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CRM Risk study materials
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CRM Risk practice questions

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Question 1Principles of Risk Management (exposure identification and enterprise risk management)

In enterprise risk management, risk is best defined as:

  1. The cost of transferring an exposure to an insurer
  2. The certainty that an organization will incur a financial loss
  3. The maximum amount an organization can afford to lose
  4. The effect of uncertainty on objectives Correct answer.

Explanation

Risk is conventionally framed as the effect of uncertainty on objectives, which can be positive as well as negative. It is broader than the certainty of loss, the price of insurance, or any single financial limit.

Question 2Principles of Risk Management (exposure identification and enterprise risk management)

Which of the following is a pure risk exposure?

  1. A fire that destroys a company's warehouse Correct answer.
  2. Buying shares of a competitor's stock
  3. Purchasing foreign currency in anticipation of exchange rate movements
  4. Investing in a new product line that may generate large profits

Explanation

A pure risk offers only the possibility of loss or no loss, with no prospect of gain. Fire, flood, and employee injury are classic pure risks, whereas investments and new ventures carry both upside and downside.

Question 3Principles of Risk Management (exposure identification and enterprise risk management)

A hazard is best described as:

  1. A condition that increases the chance or size of a loss Correct answer.
  2. The legal duty to pay for another party's injury
  3. The financial consequence of a loss
  4. The event that actually causes a loss

Explanation

A hazard is a condition or circumstance, such as oily rags or an icy walkway, that raises the likelihood or magnitude of loss. The peril is the cause of loss, and the loss itself is the financial consequence.

Question 4Principles of Risk Management (exposure identification and enterprise risk management)

A customer slips on a wet floor in a retail store and is injured. The store's exposure is classified as:

  1. A liability loss exposure Correct answer.
  2. A personnel loss exposure
  3. A property loss exposure
  4. A net income loss exposure

Explanation

Liability exposures arise from legal obligations to third parties for bodily injury or property damage caused by the organization. Property exposures concern the organization's own assets, and personnel exposures concern its workforce.

Question 5Principles of Risk Management (exposure identification and enterprise risk management)

An analyst charts each step of a warehouse's receiving and shipping process, looking for points where goods could be damaged or stolen. This is an example of:

  1. Financial statement analysis
  2. Reviewing prior loss runs
  3. Risk mapping across business units
  4. Process flow charting Correct answer.

Explanation

Flow charting traces a process step by step so that points of potential loss become visible. It is a diagnostic identification technique, distinct from financial analysis or historical claims review.

Question 6Principles of Risk Management (exposure identification and enterprise risk management)

Which statement best describes enterprise risk management?

  1. It guarantees that an organization will not suffer unexpected losses
  2. It identifies, assesses, and manages risks across the whole organization in a coordinated, portfolio view Correct answer.
  3. It manages each risk department by department without coordination
  4. It focuses exclusively on risks that can be insured

Explanation

ERM takes a portfolio view so that risks are identified, assessed, and managed in a coordinated way across the enterprise and linked to strategy. It supplements rather than replaces the management of individual risks.

Question 7Principles of Risk Management (exposure identification and enterprise risk management)

Which of the following is a preloss objective of a risk management program?

  1. Continued operation after a loss
  2. Ensuring the firm's survival after a catastrophic loss
  3. Stability of earnings after a loss
  4. Economy in the cost of managing risk Correct answer.

Explanation

Preloss objectives are pursued before a loss occurs and include economy in risk management operations, reduced anxiety, legal compliance, and social responsibility. Survival, continuity, and earnings stability are postloss objectives.

Question 8Principles of Risk Management (exposure identification and enterprise risk management)

The maximum level of risk an organization can bear before its objectives or solvency are threatened is known as its:

  1. risk capacity Correct answer.
  2. risk retention
  3. risk tolerance
  4. risk appetite

Explanation

Risk capacity is the outer limit of risk the organization could absorb without breaching objectives or solvency. Appetite is the level it chooses to pursue within that capacity, and tolerance is the acceptable variation around the appetite.

