Chapter 23: Treasury Risk Management (CAIIB – Paper 2)
1. What is the primary objective of supervising a bank’s treasury?
A. Maximizing speculative profits
B. Reducing customer complaints
C. Ensuring risk management and regulatory compliance
D. Increasing branch-level autonomy
The supervision of treasury activities ensures that all transactions comply with regulatory requirements, internal policies, and risk limits, rather than just pursuing profits.
2. Which of the following is a key responsibility of treasury control functions?
A. Monitoring exposure to market, liquidity, and operational risks
B. Setting branch-level interest rates independently
C. Approving customer loans above regulatory limits
D. Conducting external audits of all bank departments
Treasury control functions are responsible for monitoring all treasury risks such as market, liquidity, and operational risks, ensuring limits are not breached.
3. Which tool is commonly used by banks to supervise treasury operations in real-time?
A. Customer Relationship Management (CRM) system
B. Treasury Management System (TMS)
C. Loan Origination System (LOS)
D. Core Banking Software (CBS) alone
A Treasury Management System (TMS) allows banks to monitor positions, limits, and risks in real-time, ensuring supervision and control of treasury activities.
4. Segregation of duties in treasury management is primarily intended to:
A. Increase profits from trading
B. Improve customer service efficiency
C. Allow treasury managers more discretion
D. Prevent fraud and reduce operational risk
Segregation of duties ensures that initiation, authorization, and recording of transactions are handled by different personnel, minimizing fraud and operational risks.
5. Which of the following is an essential part of treasury risk control?
A. Setting and monitoring risk limits for various positions
B. Directly negotiating loans with large corporate clients
C. Hiring external auditors for branch audits
D. Preparing HR appraisal reports
Risk limits for trading, investment, and liquidity positions are set and monitored by treasury risk control to prevent excessive exposure.
6. Market risk in treasury primarily arises due to changes in:
A. Customer loan defaults
B. Operational errors in branches
C. Interest rates, exchange rates, and security prices
D. Employee turnover
Market risk arises from fluctuations in interest rates, foreign exchange rates, equity prices, and other market variables that affect the value of treasury positions.
7. Value at Risk (VaR) is a common measure used to assess:
A. Credit exposure of borrowers
B. Potential loss in market positions under normal conditions
C. Operational efficiency of treasury staff
D. Regulatory compliance status
VaR quantifies the maximum expected loss in a portfolio over a given period and confidence level due to market risk factors like interest rate and forex changes.
8. Credit risk in the treasury arises when:
A. Counterparties fail to meet their contractual obligations
B. Interest rates fluctuate unexpectedly
C. Securities are mispriced in the market
D. Internal audit identifies gaps
Credit risk occurs when a counterparty or borrower fails to honor their financial obligations, which can include derivative contracts, interbank lending, or securities settlements.
9. Which of the following is a common tool to mitigate credit risk in treasury operations?
A. Increasing trading volume
B. Reducing liquidity reserves
C. Ignoring counterparty ratings
D. Setting counterparty limits and requiring collateral
Banks mitigate credit risk by defining exposure limits per counterparty, assessing creditworthiness, and requiring collateral or guarantees where necessary.
10. Stress testing in treasury risk management is primarily used to:
A. Evaluate employee performance
B. Assess potential losses under extreme but plausible market conditions
C. Determine customer creditworthiness
D. Prepare statutory reports only
Stress testing evaluates how treasury positions would perform under extreme scenarios, such as sudden interest rate hikes, forex shocks, or credit defaults, helping management prepare mitigation strategies.
11. Value at Risk (VaR) provides information about:
A. The maximum expected loss over a specific time period at a given confidence level
B. The average return of a security
C. The total market capitalization of a portfolio
D. The interest earned on deposits
VaR quantifies the potential loss a portfolio could experience over a defined period at a specific confidence level, considering normal market conditions.
12. Which of the following methods is commonly used to calculate VaR?
A. Discounted cash flow method
B. Capital adequacy ratio
C. Historical simulation, variance-covariance, and Monte Carlo simulation
D. Loan-to-value ratio
VaR can be calculated using different approaches: historical simulation (using past data), variance-covariance (based on statistical assumptions), and Monte Carlo simulation (randomized scenario generation).
