IAI Actuarial Core Principles · Business Economics · Role, structure and stability of the financial system
Which of the following best describes systemic risk in a financial system?
Systemic risk is the danger that trouble at one financial institution or market spreads through links such as counterparty exposures, shared assets and loss of confidence, damaging the wider financial system rather than staying a purely firm-specific problem.
- AThe risk that a single firm's investments earn lower returns than the market average
- BThe risk that the failure or distress of one institution or market spreads through linkages and impairs the functioning of the wider financial systemCorrect
- CThe risk that interest rates rise faster than inflation over a long period
- DThe risk that a borrower defaults on one specific loan because of its own poor management
- The risk that a currency depreciates against a trading partner's currency
Explanation
Systemic risk is about contagion: distress at one institution or market is transmitted to others through counterparty exposures, common asset holdings and confidence effects, threatening the whole system. Option 0 and option 3 describe firm-specific risks, which can be diversified and do not spread. Options 2 and 4 describe macroeconomic price risks, not contagion.
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