Sample Questions Risk Management

1. Risk management is about

a. Understanding and mitigating risk
b. Avoiding risk
c. Taking risks
d. None of the above
2. Consider a contract that is always a liability to the financial institution. Does this contract:
a) Have no credit risk to the financial institution
b) Always have credit risk to the financial institution
c) May or may not exhibit credit risk to the financial institution
d) Inadequate information to comment on
3. Which of these is not a credit risk mitigation technique:
a) Netting
b) Collaterization
c) Neither (a) nor (b)
d) Both (a) and (b)
4. An investor holds a portfolio of Rs. 200 million half of it are A-rated bonds while the other half
consists of BBB-rated bonds. Assume that the one-year probabilities of default for A-rated and
BBB-rated bonds are 1.5% and 3.75%, respectively, and that they are independent. If the recovery
value for A-rated bonds in the event of default is 75% and the recovery value for BBB-rated bonds
is 65%, what is the one-year expected credit loss from this portfolio?
a) Rs. 28,12,500
b) Rs. 24,37,500
c) Rs. 3,75,000
d) None of the above
5. Which of the following is used to estimate probability of default in the KMV model?
a) Vector Analysis
b) Total Return Analysis
c) Equity Price Volatility
d) None of the above
6. Consider a contract that is always an asset to the financial institution. Does this contract:
a) Have no credit risk to the financial institution
b) Always have credit risk to the financial institution
c) May or may not exhibit credit risk to the financial institution

d) Inadequate information to comment on

7. Let us assume that for an investor holding equity in a firms capital structure adds to the credit
worthiness of the firm. Which of the following support(s) this argument?
I.
Equity does not require payments that could lead to default
II.
Equity capital does not mature, so it represents a permanent capital base
III.
Equity provides a cushion for debt holders in case of bankruptcy
IV.
The cost of equity is lower than the cost of debt.
a)
b)
c)
d)

I, II, and III

All of the above
I, II, and IV
III only

8. For obligors from the same industry and similar sized idiosyncratic risk, which loan is more risky?
a) Rs. 2,00,000 with a 50% recovery rate
b) Rs. 2,00,000 with no collateral
c) Rs. 8,00,000 with 40% recovery rate
d) Rs. 8,00,000 with 60% recovery rate
9. Consider a contract that can become either an asset or a liability to the financial institution.
Does this contract:
a) Have no credit risk to the financial institution
b) Always have credit risk to the financial institution
c) May or may not exhibit credit risk to the financial institution
d) Inadequate information to comment on
10. Credit positions should be taken to cover all of the following except:
a) Nonperforming loans
b) The expected loss of a loan portfolio
c) An amount equal to the VaR of the credit portfolio
d) Excess credit profits earned during the below average loss years
11. Assume XYZ Ltd. has assets currently estimated at Rs. 20 crores. The annual asset volatility is 30%
and XYZ Ltd. has a loan with a face value of Rs. 8 crores payable after 2 years. If the risk free
interest rate is 5%, what is the market value of the loan? You can use the Black Scholes Merton
model to value the loan.
a) Rs.6.78 crores
b) Rs. 8 crores
c) Rs. 10 crores
d) Rs. 9.56 crores

12. The credit risk of a portfolio having an exposure of Rs. 25 million in a BBB rated bond when
calculated using an estimated variance of 3% at a 99% VaR level (you can take the Z value to be
2.33) is:
a) Rs. 7,50,000
b) Rs. 5,82,500
c) Rs. 17,47,500
d) Rs. 7,500
13. The KMV model deals with off balance sheet liabilities through:
a) Appropriate adjustment of the default points through liabilities
b) Treats them as on balance sheet items
c) Completely ignores off balance sheet items
d) Assumes some historical values for these liabilities
14. The Expected Default Frequency and the Actual Default frequency are:
a) Always the same
b) Never the same
c) Can be same or different
d) Cant say based on the information provided

