frequency of distribution and ignores the severity.
D)it measures the extreme values of the distribution with the probability of its occurrence.
E)it measures the severity of distribution and ignores the frequency.

Question 39

One measure of deviation or surprise is by calculating the expected squared distance of each of the various outcomes from their mean value.This is a weighted average squared distance of each possible value from the mean of all observations, where the weights are the probabilities of occurrence.Computationally, we do this by individually squaring the deviation of each possible outcome from the expected value, multiplying this result by its respective probability or likelihood of occurring, and then summing up the resulting products.Identify the measure produced.

A)Variance
B)Confidence
C)Standard deviation
D)Mode
E)Range

Question 40

Which of the following statements is true about the risk metrics?

A)It is a system of related measures that help us measure the emotional aspects of risk.
B)It is important but not critical because enterprises have alternative measures to see whether they have reached risk management objectives.
C)It is an independent entity and can stand alone.
D)It allows us to measure risk, giving us an ability to control risk and simultaneously exploit opportunities as they arise.
E)The risk being considered in a particular situation does not dictate the risk measure used because they are standard for almost all risk types.

Question 41

Which of the following can be defined as the worst-case scenario dollar value loss that could occur for a company exposed to a specific set of risks?

A)Fair-Risk value
B)Value at Risk
C)Loss-Threshold value
D)Volatility Arbitrage
E)Market at Risk

Question 42

Explain range as a measure of risk.

Question 43

How is semivariance different from the other measures of risk? When is it used as a measure of risk?

Question 44

Identify the amount needed to have in reserve in order to stave off insolvency with the specified level of probability.

A)Value at Risk
B)Threshold value
C)Fair value
D)Mean value
E)Reserve value

Question 45

Which of the following can be used to give us a relative value of risk when the means of the distributions are not equal?

A)Confidence level
B)Standard deviation
C)Coefficient of variation
D)Semivariance
E)Range

Question 46

All the other measures of risk give the same attention or importance to both positive and negative deviations from the mean or expected value.Identify the odd one.

A)Standard deviation
B)Coefficient of variation
C)Variance
D)Semivariance
E)Range

Question 47

In the context of pure risk exposures, the equivalent notion to value at risk (VaR) is the:

A)Maximal Probable Actual Loss
B)Maximal Probable Expected Loss.
C)Maximal Probable Absolute Loss
D)Maximal Probable Annual Loss.
E)Maximal Probable Hypothetic Loss

Question 48

The birth of the "modern" ideas of chance occurred when a problem was posed to mathematician Blaisé Pascal by a frequent gambler.What was the problem? What was Pascal's approach to it?
The problem posed was: If two people are gambling and the game is interrupted and discontinued before either one of the two has won, what is a fair way to split the pot of money on the table? Clearly the person ahead at that time had a better chance of winning the game and should have gotten more.The player in the lead would receive the larger portion of the pot of money.However, the person losing could come from behind and win.It could happen and such a possibility should not be excluded.How should the pot be split fairly?

Question 49

The coefficient of variation is calculated by dividing the:

A)mean of the distribution by its standard deviation.
B)mean of the distribution by its variance.
C)variance of the distribution by its standard deviation.
D)standard deviation of the distribution by its mean.
E)variance of the distribution by its mean.

Question 50

How do you calculate the coefficient of variation? When is it useful?

Question 51

The coefficient of variation essentially trades off risk, which is measured by the _____, with the return.

A)standard deviation
B)range
C)mean
D)expected value
E)variance

Question 52

If we compare one standard deviation with another distribution of equal mean but larger standard deviation, we could say that:

A)the risk of the distribution is equal.
B)the distribution with the larger standard deviation is riskier.
C)the distribution with the smaller standard deviation is riskier.
D)it is impossible to tell which distribution is riskier because the mean is equal.
E)the distribution with the higher severity would be riskier.

Question 53

Which of the following measures of risk treats positive and negative deviations from the mean or expected value independently?

A)Range
B)Variance
C)Standard deviation
D)Coefficient of variation
E)Semivariance

Question 54

Identify the Greek symbol that denotes standard deviation.

A)δ
B)β
C)σ²
D)δ²
E)σ

Question 55

From this model we can get a measure of how the return on an asset systematically varies with the variations in the market, and consequently we can get a measure of systematic risk.Identify this model.

A)Discounted Cash Flow Model
B)Capital Asset Pricing Model
C)Modigliani-Miller Model
D)Absolute Return Model
E)Value at Risk Model

Question 56

Probability can have two different meanings or forms as related to statements of uncertain outcomes.Distinguish between the following sentences: "If I sail west from Europe, I have a 50 percent chance that I will fall off the edge of the earth" and "If I flip a coin, I have a 50 percent chance that it will land on heads."

Question 57

Why was the notion of "equally likely outcomes" insufficient?

Question 58

The use of the semivariance turns out to result in the exact same ranking of uncertain outcomes with respect to risk as the use of the variance when the:

A)distribution is asymmetric.
B)coefficient of variation is introduced.
C)distribution is symmetric.
D)range of distributions is equal.
E)standard deviation and mean of distributions is equal.

Question 59

The CAPM model assumes that investors in assets expect to be compensated for two factors.Identify them.

A)Systematic risk and nondiversifiable risk
B)Idiosyncratic risk and time value of money
C)Time value of money and nondiversifiable risk
D)Time value of money and net present value
E)Depreciation and net present value

Question 60

The coefficient of variation essentially trades off risk with the return.This return is measured by:

A)range.
B)expected value.
C)standard deviation.
D)variance.
E)skewness.

Question 61

The risk-reward tradeoff is essentially a(n) _____ analysis taking uncertainty into account.

Question 62

The VaR examines the size of loss that would occur only 1 percent of the time, but it does not specify the size of the shortfall that the company would be expected to have to make up by a distress liquidation of assets should such a large loss occur.A measure called the _____ is used for this.

Question 63

In economic terms, a risk is a "surprise" outcome that is a consequence of _____.

Question 64

_____ is the number of times the event is expected to occur in a specified period of time.

Question 65

The birth of the "modern" ideas of chance occurred when a problem was posed to mathematician _____ by a frequent gambler.

Question 66

The _____ is the display of the events on a map that tells us the likelihood that the event or events will occur.

Question 67

The _____ is the average square deviation in a distribution.

Question 68

Using _____ as a measure of risk leaves the picture incomplete because it cannot distinguish in riskiness between two distributions of situations where the possible outcomes are unbounded.

Question 69

The size of the loss in terms of dollars lost per claim is called _____.

Question 70

Regardless of the source of the likelihoods, we can obtain an assessment of the probabilities or relative frequencies of the future occurrence of each conceivable event.The collection of possible events together with their respective probabilities of occurrence is called a _____ distribution.

Question 71

The calculation and interpretation of VaR and Maximal Probable Annual Loss (MPAL) is the same.In _____ contexts one often encounters the term MPAL, whereas in _____ one often encounters the term VaR.

Question 72

_____ is the deviation from the expected value.

Question 73

For a given level of confidence and over a specified time horizon, _____ can measure risks in any single or an entire portfolio as long as we have sufficient historical data.

Question 74

_____ is the premium over and above the actuarially fair premium that a risk-averse person is willing to pay to get rid of risk.

Question 75

The _____ is the standard deviation of a distribution divided by its mean.