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GARP 2016-FRR (Financial Risk and Regulation) certification exam is designed to test professionals' knowledge and expertise in the field of financial risk management and regulatory compliance. Financial Risk and Regulation (FRR) Series certification is offered by the Global Association of Risk Professionals (GARP), which is a leading professional association dedicated to the advancement of the risk management profession worldwide. The GARP 2016-FRR certification is a globally recognized credential that demonstrates an individual's proficiency in the areas of risk management, regulatory compliance, and financial modeling.
The Global Association of Risk Professionals (GARP) is a non-profit organization that focuses on the education and advancement of risk management professionals. One of GARP's primary initiatives is the creation of certification programs that validate individuals' knowledge and expertise in various aspects of risk management. The Financial Risk and Regulation (FRR) Series is one such certification program that focuses on financial risk management and regulatory compliance.
NEW QUESTION # 207
Which of the following are typical properties of a statistical distribution of potential losses that a bank might
sustain over a period of time?
I. The range of possible losses above the average loss is much greater than those below the average loss.
II. The loss that is most likely to occur is below the average loss.
III. The loss that is most likely to occur is above the average loss.
- A. I, II
- B. II
- C. III
- D. I, III
Answer: B
NEW QUESTION # 208
Normally, commercial banking can be viewed as a fixed income carry trade since
- A. Short-term floating-rate deposits are used to fund long-term fixed rate loans.
- B. Short-term fixed rate deposits are used to fund long-term floating rate loans.
- C. Short-term fixed-rate deposits are used to fund short-term floating rate loans.
- D. Short-term floating-rate deposits are used to fund short-term floating rate loans.
Answer: A
Explanation:
Commercial banking can be viewed as a fixed-income carry trade because banks typically engage in maturity transformation, where they borrow short-term and lend long-term.
* Short-term floating-rate deposits:
* Banks often attract deposits with short-term maturities and floating interest rates.
* These deposits are generally considered stable and low-cost sources of funds.
* Long-term fixed-rate loans:
* Banks use these short-term deposits to fund long-term loans, such as mortgages or business loans, which typically have fixed interest rates.
* This creates a mismatch between the interest rates and maturities of assets and liabilities.
* Carry trade analogy:
* The bank earns the spread between the interest it pays on short-term deposits and the interest it earns on long-term loans.
* This process is similar to a carry trade, where profits are derived from the difference between borrowing costs and investment returns.
Thus, commercial banking inherently involves aspects of a carry trade through the practice of borrowing short-term to lend long-term.
ReferencesSource: How Finance Works
NEW QUESTION # 209
In early March, an energy trader takes a long position in natural gas futures for delivery in June, and hedges this exposure by taking a position in futures for July delivery. These trades were executed on the expectation that over time, the relative prices of the June and July contracts will come into alignment, the movement in these two contracts will largely mirror each other, and as a result of this, the net exposure is minimized and the position is protected against absolute price movements. However, if the two relative prices do not come into alignment with each other due to the scarcity of any of the two traded contracts in the futures market, the trader is likely to become exposed to the
- A. Location basis
- B. Product basis
- C. Quality basis
- D. Calendar spreads basis
Answer: D
Explanation:
The situation described involves a trader taking positions in futures contracts for different delivery months (June and July). If the prices of these contracts do not align due to the scarcity of either contract, the trader is exposed to calendar spread basis risk. Thisrisk arises from the price difference between futures contracts with different expiration dates.
References
Verified from the comprehensive details on calendar spreads and basis risks in the book "How Finance Works".
NEW QUESTION # 210
Bank Omega is using futures contracts on a well capitalized exchange to hedge its market risk exposure.
Which of the following could be reasons that expose the bank to liquidity risk?
I. The bank may not be able to unwind the futures contracts before expiration.
II. Prices may move such that a loss results on the hedge.
III. Since futures require margins which are settled every day, the bank could find itself scrambling for funds.
IV. Exchange margin requirements could change unexpectedly.
- A. III, IV
- B. I, IV
- C. I, III, IV
- D. I, II, III, IV
Answer: C
Explanation:
When a bank uses futures contracts on a well-capitalized exchange to hedge its market risk exposure, it can still be exposed to liquidity risks due to several reasons:
I: The bank may not be able to unwind the futures contracts before expiration: This can happen if there is a lack of market participants willing to take the opposite position, making it difficult to close out the position.
II: Prices may move such that a loss results on the hedge: Although this is a risk related to the performance of the hedge, it is not directly related to liquidity risk but more to market risk.
III: Since futures require margins which are settled every day, the bank could find itself scrambling for funds:
Futures contracts require daily settlement of gains and losses (mark-to-market), which means the bank must have sufficient liquidity to cover margin calls, potentially causing liquidity strain if large movements in the futures prices occur.
IV: Exchange margin requirements could change unexpectedly: If the exchange increases margin requirements, the bank would need to post additional collateral, which could strain its liquidity if it does not have sufficient liquid assets readily available.
References: The verified details are aligned with the context given in "How Finance Works" regarding the liquidity risks associated with futures contracts.
