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What are the single-point-of-entry and multiple-point-of-entry strategies for cross-border bank resolution?
Single Point of Entry resolves a G-SIB only at the parent level, absorbing losses through bail-in of parent TLAC and keeping subsidiaries operating. Multiple Point of Entry resolves multiple entities simultaneously across jurisdictions. The choice depends on the group's organizational structure.
What is a risk parity portfolio, how does it differ from traditional 60/40 allocation, and what role does leverage play?
Risk parity equalizes risk contributions across asset classes rather than capital weights. A traditional 60/40 portfolio has ~90% of its risk from equities. Risk parity overweights bonds and underweights equities, often adding leverage to achieve competitive returns.
What are the practical limitations of mean-variance optimization, and how do risk managers address them?
Mean-variance optimization is extremely sensitive to input estimates, often producing concentrated and unstable portfolios. Practical remedies include adding allocation constraints, using Black-Litterman to blend equilibrium returns with views, and resampling the efficient frontier.
What is the Default Risk Charge under FRTB and how is it calculated?
The Default Risk Charge captures jump-to-default risk — the sudden loss when an issuer defaults. It is calculated by computing JTD amounts (notional times LGD), netting within the same obligor, applying rating-based risk weights, and aggregating with prescribed correlations.
How does the ARIMA model work for time series forecasting in risk management?
ARIMA stands for AutoRegressive Integrated Moving Average and combines three components: AR(p) for autoregressive terms, I(d) for differencing to achieve stationarity, and MA(q) for moving average error terms. Choosing the right parameters requires stationarity tests and ACF/PACF analysis.
How does SA-CCR compute exposure at default for derivative portfolios?
SA-CCR is the Basel Committee's standardized method for computing Exposure at Default (EAD) for derivative positions. The master formula is EAD = 1.4 x (RC + PFE), where RC is replacement cost and PFE is potential future exposure.
How do you detect heteroskedasticity in a linear regression, and why does it matter for FRM?
Heteroskedasticity is the condition where the variance of regression residuals is not constant across observations. In risk management, this is extremely common due to volatility clustering.
How should risk managers think about event risk — the kind that standard models completely miss?
Event risk involves sudden, severe market dislocations that standard VaR models cannot capture. Practical management combines stress testing, reverse stress testing, scenario analysis, and position limits — supplementing quantitative models with expert judgment.
What are covered bonds, and how do they differ from regular asset-backed securities?
Covered bonds differ from ABS through dual recourse — investors can claim against both the cover pool and the issuing bank. Assets stay on-balance-sheet with dynamic management and overcollateralization, making them structurally safer.
What are the key simulation techniques and variance reduction methods used in risk management?
Monte Carlo estimates are noisy, especially for tail risk metrics. Variance reduction techniques — antithetic variates (using Z and -Z), control variates (benchmarking), and importance sampling (shifting the distribution) — improve precision without extra simulations.
How do CDOs work, and what's the difference between cash CDOs and synthetic CDOs?
A CDO is a securitization where the collateral pool consists of debt instruments. Cash CDOs physically purchase bonds, while synthetic CDOs use CDS contracts to gain credit exposure without buying the underlying assets.
What are regime-switching models and how are they applied to market risk?
Regime-switching models assume that financial markets alternate between distinct states — typically a calm regime and a volatile crisis regime — each governed by different statistical parameters. They capture the abrupt shifts between market conditions that standard GARCH models miss.
Can you explain each of Basel's seven operational risk event types with examples?
Basel's seven operational risk event types provide a consistent taxonomy across banks globally. Here is each with illustrative examples...
How does a defined benefit pension fund approach enterprise risk management?
DB pension risk management is fundamentally ALM: funded-ratio volatility driven by rates, inflation, longevity, and contribution risk.
How does Basel set the correlation parameter R in the IRB formula?
Basel prescribes R: corporate formula interpolates 24% (low PD) to 12% (high PD). QRRE fixed at 4%, mortgage 15%. Higher credit quality = higher systematic correlation...
How do different commodity futures curve shapes affect investment strategy? Can you trade the curve itself?
Commodity futures curves shift dynamically between contango and backwardation based on supply-demand dynamics. Sophisticated investors trade these shifts through calendar spreads and roll yield enhancement strategies.
What is cross-validation and why is it essential for machine learning in finance?
Cross-validation divides data into multiple train/test splits to get a robust estimate of model performance. For financial time series, standard k-fold CV introduces look-ahead bias, so walk-forward validation that respects temporal ordering must be used instead.
How do ESG factors actually affect corporate financial decisions? Is it just PR or does it matter for valuation?
ESG integration in corporate finance goes beyond PR — it directly affects cost of capital, capital budgeting decisions, risk assessment, and access to funding. Companies with strong ESG profiles tend to enjoy lower WACC and more favorable financing terms.
What is a variance swap and how does it differ from a volatility swap?
A variance swap is an OTC derivative that pays the difference between realized variance and a pre-agreed strike variance over a specified period. It provides pure exposure to volatility without any directional bet on the underlying asset.
What are my duties to my employer under Standard IV? Can I prepare to leave for a competitor?
Standard IV requires loyalty to your employer but not absolute loyalty — client interests still come first. You can prepare to leave while employed but cannot solicit clients or take proprietary information before resigning.
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