Question 9Principles of Risk Management (exposure identification and enterprise risk management)

A firm manages currency risk in treasury, safety risk in operations, and cyber risk in IT, with no cross-functional reporting. The most significant weakness of this structure is that it:

  1. duplicates the work of external auditors
  2. eliminates the need for a board risk committee
  3. increases the cost of individual insurance policies
  4. prevents the firm from seeing how exposures combine or offset across units Correct answer.

Explanation

Managing risks in isolated silos hides interdependencies, so correlations, netting effects, and concentrations never surface. That aggregation failure is the central weakness that ERM is designed to correct.

Question 10Principles of Risk Management (exposure identification and enterprise risk management)

Within the COSO Enterprise Risk Management framework, 'Governance and Culture' is one of the framework's:

  1. five components Correct answer.
  2. four risk treatment options
  3. seven categories of hazard
  4. three lines of defense

Explanation

The COSO ERM framework is organized around five components: governance and culture, strategy and objective-setting, performance, review and revision, and information, communication, and reporting. Governance and culture is the foundational component.

Question 11Principles of Risk Management (exposure identification and enterprise risk management)

A manufacturer discontinues a product line because the associated liability exposure cannot be managed to its satisfaction. Under ISO 31000, this treatment is:

  1. Risk sharing
  2. Risk reduction
  3. Risk retention
  4. Risk avoidance Correct answer.

Explanation

Avoidance removes the activity that creates the exposure, so the risk no longer exists for the organization. Reduction, sharing, and retention all leave the activity in place while altering its likelihood, severity, or funding.

Question 12Principles of Risk Management (exposure identification and enterprise risk management)

A risk map plotting likelihood against consequence is used primarily to:

  1. satisfy statutory financial reporting requirements
  2. prioritize exposures so resources go to the most significant risks Correct answer.
  3. calculate the premium an insurer will charge
  4. determine the exact dollar value of a future loss

Explanation

A likelihood-by-consequence map ranks exposures visually so that the largest and most probable ones attract resources first. It supports prioritization and communication rather than precise measurement.

Question 13Principles of Risk Management (exposure identification and enterprise risk management)

A risk manager reviews the property schedule and the accounts receivable aging report to find assets whose loss would strain the balance sheet. This technique is:

  1. Checklist analysis
  2. Physical inspection
  3. Incident recall
  4. Financial statement analysis Correct answer.

Explanation

Financial statement analysis uses balance sheet and income statement items to identify assets, income streams, and obligations whose impairment would harm the organization. It complements rather than replaces physical inspection of operations.

Question 14Principles of Risk Management (exposure identification and enterprise risk management)

The principal limitation of using a standardized checklist to identify loss exposures is that it:

  1. cannot be combined with other identification methods
  2. always overstates the cost of risk
  3. covers only exposures the author anticipated and may miss firm-specific or emerging ones Correct answer.
  4. requires actuarial software that most organizations lack

Explanation

Checklists capture known exposures efficiently but are bounded by their authors' foresight, so new, unusual, or site-specific exposures escape them. They work best alongside open-ended techniques such as inspections and scenario work.

Question 15Principles of Risk Management (exposure identification and enterprise risk management)

Which of the following best describes a key risk indicator?

  1. A measure that signals a rising exposure Correct answer.
  2. The ratio of premium to total assets
  3. A record of losses that have already occurred
  4. The portion of each loss the firm retains

Explanation

A key risk indicator is a forward-looking metric showing whether an exposure is trending toward a risk appetite limit. Loss records are backward-looking and describe what has already happened.

Question 16Principles of Risk Management (exposure identification and enterprise risk management)

In an ERM program, a risk owner is best described as:

  1. any employee who happens to report a hazard
  2. the insurer that indemnifies the risk
  3. the individual with authority and accountability for managing a particular risk Correct answer.
  4. the auditor who tests controls over the risk

Explanation

A risk owner is a named person with the authority and accountability to manage the exposure and report on it. Auditors and insurers provide assurance or funding but do not own the risk.

