Deck 26: Risk-Management Models

Question 1

In the structural model,the firm's equity can be viewed as:

A) a European call option on the assets of the firm
B) a European put option on the assets of the firm
C) an American call option on the assets of the firm
D) an American put option on the assets of the firm
E) riskless debt plus shorting a put option on the assets of the firm

Answer 1

A

Question 2

The following is NOT a valid step in scenario analysis (popularly known as stress testing):

A) select a particular set of "scenarios" that the firm wants to protect against
B) scenarios can correspond to various states of the economy represented by paths of the state variables (which may be a collection of macroeconomic variables such as inflation,gross domestic product,unemployment,and interest rates)
C) the set of scenarios can be generated by changing the state variables by some known amounts (such as raising interest rates by 1 percent or decreasing unemployment by 2 percent)
D) for these scenarios,the firm computes the losses realized on its assets and liabilities
E) the firm computes VAR based on the scenarios selected

Answer 2

E

Question 3

Which of the following statements regarding risk measures is INCORRECT?

A) A risk measure is a positive real valued function that quantifies the "risk" to changes in a firm's equity capital-losses-over some time period.
B) Examples of risk measures include the maximum loss,the expected loss,and the value-at-risk.
C) Artzner,Delbaen,Eber,and Heath (1999)identified four different properties or axioms that a good risk measure should satisfy.
D) A risk measure satisfying Artzner,Delbaen,Eber,and Heath (1999)four axioms is called a coherent risk measure.
E) Value-at-risk is the best risk measure because it satisfies all four properties above.

Answer 3

E

Question 4

What is the definition of value-at-risk (VAR)for a one-year horizon?

A) VAR is the standard deviation of the firm's equity returns per year.
B) VAR is the variance of the firm's equity returns per year.
C) VAR is the value that the firm's losses will exceed with a given probability for a one-year horizon.
D) VAR is the value that the firm's profits will exceed with a given probability for a one-year horizon.
E) VAR is the variance of the firm's profits per year.

Question 5

What is the key problem with the structural model?

A) It assumes a simple liability structure for the firm's balance sheet.
B) It assumes the assets of the firm trade in frictionless and competitive markets.
C) It assumes interest rates are constant.
D) It assumes a lognormal distribution for asset returns.
E) It assumes the equity pays no dividends.

Question 6

Many of the tools of risk management can be developed by focusing on computing a loss distribution.Denote the time t value of a firm's assets,liabilities,and equity by A_t,L_t,and E_t,respectively.If $\Delta$ denotes a change in these quantities,and x denotes a predetermined value,then the risk measurement problem may be set up as:

A) computing Prob { $\Delta$ E_t $\le$ x}where $\Delta$ E_t $\equiv$$\Delta$ A_t - $\Delta$ L_t
B) computing Prob { $\Delta$ E_t $\le$ x}where $\Delta$ E_t $\equiv$ $\Delta$ A_t + $\Delta$ L_t
C) computing Prob { $\Delta$ A_t $\le$ x}where $\Delta$ A_t $\equiv$ $\Delta$ E_t - $\Delta$ L_t
D) computing Prob { $\Delta$ L_t $\le$ x}where $\Delta$ L_t $\equiv$ $\Delta$ A_t - $\Delta$ E_t
E) None of these answers are correct.

Question 7

Which of the following statements is NOT true about asset-backed securities (ABS)?

A) ABS are issued by a legal entity called a special purpose vehicle (SPV).
B) ABS SPV assets consist of a collection of loans.
C) ABS are tranched so that the cash flows follow a "waterfall."
D) ABS are sometimes called structured debt.
E) ABS are very similar to corporate debt.

Question 8

Which of the following statements regarding Goldman Sachs avoiding huge losses from mortgage-backed securities (MBS)is INCORRECT?

