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Answer: Under the standardized approach, the liquidity horizons of risk factors are incorporated into market risk capital calculations through the risk weights determined by the Basel Committee.
**Correct Answer: A** **Explanation:** A is correct. Liquidity horizons enter the standardized approach of the FRTB in the risk weights set by the Basel Committee. Delta sensitivities are determined by the bank. B is incorrect. Under Basel I and II.5, one-day changes could be scaled to deduce 10-day changes but under FRTB actual past 10-day periods must be used in historical simulation approach. C is incorrect. The standardized approach assumes there are no diversification benefits between risk factors in different risk classes. D is incorrect. Under the historical simulation approach, the liquidity-adjusted ES assigns risk factors to one of five liquidity horizons, and using the cascade approach it is assumed that the behavior of each category of risk factors is independent of the behavior of the other categories. **Section:** Market Risk Measurement and Management **Learning Objective:** Compare the various liquidity horizons proposed by the FRTB for different asset classes and explain how a bank can calculate its expected shortfall using the various horizons. **Reference:** John C. Hull, Risk Management and Financial Institutions 6th Edition (Hoboken, NJ: John Wiley & Sons, 2023). Chapter 18. Fundamental Review of the Trading Book
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A regulatory capital analyst at a large European bank is studying the liquidity horizons specified for different risk factors in the Fundamental Review of the Trading Book (FRTB). The analyst examines how these liquidity horizons are included in and impact the bank's calculations of capital requirements. Which of the following statements is correct?
A
Under the standardized approach, the liquidity horizons of risk factors are incorporated into market risk capital calculations through the risk weights determined by the Basel Committee.
B
When a bank uses the historical simulation approach, the impact of 1-day changes in risk factors are scaled to the liquidity horizon for the risk factor by multiplying by the square root of time.
C
The standardized approach incorporates the diversification benefits between risk factors with different liquidity horizons through the risk weights set by the Basel Committee.
D
The historical simulation approach estimates a liquidity-adjusted ES by assuming a 10-day liquidity horizon for all risk factors, since their behavior will most likely be highly correlated during volatile market conditions.