Attempt CAIIB Risk Management Practice Quiz & Download PDF

1. ‘Prepayment risk’ in mortgage portfolios is a form of which broader risk category?

A) Credit risk, as prepayments indicate borrower financial stress
B) Market risk, specifically a form of option risk or extension/contraction risk embedded in the mortgage loan
C) Operational risk arising from loan administration failures
D) Liquidity risk due to sudden cash inflows

2. Which of the following is the PRIMARY purpose of a ‘netting agreement’ in the context of OTC derivative counterparty risk?

A) To eliminate all credit risk on derivative transactions
B) To allow bilateral offsetting of positive and negative MTM values across multiple derivative contracts with the same counterparty, reducing gross exposure to net exposure
C) To convert OTC derivatives to exchange-traded instruments
D) To extend the maturity of derivative contracts to reduce rollover risk

3. In operational risk management, the ‘Business Indicator (BI)’ under the Standardized Measurement Approach (SMA) is computed from:

A) The bank’s net interest income over the past 3 years only
B) Three components: Interest, Leases and Dividends Component (ILDC); Services Component (SC); and Financial Component (FC)
C) Total operating expenses as a percentage of gross income
D) The number of operational loss events over the past 10 years

4. A bank’s ALM committee (ALCO) observes that its 1-year repricing gap is significantly positive. This means:

A) The bank faces reinvestment risk if interest rates fall
B) The bank’s NII will increase if interest rates rise, as rate-sensitive assets reprice upward faster than rate-sensitive liabilities
C) The bank is exposed to duration mismatch risk on its long-term bonds
D) The bank faces funding liquidity risk in the short term

5. The ‘Supervisory Review and Evaluation Process (SREP)’ under Pillar 2 of Basel III allows supervisors to:

A) Set risk weights lower than Pillar 1 minimums for well-managed banks
B) Impose bank-specific additional capital requirements (Pillar 2 add-ons) beyond Pillar 1 minimums if a bank’s ICAAP is deemed inadequate or risks are under-capitalized
C) Approve internal models for all banks without minimum data requirements
D) Replace Pillar 1 capital requirements with qualitative risk assessments

6. In statistical risk measurement, ‘Expected Shortfall (ES)’ is considered superior to VaR primarily because:

A) ES is simpler to compute and explain to regulators
B) ES satisfies the mathematical property of sub-additivity, meaning portfolio ES ≤ sum of individual ESs, and it captures the expected magnitude of losses beyond the VaR threshold
C) ES is mandated for all banks under Basel II Pillar 1
D) ES ignores extreme tail events, making it more stable over time

7. A bank is assessing ‘green finance’ risk. A corporate borrower heavily dependent on coal mining is subject to which specific type of climate risk that could impair loan repayment?

A) Physical risk from increased flood frequency
B) Transition risk from carbon taxes, regulatory phase-outs of coal, and stranded asset risk making the business model unviable
C) Operational risk from climate change
D) Counterparty risk from climate-sensitive insurers

8. Under the Basel Standardized Approach for operational risk capital (pre-SMA), the ‘Alternative Standardized Approach (ASA)’ was specifically designed for banks where:

A) Gross income is not a good indicator of operational risk in retail banking and commercial banking activities
B) The bank has more than $1 billion in total assets
C) The bank operates in more than 3 jurisdictions
D) The bank’s trading income exceeds 50% of gross income

9. In the context of credit risk, ‘recovery rate’ in bond markets is empirically found to be:

A) Positively correlated with default rates — when more companies default, recovery rates are high
B) Negatively correlated with default rates — when default rates rise (economic downturns), recovery rates tend to fall simultaneously
C) Completely independent of default rates
D) Perfectly stable at 40% across all asset classes and economic cycles

10. Under RBI’s Master Circular on Exposure Norms, the concept of ‘deemed advance’ includes:

A) Only direct term loans and working capital facilities
B) Guarantees, letters of credit, co-acceptances, and similar off-balance sheet credit exposures which represent contingent liabilities that may crystallize into actual credit exposures
C) Investment in government securities under HTM category
D) Interbank placements with maturity below 30 days

