CRM 301: Chapter 4

Sixth National Bank stores all of its financial records in an electronic data base. Sixth National customers are able to access their accounts on-line with a user identification number and password. Last weekend, a computer hacker was able to breach the firewall of the electronic data base and gain access to customer account data. This operational risk for Sixth National Bank is

A systems risk

An insurer can eliminate interest rate risk through which one of the following?

Cash matching

Determining earnings-at-risk (EaR) entails modeling the influence of factors such as

Changes in the prices of products and production costs on an organization's earnings

The Basel I capital requirements differ from capital-to-assets ratios used prior to 2003 by

Considering the relative risk of the assets

Which one of the following statements is true if earnings at risk are $200,000 with 90% confidence?

Earnings at risk are projected to be less than $200,000 10% of the time

The level of capital required to provide a cushion against unexpected loss of economic value at a financial institution is known as

Risk capital

Which one of the following organizations would most likely be able to compete effectively during financial crises?

An organization with large cash reserves

Which one of the following types of organization would most likely be affected by commodity price risk?

A manufacturer

The market value surplus of an insurer is equal to the fair value of assets minus the present value of liabilities plus the market value margin. The market value margin is

An additional payment in case the reserves are inadequate

The process of comparing the key risk indicators of an organization with those of other organizations in the same industry is known as

Benchmarking

Insurance Company monitors key indicators of underwriting effectiveness. Some indicators they monitor include: percentage of business quoted that was written, application processing time, premium volume handled by underwriters, skill level of underwriters, and benchmarking between different underwriting offices. The indicators of underwriting performance Insurance Company uses are called

Control indicators

Which one of the following types of financial risk has only negative potential?

Credit risk

Market value surplus (MVS) of an insurer =

Fair value of assets - Fair value of liabilities

Basel I and Basel II prescribe capital requirements for

Financial insititutions

Most organizations face some market risk, credit risk, and/or price risk. Collectively, these risks are called

Financial risks

A significant difference between the Basel I regulatory capital requirements and the Basel II regulatory capital requirements is that Basel II

Includes a capital requirement for operational risk that Basel I does not include

In determining economic capital for insurers, various risks are quantified. One such risk is the potential for adverse loss experience or catastrophic losses. This risk is known as

Insurance risk

Which one of the following was considered a weakness of the Basel I methodology?

It did not sufficiently account for systemic risk

There are numerous advantages associated with economic capital analysis. One of these advantages is that

It focuses attention on the risks attached to each of an organization's activites

Which one of the following is a benefit of the conditional value at risk (CVaR) method?

It takes into account the extremely large losses that may occur

Value at risk (VaR) is a method of determining the probability of loss on an investment portfolio over a certain time horizon. The VaR method includes which one of the following assumptions?

No trading in the portfolio

Which one of the following statements is true regarding operational risk?

Operational risk is integrated in every activity of an organization

Risk indicators such as experience and authority levels apply to which one of the following operational risk classes?

People

Which one of the following categories of operational risk includes many risks which are hazard risks or other forms of insurable risk?

People

Fair value accounting uses the term market value surplus (MVS) for an organization's net worth. Which one of the following is the term used for an insurer's net worth under statutory accounting principles (SAP)?

Policyholders' surplus

U.S. Petroleum Company would like to purchase oil drilling rights in another nation. That nation, however, is run by a dictator who last year confiscated another foreign company's oil equipment. U.S. Petroleum decided to enter the country through a joint venture with the dictator's brother who heads a small oil company. By entering the foreign nation through a joint venture, U.S. Petroleum was addressing which risk?

Political risk

Chuck is Vice President of Claims for Insurance Company. The company has 37 adjusters in the field, and needs to hire four new adjusters. Chuck is curious about the relationship between prior experience of the adjuster and policy owner complaints. He collected data on the number of complaints for each adjuster on staff over time. The he used a statistical technique to analyze the relationship between adjuster experience and complaints, and the trend of the relationship over time. The statistical analysis confirmed that that there were significantly fewer complaints with more experienced adjusters, and that the relationship grew stronger with more years of experience. The technique Chuck used to relate indicators to outcomes is called

Regression analysis

One category of operational risk that a business must manage is risk associated with people. One of the strategies to mitigate people's risk is to use care when hiring employees. This strategy employs background checks, pre-employment tests, and checking references. This strategy is

Selection

Which one of the following statements is true regarding strategic risks?

Strategic risks are external to an organization

Economic capital is defined as

The amount of capital required to maintain solvency at a given risk tolerance level

Risk that is common to all securities of the same of the same general class and cannot be eliminated through diversification is called

Systematic risk

Which one of the following commonly used categories of operational risk includes risks associated with technology and equipment?

Systems

Risk managers can have a hard time valuing which one of the following types of property due to the unique features of each tract?

Unimproved land

The financial crisis of 2008 highlighted the leverage of many global financial institutions and lead regulators to focus on risk-based capital. Leverage refers to

Using borrowed money to invest

Management of LNM Insurance Company is considering investing in the Stability-Growth Mutual Fund; however they are concerned about the volatility of the investment. The fund's manager said that on any given day, there is a 5% probability of losing more than 3% of the investment's worth. The statisic quoted by the fund manger is a

Value-at-risk

Which one of the following statements is true regarding key risk indicators (KRIs)?

A KRI must be leading, rather than lagging, to be effective

Pacific Pine is a forest products company based in the state of Washington. Pacific Pine harvests timber on six large tracts of land they own. Most of the wood harvested is shipped to countries in the Pacific Rim. A key economic risk that Pacific Pine faces is that one or more of the Pacific Rim countries will impose a fee on imported wood to protect domestic lumber companies. Such a fee is called

A tariff

A vitamin manufacturer has decided to dedicate research funding to developing products for senior citizens rather than infants. The manufacturer is responding to which one of the following types of strategic risk?

Demographics

One strategic risk confronting organizations is changes in the statistical characteristics of human populations. Increasing longevity may make it difficult for a company to pay post-retirement health care benefits and pension benefits, and decreasing fertility rates may reduce sales for baby-products companies. This strategic risk called

Demographics

A disadvantage of value-at-risk (VaR) is that VaR

Does not accurately measure the extent to which a loss might exceed the threshold

Insurance companies use a number of measures to track their operating performance. One measure employed compares the amount the insurer has paid in losses to the premiums it has earned. This measure is the insurer's

Loss ratio

An insurer's fair value is complicated because no ready market exists for trading in insurers. To calculate the fair value of an insurer's reserves, a present value discount is used and a

Market value margin is added

One category of operational risk includes procedures and practices organizations use to conduct their business activities. This category is

Process risk

When interest rates were high, Protection First Insurance Company purchased a $1,000 corporate bond that will pay $80 in interest annually until in matures in 15 years. Based on the purchase price, this bond will provide Protection First a 10% annual rate of return if the insurer holds the bond until it matures. Six years after the bond was purchased, interest rates had declined significantly. Although the bond still pays $80 in interest annually, Protection First can no longer earn a 10% rate of return on the periodic interest payments. This risk is called

Reinvestment risk

Economic capital models the potential variability in a firm's market assets and liabilities, taking into consideration all of the firm's risks. These risks are considered together to estimate at the firm-level the probability that a firm's liabilities may exceed assets by specified levels over a one-year period. This probability measure is based on a concept

Value at risk