15. What is the most significant difference to consider when assessing the credit worthiness of a
country rather than a company?
a) The countrys willingness and its ability to pay must be analyzed
b) Financial data on a country is often available only with long lags
c) It is more costly to do due diligence on a country rather than on a company
d) A country is often unwilling to disclose sensitive financial information
16. Assume that is a certain database of 5000 firms, there are 500 firms with a distance to default of
2.85 sigma. Of these 500 firms, let us assume that 25 have actually defaulted. The Actual Default
Frequency then is:
a) 0.05
b) 0.075
c) 0.003
d) 0.004
17. ABC Public Ltd. has (in Rs crores) Total Assets of 2000, Working Capital of 546, EBIT of 540, Net
sales of 800, retained earnings of 630 and a market value of equity equal to 350. What is the
Altman Z score for ABC Public Ltd.?
a) 2.5688
b) 2.1646
c) 2.50

d) 2.023
18. Creditmetrics estimates the VaR using all of the following information except:
a) Borrower credit ratings
b) The rating migration matrix
c) Recovery rates on defaulted loans
d) Treasury yields
19. Suppose a firm is expected to have total assets equal to Rs. 1000 crores and liabilities to the
tune of Rs. 750 crores with an annual asset volatility of 10%. What is the distance to default in
this case?
a) 2 standard deviations
b) 2.5 standard deviations
c) 3 standard deviations
d) Cannot say
20. The transition matrix in credit risk measurement generally represents:
a) Probabilities of ratings migration over the lifetime of the loan
b) Correlations among the transitions for the various rating quality assets within one year
c) Correlations of various market movements that impact rating quality for a 10 day
holding period
d) Probabilities of migrating from one rating quality to another within one year
21. A portfolio manager has been asked to take the risk related to the default of two securities A and
B. She has to make a large payment if, and only if, both A and B default. For taking this risk, she
will be compensated by receiving a fee. What can be said about this fee?
a) The fee will be larger if the default of A and of B are highly correlated
b) The fee will be smaller if the default of A and of B are highly correlated
c) The fee is independent of the correlation between the default of A and of B
d) None of the above are correct
22. Which of the following statements about Basel II capital requirements is false?
a) It increases the risk sensitivity of minimum capital requirements for internationally active
banks
b) It addresses only credit and market risk
c) US insurance companies are not required to comply with Basel II capital requirements
d) Banks are not allowed to use their internal models for credit risk in determining the capital
requirements for credit risk
23. The risk of a stock or bond that is correlated with the market (and thus can be diversified) is
known as:
a) Interest Rate Risk
b) Foreign Exchange Risk
c) Model Risk

d) Specific Risk
24. Identify the risks of being short $50 million of gold two weeks forward and being long $50
million of gold one year forward.
a) Gold liquidity squeeze
b) Spot risk
c) Gold lease rate risk
d) Interest rate risk
a)
b)
c)
d)

II only
I, II and III only
I, III, IV only
I, II, III and IV

25. Which of the following statements about Operational Risk is true?

a) Measuring operational risk requires both estimating the probability of an operation loss
event and the potential size of the loss
b) Measurement of operational risk is well developed, given the general agreement among
the institutions about the definition of this risk
c) The operational risk manager has the primary responsibility for managing operational
risk
d) Operational risks are clearly separate from other risks such as credit and market risks
26. The measurement of exposure to operational risk should be based on the assessment of:
I.
The probability of an operational failure
II.
The extent of insurance coverage
III.
The probability distribution of losses in case of failure
a)
b)
c)
d)

I only
II only
I and III only
I, II and III

27. Which is the correct statement:

a) Operational risk has no impact on credit and market risk
b) Operational risk has no impact on market risk but has impact on credit risk
c) Operational risk has no impact on credit risk but has impact on market risk
d) Operational risk has impact on market and credit risk
28. Under the assumption of perfect markets, risk management expenditures aimed at reducing a
firms diversifiable risk serve to:
a) Decrease the firms value, wherever the costs of such risk management are positive

b) Make the firm more attractive to the shareholders as long as costs of risk management
are reasonable
c) Increase the firms value by lowering its cost of equity
d) Has no impact on the firm value

29. Operational Risk Capital should provide a cushion against:

I. Expected losses
II. Unexpected losses
III. Catastrophic losses
a.
b.
c.
d.

I only
II only
I and II only
I, II and III

30. You are modeling the number of operational risk loss events that could adversely affect the bank
you work for in 2016. You also expect the number of operational risk loss events for the year to
be relatively small. Which type of distribution are you least likely to use:
a. Normal distribution
b. Binomial distribution
c. Negative Binomial distribution
d. Poisson distribution
31. Which of the following statements is most likely to be valid about hedging operational risk?
I. A primary disadvantage of insurance as an operational risk management tool is the
limitation of policy coverage
II. If an operational risk hedge works properly, a firm will avoid damage to its reputation
from high severity operational risk event
III. While all insurance contracts suffer from the problem of moral hazard, deductibles help
reduce the problem
IV. Catastrophe (CAT) bonds allow a firm to hedge operational risks associated with natural
disasters
a.
b.
c.
d.

