The exposure at default is the greatest for the certificate of deposit as the entire notional amount is exposed to the risk of default. The other choices represent derivatives for which the current replacement value, which would be far less than notional, would be the credit exposure.

Said another way - if the counterparty were to default, the entire money in the CD would be at risk, whereas for the derivative contracts it would only be the replacement value that would be at risk.

All of the listed reports (or information) would be useful to a risk manager analyzing liquidity risk. Therefore Choice ' c ' is the correct answer. Additionally, reports on assets brought on margin (that may result in collateral or margin calls), trading exposures to different counterparties, reports on financial health, share price and credit ratings of key counterparties will also be useful.

Historical Simulation VaR is conceptually very straightforward: actual prices as seen during the observation period (1 year, 2 years, or other) become the ' scenarios ' forming the basis of the valuation of the portfolio. For each scenario, full revaluation is performed, and a P & L data set becomes available from which the desired loss quantile can be extracted.

Historical simulation is based upon actually seen prices over a selected historical period, therefore no distributional assumptions are required. The data is what the data is, and is the distribution. Statement I is therefore not correct.

It uses full revaluation for each historical scenario, therefore statement II is correct.

Since the prices are taken from actual historical observations, a correlation matrix is not required at all. Statement III is therefore incorrect (it would be true for Monte Carlo and parametric Var).

Historical simulation VaR suffers from the limitation that if enough representative data points are no available during the historical observation period from which the scenarios are drawn, the results would be inaccurate. This is likely to be the case for new products. Therefore Statement IV is incorrect.

Choice ' c ' relates to operational risk and process capabilities, generally not a concern when evaluating market risk of a portfolio. Choice ' a ' , Choice ' b ' and Choice ' d ' represent real concerns for the risk manager when building stress tests for the value of a portfolio.

Choice ' a ' is relevant because certain shocks may be inconsistent with each other, and therefore implausible. For example, an increase in futures prices may be inconsistent with without spot prices and/or interest rates increasing according to the no-arbitrage condition. Choice ' b ' is relevant when modeling a covariance matrix in a stressed situation with higher correlations, as a hypothetical covariance matrix which is not positive semi-definite may give absurd results (negative variance). Choice ' d ' is relevant as liquidity risks may affect the price that can be realized for positions held.

The probability that only none of the three bonds will default is equal to the probability of all surviving. Since default correlation is zero, we can simply multiply the probabilities of survival. Therefore the correct answer is 94% = (1 - 1%) * (1 - 2%) * (1 - 3%)

Choice ' a ' (The amplification of smaller initial shocks to one risk factor creating larger subsequent shocks through system-wide interactions between other risks, creating self-perpetuating downward stresses in the markets) is the most comprehensive description of ' feedback effects ' , as described in the BCBS document on stress testing. Choice ' c ' is one manifestation of feedback effects, but does not describe the entire effect. Choice ' b ' is not a description of ' feedback effects ' , but one of the various weaknesses in stress testing that was seen during the crisis. Choice ' d ' is plain nonsensical.

The BCBS paper provides a good and succinct description of feedback effect: how mortgage default shocks led to a deterioration of market prices of CDOs, followed by a drying up of the liquidity in these markets. This led to banks having to hold on to assets they intended to securitize (securitization and warehousing risk), and given the absence of transparency on who was exposed to what, banks refusing to lend to each other and a drying up of the wholesale funding market as well. All of this was additionally accompanied by a general flight to quality, households withdrawing money from money market funds creating a crisis in that market as well. At each stage, the initial shock was amplified and fed back into the system through interactions that had not been imagined by any market participant or regulator, leave alone risk managers.

The economic capital required to avoid insolvency is just the asset VaR, ie $100. This means that if the worst case losses are realized, the institution would need to have a buffer equivalent to those losses which in this case will be $100, and this buffer is the economic capital.

The actual value of liabilities is not relevant as they are considered ' riskless ' from the institution ' s point of view, ie they will be taken at full value. In this particular case, the institution has $200 in capital which is more than the economic capital required.

Therefore Choice ' c ' is the correct answer.

Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk, but excludes strategic and reputational risk.

Therefore any losses from poor strategic planning will not be a part of operational risk. Choice ' d ' is the correct answer.

Note that floods, earthquakes and the like are covered under the definition of operational risk as losses arising from loss or damage to physical assets from natural disaster or other events.

Marginal VaR of a component of a portfolio is the change in the portfolio VaR from a $1 change in the value of the component. It helps a risk analyst who may be trying to identify the best way to influence VaR by changing the components of the portfolio. Marginal VaR is also important for calculating component VaR (for VaR disaggregation), as component VaR is equal to the marginal VaR multiplied by the value of the component in the portfolio.

Marginal VaR is by definition the derivative of the portfolio value with respect to the component i. This is reflected in Choice ' a ' above. Using the definitions and relationships between correlation, covariance, beta and volatility of the portfolio and/or the component, we can show that the other two choices are also equivalent to Choice ' a ' .

Therefore all the choices present are correct.