Question 17Principles of Risk Management (exposure identification and enterprise risk management)

A firm is entering a market where it has no loss history and little data on which to model outcomes. The most appropriate approach to assessing the risks is:

  1. Waiting until several years of data are available
  2. Scenario analysis using expert judgment Correct answer.
  3. Monte Carlo simulation using internal data
  4. An actuarial loss development projection

Explanation

When data are sparse, structured expert judgment and scenario analysis give a defensible view of likelihood and consequence. Quantitative modelling requires credible data, and waiting for a claims history leaves the firm unmanaged in the meantime.

Question 18Principles of Risk Management (exposure identification and enterprise risk management)

In the three lines of defense model, the first line is:

  1. The independent risk and compliance function
  2. Internal audit
  3. The board of directors
  4. Operational management that owns and manages risk day to day Correct answer.

Explanation

The first line consists of operational management, which owns and manages risk in the course of running the business. The second line provides frameworks and oversight, and internal audit forms the third line.

Question 19Principles of Risk Management (exposure identification and enterprise risk management)

Risk control techniques differ from risk financing techniques in that risk control techniques:

  1. are used only for speculative risks
  2. transfer the financial consequences of loss to a third party
  3. reduce loss frequency or severity rather than fund losses Correct answer.
  4. always eliminate the exposure entirely

Explanation

Risk control attacks the loss itself, lowering how often it happens or how large it is. Risk financing instead provides funds to pay for losses that occur, through insurance, reserves, or credit arrangements.

Question 20Principles of Risk Management (exposure identification and enterprise risk management)

A firm's net income exposure from a fire is best measured by considering:

  1. the deductible stated in the property policy
  2. the market value of the land on the site
  3. lost revenue and continuing expenses during the interruption, plus extra costs to resume operations Correct answer.
  4. the book value of the destroyed building only

Explanation

Net income exposure measures lost profit, which includes revenue not earned, continuing fixed expenses, and extra costs needed to restore operations. Physical damage to the building is a separate property exposure.

Question 21Principles of Risk Management (exposure identification and enterprise risk management)

A board states it will accept up to $5 million of retained loss per year, and management sets unit-level limits within a band around that figure. The band represents the organization's:

  1. risk capacity
  2. risk transfer limit
  3. risk avoidance threshold
  4. risk tolerance Correct answer.

Explanation

Risk tolerance is the acceptable variation around the stated appetite, expressed as operating limits for units or activities. Capacity is the outer limit the firm could bear, and appetite is the overall level it chooses to pursue.

Question 22Principles of Risk Management (exposure identification and enterprise risk management)

Why does a portfolio view of risk often produce a lower total exposure estimate than adding up each unit's worst case?

  1. Because individual units routinely understate their own exposures
  2. Because imperfectly correlated exposures are unlikely to peak at the same time Correct answer.
  3. Because aggregation automatically reduces the premiums charged by insurers
  4. Because a portfolio view removes the possibility of any loss

Explanation

When exposures are imperfectly correlated they are unlikely to peak simultaneously, so the aggregate worst case is lower than the sum of individual worst cases. This diversification effect is a central argument for portfolio-level risk measurement.

Question 23Principles of Risk Management (exposure identification and enterprise risk management)

Which practice best positions an organization to identify emerging risks before they become losses?

  1. Scanning regulatory and industry sources Correct answer.
  2. Risk appetite set once at program launch
  3. A static checklist reviewed every five years
  4. The prior year's paid claims

Explanation

Emerging risks surface before loss data exists, so identification depends on regularly scanning external and internal signals such as regulatory consultations, research, and near-miss reports. Static and historical tools look backward and typically miss them.