I, III and IV only

I, II and IV only
II and III only
III and IV only

32. Which of the following will be recognized under the proposed Basel III norms for capital
allocations?

a.
b.
c.
d.

Counter cyclicality
Liquidity
Leverage
All of them

33. Under Basel II requirements, the capital allocation required by an Indian bank for investments in
domestic government securities is
a. 0
b. 8% of the exposure
c. 9% of the exposure
d. None of the above
34. Which type of operational risk can be effectively handled by a relevant insurance policy?
a. High frequency, low severity
b. Low frequency, high severity
c. Operational losses whose magnitude is affected by the actions of the company
d. Operational losses for which insurance companies only sell policies with low limits
35. Which of the following are issues that any regulator, based on the lessons of the 2008 Global
Financial Crisis, is interested in looking at from a risk management perspective?
a. Centralized clearing of all products and trades
b. Transparency in trading by use of electronic trading platforms
c. Insulate proprietary trading from other activities
d. All of the above
36. Assume that an investor holds a portfolio of 10 C rated bonds. The probability of any one of the
bonds defaulting in the next one year is 35% and also all the bonds in the portfolio is independent
of each other. What is the probability that the investor suffers at least one default in the next one
year?
a. 65%
b. 35%
c. 96.65%
d. Cant say based on the information provided
37. Which of the following conditions need to be satisfied when developing a default prediction
model?
a. The model should be easy to define
b. The model should be easy to apply and produce as unambiguous results as
possible
c. The model should be amenable to future improvements
d. All of the above

38. Which of the following statements about Basel II capital requirements is false?
a. It increases the risk sensitivity of minimum capital requirements for internationally active
banks
b. It addresses only credit and market risk
c. US insurance companies are not required to comply with Basel II capital requirements
d. Banks are not allowed to use their internal models for credit risk in determining the capital
requirements for credit risk
39. Which of the following is not a type of operational risk as defined by Basle II?
a. Human error and internal fraud
b. Destruction by fire or other external catastrophes
c. Failure of breakdown of internal control processes
d. All of the above
40. Based on the information in the table, what is the probability of getting a wrong prediction?

Actual Ratings

Predicted Ratings

a.
b.
c.
d.

AAA

AAA

AA

BBB

AA

52

17

11

85

BBB

13

16

49/209
160/209
49/160
Cannot be determined

41. Consider the following statement: Discriminant model is more stable than the Logit model.
Which of the following choices is correct?
a. The given statement is false as the discriminant module assumes multivariate normality
of the variables
b. The given statement is true as the discriminant module assumes multivariate normality
of the variables
c. The given statement is false as the discriminant module does not assume normality of the
variables
d. Insufficient information to make a decision

42. ABC Ltd. has (in Rs crores) Total Assets of 2000, Working Capital of 546, EBIT of 540, Net sales of
800, retained earnings of 630 and a market value of equity equal to 350. The Altman Z Score is
calculated based on the equation

ZPublic = 1.2X1 + 1.4X2 + 3.3 X3 + 0.6 X4 + 1.0X5

Where,
X1 = Working Capital / Total Assets
X2 = Retained Earning / Total Assets
X3 = EBIT / Total Assets
X4 = Market Value of Equity / Total Assets
X5 = Net Sales / Total Assets
What is the Altman Z score for ABC Ltd.?
a. 2.5688
b. 2.1646
c. 2.50
d. 2.023
43. Consider a Logit model. Which of the following statements is correct?
a. The Y variable will be Log(P/(1-P)) and the equation will be modeled as Log(P/(1-P)) = A +
Bx.
b. The Y variable will be Log(P) and the equation will be modeled as Log(P) = A + Bx.
c. The Y variable will be Log(1-P) and the equation will be modeled as Log(1-P) = A + Bx.
d. None of the above
44. Between the Discriminant model and the Logit model the following statement holds:
a. Logit models over-fits the data as multicolinearity is disregarded
b. Logit models over-fits the data but does account for multicolinearity
c. Logit models fits the data appropriately but disregards multicolinearity
d. Logit models fits the data appropriately but accounts for multicolinearity
45. The severity distribution of operational losses usually has the following shape:
a. Symmetrical with short tails
b. Long tailed to the right
c. Uniform
d. Symmetrical with long tails
46. Consider the data in the following table. Based on the information in the table, which of the
following statements would be true?
Description
Asset Turn over (Sales/Total Assets)
Cash profit
PAT as % of net worth
Deferred tax liability
Cumulative retained profits

