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FRM Part II Updated
How does the FRTB define the boundary between the trading book and banking book, and why does it matter for capital?
The FRTB was introduced to address boundary arbitrage — banks exploiting the trading/banking book classification to minimize capital. FRTB imposes strict presumptive assignment rules and transfer restrictions.
How is the Basel leverage ratio calculated and why was it introduced alongside risk-based capital requirements?
The Basel III leverage ratio is a simple, non-risk-weighted measure designed as a backstop to the risk-based capital framework. It was introduced because some banks appeared well-capitalized on a risk-weighted basis but were dangerously leveraged.
Why did Basel move from the AMA to the SMA for operational risk capital, and how does the SMA work?
The transition from AMA to SMA represents a shift from internal model freedom to a standardized formula. The AMA was abandoned due to excessive variability, model risk, insufficient data, and gaming potential.
Can banks use insurance to reduce operational risk capital requirements, and what are the limitations?
Under the AMA, banks could receive up to 20% capital credit for insurance, subject to strict criteria. Under the SMA, direct insurance mitigation is not recognized, though recoveries indirectly lower the Internal Loss Multiplier.
What are the key elements of a business continuity plan and how does it relate to operational resilience?
Business Continuity Planning is the process of preparing for and recovering from disruptive events. Post-2020, regulators have expanded BCP into a broader concept called operational resilience, which focuses on operating through disruptions rather than just recovering from them.
How should banks manage third-party risk, and what are the regulatory expectations for outsourcing critical functions?
Third-party risk management has become one of the most scrutinized areas of operational risk. Regulators view outsourcing as transferring the activity but not the responsibility — the bank remains fully accountable.
How is the Liquidity Coverage Ratio (LCR) calculated and what qualifies as High-Quality Liquid Assets?
The Liquidity Coverage Ratio ensures banks hold enough liquid assets to survive a 30-day stress scenario. The formula divides the stock of HQLA by total net cash outflows, with a minimum requirement of 100%.
How does the Net Stable Funding Ratio (NSFR) work and how does it complement the LCR?
The NSFR promotes stable long-term funding by requiring banks to fund their activities with sufficiently stable sources over a one-year horizon. While the LCR prevents short-term liquidity crises, the NSFR prevents the structural mismatches that cause them.
What is intraday liquidity risk and how do the BCBS monitoring tools address it?
Intraday liquidity risk is the risk that a bank cannot meet its payment and settlement obligations throughout the business day. The BCBS prescribed seven monitoring tools to help supervisors assess banks' intraday liquidity management.
What should a contingency funding plan include and how are escalation triggers designed?
A Contingency Funding Plan is a predefined action plan activated during liquidity stress. It includes governance structures, early warning indicators, staged escalation frameworks, and quantified action menus for each stage of deterioration.
What are the unique challenges in measuring hedge fund risk and how do standard risk metrics fail?
Hedge fund risk measurement is challenging because hedge fund return distributions violate many assumptions underlying standard risk metrics. Non-normal distributions, stale pricing, leverage distortion, and option-like payoffs all cause standard measures to understate true risk.
How do you measure risk in private equity funds, and why are standard portfolio metrics inadequate?
Private equity risk measurement is challenging due to illiquidity, smoothed valuations, and the J-curve pattern. Standard metrics like volatility, Sharpe ratio, and correlation are systematically biased when applied to PE, overstating its risk-adjusted appeal.
What are the key risks in structured credit products like CDOs and how does tranching affect the risk profile?
Structured credit products like CDOs pool exposures and redistribute risk through a waterfall structure. Tranching doesn't reduce total risk — it concentrates and redistributes it, making correlation assumptions critical to valuation.
How does risk budgeting work in portfolio construction and what are its practical applications?
Risk budgeting allocates a total risk budget across portfolio components, ensuring each position contributes the intended amount of risk. Unlike traditional return-based approaches, risk budgeting starts with risk and distributes risk-taking capacity intentionally.
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