Question 24Principles of Risk Management (exposure identification and enterprise risk management)

A risk register lists an inherent exposure of $10 million and a residual exposure of $4 million for the same risk. The $6 million difference most likely represents:

  1. the amount the insurer will pay on a claim
  2. the amount of loss the firm could not survive
  3. the risk appetite set by the board
  4. the effect of risk treatment measures already in place Correct answer.

Explanation

Inherent risk is the exposure before controls or other treatments, and residual risk is what remains once those measures operate. The gap between them reflects risk reduced, avoided, or transferred.

Question 25Principles of Risk Management (exposure identification and enterprise risk management)

The total cost of risk for an organization consists of:

  1. premiums paid, retained losses, and the administrative cost of managing risk Correct answer.
  2. only the premiums paid to insurers
  3. only the cost of safety equipment and training
  4. only those losses that are uninsured

Explanation

The total cost of risk combines insurance premiums, retained losses including deductibles and uninsured amounts, and the administrative cost of the risk management function. Relying on any single component understates the true burden.

Question 26Principles of Risk Management (exposure identification and enterprise risk management)

Which type of risk involves the possibility of either gain or loss from an uncertain event?

  1. Compliance risk
  2. Pure risk
  3. Operational risk
  4. Speculative risk Correct answer.

Explanation

Risks are divided by outcome profile: pure risks offer only loss or no loss, while speculative risks have two-way outcomes that can produce gain as well as loss, such as price movements or new product launches. Only speculative risk carries an upside.

Question 27Principles of Risk Management (exposure identification and enterprise risk management)

Risk appetite is best described as:

  1. the largest loss an organization could absorb before its solvency is threatened
  2. the process of reducing exposures through avoidance, prevention, and other control measures
  3. the amount and type of risk an organization is willing to accept in pursuing its objectives Correct answer.
  4. the combined maximum probable loss from every exposure recorded in the organization's risk register

Explanation

Risk appetite is a forward-looking statement of willingness, set by the board and expressed in qualitative and quantitative terms, that guides which risks the organization will pursue, limit, or reject. It is a choice about desired risk-taking rather than an outer capacity limit or a control process.

Question 28Principles of Risk Management (exposure identification and enterprise risk management)

A risk manager diagrams each step of the order-fulfillment process, marking where goods, funds, or data could be damaged, lost, or misdirected. Which exposure identification method is being used?

  1. Financial statement method
  2. Loss history analysis
  3. Flow chart method Correct answer.
  4. Questionnaire method

Explanation

The flow chart method traces an operation step by step so that exposures are found at each point where property, people, income, or liability are at stake. Its strength is revealing dependencies and gaps between steps that a static asset list would miss.

Question 29Principles of Risk Management (exposure identification and enterprise risk management)

The primary purpose of a risk register is to:

  1. replace the organization's insurance program with a documented self-funding plan
  2. satisfy regulatory filing requirements that apply to publicly traded companies
  3. calculate the precise probability of every identified loss event
  4. record identified risks with assigned owners, ratings, and agreed treatment actions Correct answer.

Explanation

A risk register is the working inventory of identified risks; each entry carries an owner, an assessment of likelihood and impact, and the chosen response, and it is updated as conditions change. It supports tracking and accountability rather than precise probability calculation.

Question 30Principles of Risk Management (exposure identification and enterprise risk management)

A bakery buys all of its specialty flour from a single mill. A fire at the mill halts production for three months, forcing the bakery to cut output even though the bakery's own plant is undamaged. The bakery's exposure is best identified as:

  1. a products liability exposure
  2. a direct property exposure
  3. a contingent business interruption exposure Correct answer.
  4. an employee benefits exposure

Explanation

Contingent business interruption covers income loss caused by physical damage at a key supplier or customer rather than at the insured's own premises. Recognizing supplier concentration is part of identifying time-element exposures that a property schedule alone will not reveal.