A) Goldman Sachs's model for measuring risks failed to give any indication of the impending crisis in the housing market.
B) Goldman Sachs's model for measuring risks indicated that there was something wrong in the MBS market.
C) Goldman Sachs convened a meeting of risk managers and senior executives who discussed the market and decided to reduce their MBS risk exposure.
D) Goldman Sachs's action enabled the firm to avoid billions of dollars in losses when the housing market crashed in summer 2007.
E) While some observers claim that this incident illustrated a failure of models,a careful consideration reveals that by raising warning signs in a timely fashion,the model saved the firm from multibillion dollar losses.

Question 9

Which of the following is a reason why the financial crisis occurred?

A) lax mortgage lending standards
B) strong government regulation of over-the-counter derivatives markets
C) accurate rating of structured debt by the credit rating agencies
D) strong due diligence of financial institutions with respect to their investments
E) sufficient capital in financial institutions

Question 10

Which of the following is NOT true about value-at-risk (VAR)?

A) VAR penalizes diversification for some asset/liability portfolios.
B) VAR should be the sole measure used to quantify a firm's insolvency risk.
C) VAR ignores losses greater than the VAR $\alpha$ -percentage level.
D) VAR is computed using the equity's loss distribution.
E) VAR measures the firm's insolvency risk.

Question 11

Your Beloved Machines Inc.'s stock has a weekly expected return of 0.0025 and weekly volatility of the returns of 0.03.Then the weekly 95 percent and 99 percent confidence levels (value-at-risk at the 5 and 1 percent levels)for YBM are (where 5 percent left tail is 1.65 standard deviations and 1 percent tail is 2.33 standard deviations away from the mean):

A) 4.70 percent and 6.74 percent
B) 5.23 percent and 3.75 percent
C) 4.70 percent and 3.75 percent
D) 2.50 percent and 3.00 percent
E) None of these answers are correct.

Question 12

Which assumption(s)does the reduced-form model relax in the structural model?

A) The simple liability structure for the firm's balance sheet.
B) The assets of the firm trade in frictionless and competitive markets.
C) Interest rates are constant.
D) All of these answers are correct.
E) None of these answers are correct.

Question 13

When a company undertakes risky ventures,who are most likely to lose if the firm defaults?

A) senior debt holders
B) junior debt holders
C) preferred stock holders (who get paid after the junior debt holders)
D) stockholders
E) It's impossible to know.

Question 14

Operational risk is:

A) the risk to a firm's financial condition resulting from adverse movements in the level or volatility of market prices
B) the risk that a counterparty will fail to perform on an obligation
C) the risk that a firm may not be able to,or cannot easily,unwind or offset an asset or liability position at or near the previous market price because of inadequate market depth or because of disruptions in the marketplace
D) the risk that deficiencies in information systems or internal controls will result in an unexpected loss
E) the risk that a firm will become insolvent

Question 15

Which of the following is a possible reason why credit rating agencies incorrectly rated structured debt?

A) incentive problems in the way credit rating agencies were paid
B) the industry is collusive
C) they were not overseen by the Securities and Exchange Commission
D) the credit rating agencies were understaffed
E) the credit rating agencies were losing profits before the crisis

Question 16

In the structural model,the firm's debt can be viewed as:

A) a European call option on the assets of the firm
B) a European put option on the assets of the firm
C) an American call option on the assets of the firm
D) an American put option on the assets of the firm
E) riskless debt plus shorting a European put option on the assets of the firm

Question 17

Which of the following statements is NOT true about derivatives?

A) Derivatives are a newcomer to financial markets in the past fifty years.
B) Derivatives help to complete markets.
C) Derivatives are regulated by either the Securities and Exchange Commission or the Commodity Futures Trading Commission.
D) Derivatives usually require models to determine hedge ratios.
E) Derivatives can be used incorrectly if not well understood.

Question 18

Which of the following are NOT included in market risk?

A) equity price fluctuations
B) interest rate fluctuations
C) commodity price fluctuations
D) risk of debt defaulting
E) exchange rate fluctuations