Sign
Negative
Negative
Negative
Positive
Negative

Value
0.515
0.007
0.025
0.005
0.003

Wald
13.950
7.051
75.044
5.805
19.226

Significance
0.000
0.008
0.000
0.016
0.000

TOL/TNW
Total term liabilities / tangible net worth
Cash to average cost of sales per day
Finished goods turnover
Constant

Positive
Negative
Positive
Positive
Negative

0.085
0.087
0.001
0.001
2.606

20.998
7.775
7.937
25.614
227.170

0.000
0.005
0.005
0.000
0.000

a. Networth should not be used as denominator

b. There are a lot of profit variables in the model leading to a high possibility of
intercorrelation
c. The finished goods turnover has a wrong sign
d. All of the above
47. Which of the following risks are not related to Operational Risk?
a. Errors in trade entry
b. Fluctuation in market prices
c. Errors in preparing the Master Agreement
d. Late confirmation
48. Consider the data in the following table. Based on the information in the table, which of the
following statements would be true?
Description
Net worth / Total Assets
PAT
PBDITA
PBT / Total Income
Cash Profit / Total Income
PAT / Net Worth
Sales / TotalAssets
Cumulative retained profits
Quick Ratio times
Debt to Equity ratio times
Company is on the BSE or not (1 or 0)
Constant
a.
b.
c.
d.

Sign
Negative
Positive
Negative
Positive
Negative
Negative
Negative
Negative
Positive
Positive
Negative
Positive

Value
5.7820
0.0050
0.0050
0.1200
0.0280
0.0280
0.8245
0.0029
0.0794
0.0520
0.6821
0.2710

Wald
48.832
12.647
13.261
3.856
7.643
54.076
21.735
7.882
0.813
8.903
4.988
0.482

Quick ratio is significant and has correct sign

PBT/Total income has correct sign
Networth should be used as a numerator
None of the above

49. Which of the following statements about Operational Risk is true

Significance
0.000
0.000
0.000
0.05
0.006
2E-13
0.000
0.000
0.367
0.003
0.026
0.48

a) Measuring operational risk requires both estimating the probability of an operation loss
event and the potential size of the loss
b) Measurement of operational risk is well developed, given the general agreement among
the institutions about the definition of this risk
c) The operational risk manager has the primary responsibility for managing operational
risk
d) Operational risks are clearly separate from other risks such as credit and market risks
50. The output from logistic regression done on 1578 firms that defaulted over a certain 10 year
period is given below. The variables used for the regression are:
Default = 1,
If the firm defaults
= 0;
Otherwise.
MCAP = Average Market capitalization of the firm (in Rs. Crores)
Salary = Workers wage and salary (In Rs. Crore)
TA = Total assets (In Rs. Crore)
Sales = Sales (In Rs. Crores)
The Logistic Regression Output is given by:
Variable
Coefficient
Std. Error
C
-1.0004
0.072337
Log(Salary/TA)
-1.50
1.04
Log(MCAP)
1.35 E 4
3.17 E 5
Log(Sales)
1.39 E 5
7.03 E 5

Z - statistic
-13.8298
-1.44131
4.261213
0.19734

Probability
0
0.0495
0
0.0036

Which of the following statements would be correct?

a. MCAP and Sales are correlated to each other, hence the coefficient of both these
variables are wrong. We should remove one variable amongst the two variables and
then re run the regression.
b. MCAP and Sales are correlated to each other, but the coefficient of both these variables
is not necessarily wrong. Hence there is no need to remove one variable amongst the two
variables and then re run the regression.
c. MCAP and Sales are correlated to each other, but the coefficient of both these variables
is not necessarily wrong. Hence we should also use a linear combination of these two
variables along with the two variables and then re run the regression.
d. None of the statements are correct