Question 31Principles of Risk Management (exposure identification and enterprise risk management)

A tenant signs a lease containing a clause requiring it to indemnify and hold the landlord harmless for injuries occurring in the leased space. From the tenant's perspective, this clause primarily creates:

  1. a liability exposure assumed by contract Correct answer.
  2. a human resources exposure from tenant staff
  3. a net income exposure from lost rent
  4. a property exposure to the leased building

Explanation

Contracts can create liability exposures that would not otherwise exist by shifting responsibility for losses to the party accepting the indemnity. Identifying assumed liability requires reading leases, service agreements, and purchase orders, not just listing owned assets.

Question 32Principles of Risk Management (exposure identification and enterprise risk management)

An organization's units score risks on their own scales: one uses 1-5, another uses dollar ranges, a third uses high/medium/low. The strongest reason to replace these with a single enterprise taxonomy is to:

  1. eliminate the need for risk owners at the business-unit level
  2. reduce the number of individual risks the organization must manage
  3. guarantee that no exposure is left out when the register is consolidated at group level
  4. allow risks to be compared and aggregated consistently across the enterprise Correct answer.

Explanation

Aggregation requires commensurability: risks scored on incompatible scales cannot be ranked, combined, or compared to appetite at the enterprise level. A shared taxonomy and rating scale create the common language that makes roll-up meaningful.

Question 33Principles of Risk Management (exposure identification and enterprise risk management)

A company buys property, equipment breakdown, and business interruption coverage from three different insurers in separate transactions. What is the principal exposure created by assembling the program this way?

  1. premiums that are necessarily higher than a single combined policy would charge
  2. loss of each insurer's right to subrogate against responsible third parties
  3. loss of the coinsurance requirement on each of the separate policies
  4. gaps and overlaps in coverage at the boundaries between the policies Correct answer.

Explanation

Policies bought piecemeal are drafted independently, so definitions, exclusions, and limits may not align where one exposure ends and another begins. Coordinating the program, including consistent definitions and other-insurance clauses, is how the risk manager prevents uncovered gaps and duplicated limits.

Question 34Principles of Risk Management (exposure identification and enterprise risk management)

Two firms form a joint venture and agree in the operating agreement that each will bear half of any environmental cleanup cost at the shared site. The venture partners have:

  1. shared the exposure through a contractual arrangement Correct answer.
  2. transferred the exposure to an insurer in exchange for a premium
  3. retained the entire exposure individually with no limits
  4. avoided the exposure entirely by forming a separate entity

Explanation

Risk sharing allocates a portion of an exposure to another party, here through a contractual split of cleanup costs. It differs from transfer because the original party keeps part of the loss rather than shedding it entirely.

Question 35Principles of Risk Management (exposure identification and enterprise risk management)

A software startup's entire product roadmap depends on one lead engineer who alone understands the core code base. If that person dies or resigns, development would stall for a year. This is best classified as:

  1. a human resources exposure Correct answer.
  2. a liability exposure
  3. a property exposure
  4. a financial risk exposure

Explanation

Human resources exposures arise from the people on whom the organization depends, including death, disability, resignation, and loss of key skills. Key-person dependency is a classic human resources exposure often addressed by cross-training, documentation, or key-person insurance.

Question 36Principles of Risk Management (exposure identification and enterprise risk management)

A parent company forms a wholly owned insurance subsidiary that issues policies to the parent and its affiliates. This arrangement is best described as:

  1. a reciprocal exchange, under which insureds pool premiums
  2. a surplus lines placement with a nonadmitted carrier
  3. a captive insurer, a formalized retention technique Correct answer.
  4. a finite reinsurance treaty that smooths reported results

Explanation

A captive is an insurer owned by the organization it insures, so the parent is formally retaining the risk within its own corporate structure while gaining the administrative and tax treatment of insurance. It is a retention technique even though the paperwork looks like insurance.

Question 37Principles of Risk Management (exposure identification and enterprise risk management)

In risk management records, how does a risk differ from an issue?

