Current Issues in Financial Markets

• Topic 01

  Climate and Financial Risk

  46 questions
• Topic 02

  Digital Assets and Crypto Risk

  74 questions
• Topic 03

  Artificial Intelligence in Risk Management

  45 questions
• Topic 04

  Geopolitical Risk and Financial Markets

  81 questions
• Topic 05

  Systemic Risk and Macroprudential Policy

  67 questions
• Topic 06

  Emerging Regulatory Topics

  103 questions

A few questions from this unit, with the answer and a full explanation. The complete bank is available when you start practising.

1. Asset-liability mismatch in the context of the 2023 Silicon Valley Bank failure involved which specific combination of risks?

   • A
     SVB's failure was due to derivatives mismatches: it had sold interest rate swaps that increased in value when rates rose, creating margin calls it could not meet
   • B
     SVB's mismatch was a leverage problem: it operated at 30x leverage, and a 3% fall in asset values wiped out its equity, triggering a regulatory capital breach and closure
   • C
     SVB funded long-duration Treasury and MBS portfolios (with high interest rate sensitivity) using highly concentrated, largely uninsured institutional deposits (which were volatile and flight-prone)
     Correct answer
   • D
     SVB's mismatch was a credit risk problem: it held low-quality loans to venture-backed startups funded by stable retail deposits, and credit losses on the loan book caused deposit withdrawal
   Explanation

   SVB's asset-liability mismatch was an extreme case of the classic banking mismatch: long-duration assets funded by short-duration volatile liabilities. SVB had accumulated a large portfolio of held-to-maturity US Treasuries and agency MBS with long durations (approximately 5–6 years average weighted) — when purchased at low 2020–2021 rates, these carried significant interest rate risk. SVB's funding was approximately 94% in uninsured deposits (above the FDIC USD 250,000 limit), heavily concentrated in the venture capital/tech startup ecosystem — a highly correlated, sophisticated investor base that could coordinate and withdraw rapidly. When SVB announced a capital raise (needed partly to crystallise losses on the bond portfolio), social media and VC networks coordinated rapid withdrawal, triggering a classic bank run. The standard DFAST stress scenarios did not specifically model the combination of unrealised bond losses and concentrated uninsured deposit bases that drove SVB's failure.

2. What is the distinction between sovereign risk and political risk for cross-border investors?

   • A
     Sovereign risk is the risk of government debt default; political risk is broader, encompassing expropriation, capital controls, and political violence even if the sovereign remains solvent
     Correct answer
   • B
     Sovereign risk is insurable through MIGA; political risk can only be mitigated through financial derivatives
   • C
     Sovereign risk affects government bonds only; political risk affects only equity investments in state-owned enterprises
   • D
     Sovereign risk arises only in emerging markets; political risk can arise in developed markets
   Explanation

   Sovereign risk specifically refers to the risk that a government defaults on its debt obligations. Political risk is broader — it encompasses any political event causing financial loss to foreign investors, including expropriation of assets, currency inconvertibility (capital controls preventing repatriation), political violence, and regulatory changes that destroy investment value, even when the sovereign remains financially solvent. An investor can suffer political risk losses in a country that is not in sovereign default.

3. During the COVID-19 market shock of March 2020, how did Bitcoin's correlation with risk assets behave, and what does this imply about crypto's diversification properties?

   • A
     Bitcoin's correlation with equities remained stable at its pre-COVID level of approximately 0.1, demonstrating the robustness of its diversification properties across market regimes
   • B
     Bitcoin's correlation with equities was irrelevant in March 2020 because the crypto market was not yet large enough to exhibit systematic co-movement with traditional assets
   • C
     Bitcoin's correlation with equities fell sharply in March 2020, confirming that crypto functions as a safe-haven asset uncorrelated with traditional financial markets during crises
   • D
     Bitcoin's correlation with equities rose sharply during the stress event — it sold off alongside risk assets, demonstrating that crypto's diversification benefit is smallest when most needed
     Correct answer
   Explanation

   In March 2020, Bitcoin sold off sharply alongside equities as investors liquidated assets to meet margin calls and raise cash. Correlation with equity indices rose well above normal levels. This is a common pattern in financial stress events: assets that appear uncorrelated under normal conditions become correlated as investors reduce all risk exposures simultaneously. This 'correlation crisis' property is a well-documented feature of crypto assets and is relevant to any portfolio manager considering crypto for diversification. The diversification benefit evaporates precisely when it is most valuable.