13. Duration in treasury risk management measures:
A. The time to maturity of a security only
B. The sensitivity of a bond’s price to changes in interest rates
C. The credit rating of a counterparty
D. The historical volatility of a stock
Duration estimates how much a bond’s price will change for a 1% change in interest rates, helping measure interest rate risk exposure.
14. Modified duration differs from Macaulay duration in that it:
A. Ignores coupon payments
B. Measures credit risk only
C. Calculates portfolio VaR
D. Adjusts Macaulay duration to directly estimate price sensitivity to yield changes
Modified duration adjusts the Macaulay duration to provide a direct estimate of how a bond’s price will change in response to changes in yield, making it a practical measure for interest rate risk.
15. Which of the following statements about VaR and Duration is correct?
A. VaR measures potential losses due to market movements, while Duration measures sensitivity to interest rate changes
B. Both VaR and Duration measure only credit risk
C. Duration is used to calculate VaR
D. VaR is irrelevant for treasury operations
VaR and Duration are distinct risk measures: VaR estimates potential portfolio losses under market risk scenarios, while Duration specifically measures interest rate sensitivity of fixed-income securities.
16. Which of the following derivatives is commonly used to hedge against interest rate risk?
A. Equity options
B. Interest rate swaps
C. Foreign currency futures
D. Commodity forwards
Interest rate swaps are commonly used by banks to hedge against fluctuations in interest rates, by exchanging fixed and floating rate cash flows.
17. A forward contract in treasury risk management is primarily used to:
A. Buy or sell commodities at market price
B. Hedge equity portfolio risk
C. Speculate on interest rates only
D. Lock in a future price of an asset or currency to manage market risk
Forward contracts allow a bank to agree today on the purchase or sale of an asset at a future date at a predetermined price, effectively hedging against market price or forex fluctuations.
18. Currency swaps are primarily used by banks to:
A. Increase trading profits from equities
B. Hedge commodity price risk
C. Exchange cash flows in different currencies to manage forex risk
D. Monitor operational risk in branches
Currency swaps help banks and corporates manage foreign exchange risk by exchanging principal and interest payments in different currencies over a specified period.
19. Options are used in treasury risk management because they:
A. Provide the right, but not the obligation, to buy or sell an asset at a predetermined price
B. Are mandatory contracts to exchange assets
C. Do not help in hedging risk
D. Are used only for accounting purposes
Options give the holder the right, without the obligation, to buy or sell an asset at a predetermined price, providing flexibility in hedging market or currency risks.
20. Futures contracts differ from forwards in that they:
A. Are private agreements with no standardization
B. Are standardized, exchange-traded contracts with daily settlement
C. Cannot be used for hedging
D. Are not regulated by exchanges
Futures contracts are standardized and traded on exchanges with daily marking-to-market, unlike forwards which are customized private agreements.
21. A bank has a bond portfolio worth ₹10 crore. The one-day 99% VaR is estimated at ₹25 lakh. What does this VaR signify?
A. The bond portfolio will definitely lose ₹25 lakh tomorrow
B. The total market value of the portfolio is ₹25 lakh
C. There is a 1% chance the portfolio will lose more than ₹25 lakh in one day
D. The interest earned on the portfolio is ₹25 lakh
VaR at 99% confidence means there is only a 1% probability that the portfolio will lose more than ₹25 lakh in one day.
22. A bond has a modified duration of 5 years and a market value of ₹50 lakh. If the interest rate increases by 1%, estimate the approximate loss in portfolio value.
23. A bank holds ₹20 crore in a government bond portfolio. Historical simulation VaR at 95% confidence over 10 days is ₹80 lakh. What is the daily VaR approximately?
A. ₹25.3 lakh
B. ₹80 lakh
C. ₹20 lakh
D. ₹10 lakh
Daily VaR ≈ Total VaR / √(number of days) = ₹80 lakh / √10 ≈ ₹25.3 lakh.
24. A zero-coupon bond has a Macaulay duration of 7 years. If the annual yield increases by 0.5%, what is the approximate percentage price change?