11. The ‘Term Structure of Interest Rates’ (yield curve) is important for market risk management because:

A) It only affects the pricing of floating rate instruments
B) Changes in the shape and level of the yield curve affect the value of all fixed income instruments, creating non-parallel shift risks including steepening, flattening, and curvature changes that cannot be captured by a single duration measure
C) It is determined solely by central bank policy rates
D) It only matters for instruments with maturity above 10 years

12. The ‘Risk Weighted Assets (RWA)’ density ratio (RWA/Total Assets) of a bank is used as an indicator of:

A) The bank’s overall profitability and efficiency
B) The average riskiness of the bank’s asset portfolio, with lower density suggesting lower risk weight assets (e.g., government bonds) and higher density suggesting riskier assets (e.g., unsecured corporate loans)
C) The bank’s liquidity position relative to total assets
D) The adequacy of the bank’s loan loss provisions

13. ‘Operational resilience’ as a concept emerging in post-COVID banking regulation focuses primarily on:

A) Maintaining minimum capital ratios throughout the business cycle
B) The ability of a bank to prevent, adapt to, respond to, recover from, and learn from operational disruptions to maintain the delivery of critical business services within defined impact tolerances
C) Eliminating all cyber risks through technology investment
D) Ensuring all operational risk events are reported to the regulator within 24 hours

14. In credit risk measurement using the ‘CreditMetrics’ framework, the primary risk metric measured is:

A) The probability of default at the individual obligor level
B) The change in portfolio value (or credit VaR) arising from rating migrations and defaults across all counterparties over a one-year horizon
C) The expected loss on individual loans based on historical LGD
D) The market risk VaR of the bank’s bond trading portfolio

15. Which of the following statements about ‘Tier 2 capital’ under Basel III is CORRECT?

A) Tier 2 capital provides better loss absorption than CET1 capital
B) Tier 2 instruments include subordinated debt with minimum original maturity of 5 years, provisions up to 1.25% of credit RWA, and are subject to amortization in the last 5 years before maturity
C) Tier 2 capital is not subject to any minimum regulatory requirement
D) Tier 2 instruments must be converted to equity on breach of 7% CET1

16. The ‘Internal Loss Multiplier (ILM)’ in the SMA for operational risk capital is designed to:

A) Reduce capital requirements for banks with strong risk management cultures
B) Scale the Business Indicator Component by the bank’s own historical loss experience, incentivizing improvement in loss data collection and operational risk reduction
C) Adjust capital for the size of the bank’s trading operations
D) Reflect macroeconomic conditions in operational risk capital requirements

17. In the context of liquidity risk management, ‘High-Quality Liquid Assets (HQLA)’ under Basel III LCR includes which of the following as a Level 1 asset?

A) Corporate bonds rated AA and above
B) Residential Mortgage-Backed Securities (RMBS)
C) Central bank reserves and marketable securities representing claims on or guaranteed by sovereigns with 0% risk weight
D) Listed equity shares meeting market capitalization criteria

18. A bank observes that its Board-approved risk appetite statement specifies: ‘Maximum tolerable Tier 1 capital depletion from stress scenarios = 200 bps’. This statement is an example of:

A) A qualitative risk appetite statement about risk culture
B) A quantitative risk appetite metric (Key Risk Metric/KRM) that defines a specific, measurable boundary for capital adequacy under stress
C) A Pillar 1 regulatory minimum capital requirement
D) An ICAAP internal capital target

19. Under the ‘Fundamental Review of the Trading Book (FRTB)’, the new Standardized Approach (SA-FRTB) uses:

A) Historical simulation VaR at 99% confidence
B) A sensitivities-based method (SBM) that computes capital charges for delta, vega, and curvature risks using prescribed risk factor shocks, plus residual risk add-on and default risk charge
C) Simple notional-based factors applied to each instrument class
D) Monte Carlo simulation of 10,000 scenarios

20. In credit risk, ‘Specific Wrong Way Risk (SWWR)’ as opposed to ‘General Wrong Way Risk (GWWR)’ arises when:

A) The correlation between counterparty credit quality and general macroeconomic factors is high
B) There is a legal or structural link between the counterparty and the reference entity in a derivative (e.g., a bank has bought CDS protection from an entity that is correlated with or owns the reference entity)
C) Wrong way risk arises only in interest rate derivatives
D) General and specific wrong way risk are identical concepts