Association of Corporate Treasurers (ACT) Qualifications Financial Risk Management Syllabus

Financial Risk Management syllabus — full chapter and topic list

Expand any chapter to see its topics and sub-topics. This is the whole examinable outline for Financial Risk Management in Association of Corporate Treasurers (ACT) Qualifications, not a summary of it.

1. 1

   Risk Management Framework

   4 topics

   • The treasury risk universe
     • Market, credit, liquidity and operational risk
     • Interrelationships between risk types
   • Risk management process
     • Identify, assess, respond and monitor
     • Risk appetite, tolerance and limits
   • Risk measurement concepts
     • Sensitivity, volatility and Value at Risk
     • Stress testing and scenario analysis
   • Risk reporting and oversight
     • Risk dashboards and limit monitoring
     • Escalation and breach management
2. 2

   Foreign Exchange Risk

   4 topics

   • Types of FX exposure
     • Transaction, translation and economic exposure
     • Exposure identification and netting
   • FX hedging instruments
     • Forwards, futures and FX swaps
     • Currency options and structured products
   • FX pricing and parity relationships
     • Spot, forward points and interest rate parity
     • Purchasing power parity and the international Fisher effect
   • FX hedging strategy and policy
     • Hedge ratios, layering and rolling hedges
     • Natural hedging and operational responses
3. 3

   Interest Rate Risk

   4 topics

   • Sources and measurement of interest rate risk
     • Repricing, fixed vs. floating mix and basis risk
     • Gap analysis and duration of liabilities
   • Interest rate hedging instruments
     • Interest rate swaps and forward rate agreements
     • Caps, floors and collars
   • Benchmark reform
     • Transition from LIBOR to risk-free rates
     • SONIA, SOFR and compounded-in-arrears conventions
   • Interest rate risk policy and strategy
4. 4

   Commodity, Credit and Counterparty Risk

   4 topics

   • Commodity price risk
     • Direct and indirect commodity exposures
     • Commodity hedging instruments and proxy hedging
   • Counterparty credit risk
     • Credit limits, exposure measurement and CVA
     • Collateral, CSAs and central clearing
   • Customer and supplier credit risk
     • Credit assessment and trade credit insurance
   • Country and political risk
5. 5

   Derivatives and Hedge Accounting

   4 topics

   • Derivative instruments and pricing
     • Linear vs. non-linear payoffs
     • Option pricing drivers and the Greeks
   • Hedge accounting under IFRS 9
     • Fair value, cash flow and net investment hedges
     • Hedge effectiveness and documentation requirements
   • Derivatives regulation
     • EMIR/UK EMIR reporting and clearing obligations
     • Margining and collateral requirements
   • Mark-to-market, valuation and credit valuation adjustments

Financial Risk Management flashcards for Association of Corporate Treasurers (ACT) Qualifications

18 of 67 cards from the Financial Risk Management deck — real questions with worked answers.

1. What are the main categories of the treasury risk universe?

   Financial risks (liquidity, funding, market — FX/interest rate/commodity, and credit/counterparty) plus operational risk. Market risk covers price movements; credit risk covers counterparty default; liquidity risk covers inability to meet obligations; operational risk covers failures in people, processes and systems.

2. Distinguish between market risk, credit risk, liquidity risk and operational risk.

   Market risk: loss from adverse moves in market prices (FX, rates, commodities). Credit risk: loss from a counterparty failing to meet obligations. Liquidity risk: inability to meet cash obligations when due (funding) or to trade without moving price (market liquidity). Operational risk: loss from inadequate/failed internal processes, people, systems or external events.

3. What are the four classic stages of the risk management process?

   1) Identify risks; 2) Assess/measure (likelihood and impact); 3) Evaluate and decide a response; 4) Monitor and report. The four response choices are often summarised as the 4 Ts: Tolerate (accept/retain), Treat (mitigate/hedge), Transfer (insure/outsource), Terminate (avoid).

4. What are the '4 Ts' of risk response?

   Tolerate (accept and retain the risk), Treat (reduce/control or hedge it), Transfer (shift to a third party via insurance, derivatives or outsourcing), and Terminate (avoid the activity altogether).