  1. A risk is measured in currency amounts, whereas an issue is measured in elapsed time.
  2. A risk can always be transferred to an insurer, whereas an issue must always be retained and funded internally.
  3. A risk is an uncertain future event, whereas an issue is a condition that has already occurred and requires action. Correct answer.
  4. A risk is owned by the board of directors, whereas an issue is owned by line management.

Explanation

A risk is prospective and uncertain, so it is assessed in terms of likelihood and impact; an issue is a present condition that has already materialized and needs resolution. Registers distinguish the two so that future threats are evaluated while current problems are worked.

Question 38Principles of Risk Management (exposure identification and enterprise risk management)

A single flood at a company's only warehouse would destroy finished goods, ruin paper sales records, and halt shipments for weeks. Why is this best treated as one integrated exposure rather than three separate risks?

  1. because flooding is a pure rather than speculative risk, and pure risks cannot be separated into components
  2. because the warehouse is a single asset and therefore must be scheduled on one policy form
  3. because property losses are always larger in dollar terms than liability losses at the same location
  4. because one event drives several losses at once, so treating them separately understates total severity Correct answer.

Explanation

Interdependent exposures share a common trigger, so their severities add up in a single event rather than occurring independently. Assessing them in isolation masks the concentration and produces a maximum loss that is far too low.

Question 39Principles of Risk Management (exposure identification and enterprise risk management)

Why does an effective ERM program combine top-down and bottom-up exposure identification?

  1. Top-down identification by leadership replaces the need for any risk register maintained at the operating-unit level.
  2. Leadership sees cross-cutting and strategic exposures, while operating staff see process-level detail that leaders miss. Correct answer.
  3. The two approaches produce identical lists, which serves as a completeness check.
  4. Bottom-up identification is mandated by accounting standards for all public entities.

Explanation

Each direction has an information advantage: leaders can see correlations, concentrations, and strategic threats across the portfolio, while staff know the specific failure points in their own processes. Combining them catches both kinds of exposure that either alone would overlook.

Question 40Principles of Risk Management (exposure identification and enterprise risk management)

A firm hedges its jet fuel cost with futures on a benchmark that does not precisely match the grade it buys, so the hedge may not fully offset actual price moves. This residual uncertainty is known as:

  1. credit risk
  2. liquidity risk
  3. basis risk Correct answer.
  4. moral hazard

Explanation

Basis risk is the risk that a hedging instrument and the exposure being hedged do not move in lockstep, leaving a gap between the hedge payoff and the actual loss. It is an exposure created by the risk financing decision itself, not by the underlying commodity.

Question 41Analysis of Risk (qualitative and quantitative analysis, forecasting)

A portfolio has a one-day 99% VaR of $2 million. What does this mean?

  1. The portfolio will lose exactly $2 million one day in every 100 days
  2. The maximum possible loss over one day is $2 million
  3. A loss greater than $2 million is expected on about 1% of trading days Correct answer.
  4. Over any 100-day period the cumulative loss will never exceed $2 million

Explanation

VaR is a quantile of the loss distribution: at 99% confidence, losses are expected to exceed the VaR threshold on roughly 1% of days. It says nothing about the size of losses beyond that threshold, and it is not a worst-case or cumulative measure.

Question 42Analysis of Risk (qualitative and quantitative analysis, forecasting)

Which of the following is a purely qualitative risk assessment technique?

  1. Historical simulation
  2. Delphi technique Correct answer.
  3. Variance-covariance VaR
  4. Monte Carlo simulation

Explanation

The Delphi technique elicits and iteratively refines expert opinions without requiring numerical loss data, which makes it a qualitative tool. The other methods all produce quantitative loss or risk estimates from data or assumed distributions.

Question 43Analysis of Risk (qualitative and quantitative analysis, forecasting)

What is the primary purpose of stress testing?

