Chapter 3: Basic Concepts of Risk Management (Sections 3.1–3.3)

Question 1

What are the five main categories of risk banks face?

Answer 1

Liquidity risk, interest-rate risk, market risk, credit risk, and operational risk.

Question 2

Why do banks use different risk measures?

Answer 2

Because each type of risk (e.g., market vs. credit) arises from different sources and requires tailored management and regulatory treatment.

Question 3

Name the four broad approaches to quantifying market risk.

Answer 3

Notional measures, sensitivity measures, distribution-based measures (VaR & ETL), and scenario-based stress tests.

Question 4

In plain English, what is Value at Risk (VaR)?

Answer 4

The maximum loss a portfolio is not expected to exceed over a given time frame at a certain confidence level (e.g., 99%).

Question 5

How does Expected Tail Loss (ETL) add to VaR?

Answer 5

By averaging the losses that occur beyond the VaR threshold, giving insight into the severity of worst-case events.

Question 6

What is gap analysis in interest-rate risk management?

Answer 6

Grouping assets and liabilities by when they reprice, then measuring the net difference (“gap”) to see how rate changes will affect earnings.

Question 7

What does ‘duration’ tell you about an asset or liability?

Answer 7

It measures the weighted average time until cash flows occur, approximating how sensitive its price is to small, parallel shifts in interest rates.

Question 8

Why might banks need to go beyond duration for large or uneven rate moves?

Answer 8

Because duration is a linear estimate—it doesn’t account for non-parallel shifts or curvature (convexity), so larger or complex changes require higher-order or simulation models.