5. Define risk appetite versus risk tolerance.

   Risk appetite is the amount and type of risk an organisation is willing to seek or accept in pursuit of its objectives (a board-set, strategic statement). Risk tolerance is the specific, often quantified, acceptable variation around objectives — the operational limits within the appetite.

6. What is Value at Risk (VaR)?

   VaR is the maximum expected loss on a position or portfolio over a given time horizon at a specified confidence level, under normal market conditions. E.g. a 1-day 95% VaR of \$1m means there is a 5% chance of losing more than \$1m in one day.

7. State the parametric (variance–covariance) VaR formula for a single position.

   $$\text{VaR} = z_{\alpha} \times \sigma \times V \times \sqrt{t}$$ where $z_{\alpha}$ is the z-score for the confidence level (e.g. $1.645$ at 95%, $2.326$ at 99%), $\sigma$ is the (per-period) volatility of returns, $V$ is the position value and $t$ is the holding period.

8. How do you scale VaR from a 1-day horizon to an N-day horizon?

   Multiply by the square root of time: $$\text{VaR}_{N} = \text{VaR}_{1} \times \sqrt{N}$$ This assumes returns are independent and identically distributed with zero autocorrelation.

9. What are the three main methods of calculating VaR?

   1) Parametric / variance–covariance (assumes normal distribution); 2) Historical simulation (re-prices the portfolio using actual past returns); 3) Monte Carlo simulation (generates many random scenarios from a statistical model).

10. What is Expected Shortfall (Conditional VaR) and why is it used?

    Expected Shortfall (ES/CVaR) is the average loss given that the loss exceeds the VaR threshold — it measures the severity of tail losses. It is preferred over VaR because it is a coherent (sub-additive) risk measure and captures tail risk that VaR ignores.

11. Name two key limitations of VaR.

    It says nothing about the size of losses beyond the confidence level (tail risk); it typically assumes normally distributed returns and stable correlations, which break down in crises; and it is not sub-additive, so it can understate diversified portfolio risk. Stress testing and ES are used to supplement it.

12. What is the purpose of stress testing and scenario analysis?

    To estimate the impact of extreme but plausible events that fall outside normal VaR assumptions. Scenario analysis applies specific hypothetical or historical event sets; stress testing flexes key variables (rates, FX, prices) to severe levels to reveal vulnerabilities and tail exposures.

13. What is the role of the 'three lines of defence' model in risk oversight?

    1st line: operational management who own and manage risk; 2nd line: risk and compliance functions that set policy, monitor and challenge; 3rd line: internal audit providing independent assurance. It clarifies accountability for risk management and control.

14. What key elements should a treasury risk report contain?

    Exposures by risk type, against approved limits and policy; hedge positions and hedge ratios; mark-to-market valuations; VaR/sensitivity measures; limit utilisation and any breaches; counterparty exposures; and forward-looking commentary. Reports should be timely, accurate, clear and aimed at the relevant audience (board, ALCO, treasury).

15. Define the three types of FX exposure.

    Transaction exposure: cash-flow risk on committed/forecast foreign-currency transactions. Translation (accounting) exposure: risk to consolidated balance sheet/P&L from retranslating foreign subsidiaries. Economic (operating) exposure: longer-term effect of FX moves on competitiveness, cash flows and value, including indirect/competitive effects.

16. What is transaction exposure and over what period does it arise?

    Transaction exposure is the risk that the home-currency value of a contracted or highly probable foreign-currency cash flow changes between the transaction date and settlement date. It runs from the moment the exposure is committed (or forecast) until the cash is actually exchanged.

17. What is translation (accounting) exposure?

    The risk that retranslating the assets, liabilities and results of foreign operations into the group reporting currency changes reported equity/earnings. It is an accounting (non-cash) exposure; many firms hedge it selectively, e.g. via net investment hedges of foreign subsidiaries.

18. What is economic exposure and why is it the hardest to hedge?

    Economic (operating) exposure is the impact of exchange-rate changes on the present value of future cash flows and competitive position, including currencies in which a firm does not directly transact. It is hard to hedge because it is long-term, uncertain in timing/amount, and depends on competitor and market responses; it is usually managed operationally (diversification, pricing, sourcing).

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