  1. To allocate regulatory capital for market risk only
  2. To assess the effect of extreme but plausible adverse scenarios Correct answer.
  3. To backtest the accuracy of a daily profit-and-loss forecast
  4. To estimate VaR at a 99% confidence level under normal conditions

Explanation

Stress testing applies severe but plausible shocks or scenarios to a portfolio to see how losses and capital would behave outside normal conditions. It complements statistical risk measures rather than replicating them.

Question 44Analysis of Risk (qualitative and quantitative analysis, forecasting)

Monte Carlo simulation is most appropriate when:

  1. The portfolio contains complex, non-linear instruments Correct answer.
  2. A long and representative history of returns is available
  3. The portfolio contains only linear positions and risk factors are normally distributed
  4. Expert opinion is the only available input

Explanation

Simulation generates a full distribution of portfolio outcomes from assumed factor distributions, which handles non-linear payoffs and path dependence where analytic formulas fail. For linear, normal portfolios the parametric approach is simpler and equally valid.

Question 45Analysis of Risk (qualitative and quantitative analysis, forecasting)

A 99% one-day VaR model is backtested over 250 trading days. How many exceptions should be expected if the model is correctly calibrated?

  1. 1
  2. 25
  3. 5
  4. 2.5 Correct answer.

Explanation

The expected exception rate equals the tail probability, 1% at 99% confidence, multiplied by the number of observations. Over 250 days this gives 250 × 0.01 = 2.5 expected exceptions.

Question 46Analysis of Risk (qualitative and quantitative analysis, forecasting)

A risk heat map typically plots which two dimensions?

  1. Likelihood of an event against its impact Correct answer.
  2. Value at risk against expected shortfall
  3. Exposure at default against recovery rate
  4. Probability of default against loss given default

Explanation

Heat maps place risks on a grid of likelihood and impact so that qualitatively assessed risks can be ranked and prioritised. Colour coding then highlights which combinations fall into high-risk zones.

Question 47Analysis of Risk (qualitative and quantitative analysis, forecasting)

In an exponentially weighted moving average volatility model with decay factor λ, a higher λ:

  1. Makes the model identical to a simple moving average
  2. Places relatively more weight on older observations Correct answer.
  3. Places more weight on the most recent observation
  4. Implies faster mean reversion to long-run volatility

Explanation

The weight on the most recent squared return is (1 − λ), so a larger λ gives that observation less weight and spreads weight further back through history, slowing the decay. A λ close to one therefore produces a smooth, slowly reacting volatility estimate.

Question 48Analysis of Risk (qualitative and quantitative analysis, forecasting)

A simple moving average forecast is best described as:

  1. An equal-weighted average of the last n observations Correct answer.
  2. A regression of the variable on its own lagged values
  3. A technique that weights recent observations most heavily
  4. A model that captures volatility clustering

Explanation

A simple moving average takes the arithmetic mean of the most recent n observations, assigning each the same weight of 1/n. Because old observations drop out abruptly, the forecast can react sharply when a large value leaves the window.

Question 49Analysis of Risk (qualitative and quantitative analysis, forecasting)

A portfolio of $10 million has a daily volatility of 1.5% and an expected daily return of zero. Using a 95% one-tailed normal deviate of 1.645, what is the one-day parametric VaR?

  1. $246,750 Correct answer.
  2. $16,450
  3. $150,000
  4. $348,900

Explanation

Parametric VaR equals the confidence-level deviate multiplied by the volatility and the exposure: 1.645 × 1.5% × $10,000,000 = $246,750. With a zero expected return, no drift adjustment is needed.

Question 50Analysis of Risk (qualitative and quantitative analysis, forecasting)

Compared with VaR at the same confidence level, expected shortfall:

  1. Is always smaller than VaR at that confidence level
  2. Averages tail losses beyond VaR and is subadditive Correct answer.
  3. Cannot be estimated by historical simulation
  4. Requires normally distributed returns

Explanation

Expected shortfall is the conditional mean of losses exceeding the VaR threshold, so it is at least as large as VaR and captures tail severity. Unlike VaR it satisfies subadditivity, making it a coherent risk measure.