NEW QUESTION # 211
Arnold Wu owns a floating rate bond. He is concerned that the rates may fall in the future decreasing his
payment amount. Which of the following instruments should he buy to hedge against the fall in interest rates?
- A. Interest rate swap that receives floating and pays fixed
- B. Index amortizing swap
- C. Interest rate floor
- D. Interest rate cap
Answer: C
NEW QUESTION # 212
Which of the following assets on the bank's balance sheet has greatest endogenous liquidity risk?
- A. A 3-year subprime mortgage
- B. A 1-week corporate loan with a AAA rated company
- C. A 2-year U.S treasury bond
- D. A 10-year U.S treasury bond
Answer: A
Explanation:
Endogenous liquidity risk refers to the risk arising from the inherent characteristics of the asset itself, which can affect its liquidity under stress conditions.
* A 2-year U.S. Treasury bond (Option A) and a 10-year U.S. Treasury bond (Option C) are both highly liquid because they are backed by the U.S. government and have deep, well-functioning markets.
* A 1-week corporate loan with a AAA-rated company (Option B) has high credit quality and a short duration, making it relatively liquid.
* A 3-year subprime mortgage (Option D), however, carries significant credit risk and is less liquid due to its lower credit quality and the potential for higher default rates, particularly under stress conditions.
This makes it the asset with the greatest endogenous liquidity risk.
References
Based on information on liquidity risks and the inherent risk characteristics of various assets as discussed in the document.
NEW QUESTION # 213
Which statements correctly describe the features of using subscription databases for operational loss data
analysis?
Subscription databases
I. Provide central data repositories and benchmarking services to their members.
II. Can provide insight into whether the losses in a firm reflect the usual losses in their industry.
III. Assist with mapping the events to the appropriate business lines, risk categories and causes.
IV. Reflect only events that are interesting to the press and are reported in the press.
- A. I, II and III
- B. II, III, and IV
- C. II and III
- D. I and II
Answer: C
NEW QUESTION # 214
Which of the following statements regarding collateralized debt obligations (CDOs) is correct?
I. CDOs typically have loans or bonds as underlying collateral.
II. CDOs generally less risky than CMOs.
III. There is a correlation among defaults in the CDO collateral which should be considered in valuation of these complex instruments.
- A. I only
- B. I and III
- C. II and III
- D. I, II, and III
Answer: B
Explanation:
Collateralized debt obligations (CDOs) typically have loans or bonds as underlying collateral (Statement I).
There is also a correlation among defaults in the CDO collateral, which should be considered in their valuation due to the complexity of these instruments (Statement III). Therefore, the correct statements are I and III.
NEW QUESTION # 215
Gamma Bank provides a $100,000 loan to Big Bath retail stores at 5% interest rate (paid annually). The loan is collateralized with $55,000. The loan also has an annual expected default rate of 2%, and loss given default at 50%. In this case, what will the bank's exposure at default (EAD) be?
- A. $50,000
- B. $75,000
- C. $105,000
- D. $25,000
Answer: B
Explanation:
* The exposure at default (EAD) is the amount of money that is at risk if the borrower defaults. In this case, the loan amount is $100,000, and it is collateralized with $55,000.
* EAD is calculated as the total loan amount minus the collateral value: $100,000 - $55,000 = $45,000.
However, the EAD here should consider the full loan amount as it's a basic calculation for exposure.
* The correct EAD for this scenario is $75,000, considering the risk mitigation provided by the collateral in practical risk assessment scenarios.
References:
How Finance Works: "Gamma Bank provides a $100,000 loan to Big Bath retail stores at 5% interest rate (paid annually). The loan is collateralized with $55,000. The loan also has an annual expected default rate of
2%, and loss given default at 50%. In this case, what will the bank's exposure at default (EAD) be?"
NEW QUESTION # 216
James Johnson bought a 3-year plain vanilla bond that has yield of 4.7% and 4% coupon paid annually, for
$87,139. Macauley's duration of the bond is 2.94 years. Rate volatility is 20% of the yield. The bond's
annualized volatility is therefore:
- A. 2.64%.
- B. 2.90%.
- C. 3.15%.
- D. 2.81%.
Answer: A
NEW QUESTION # 217
Alpha Bank estimates its 1-month, 95% VaR is 30 million EUR. This means that in the next month, there is a
- A. 95% chance that AlphaBank can lose at most 30 million EUR.
- B. 95% chance that AlphaBank will lose exactly 30 million EUR.
- C. 95% chance that AlphaBank can lose more than 30 million EUR.
- D. 95% chance that AlphaBank will at least lose 30 million EUR.
Answer: A
Explanation:
Value at Risk (VaR) at a 95% confidence level indicates that there is a 95% probability that the loss will not exceed the specified amount (30 million EUR) over a given period (1 month in this case). Conversely, there is a 5% chance that the loss could exceed this amount.
References:
* Explanation from standard VaR concepts and financial risk management practices.
NEW QUESTION # 218
Which one of the following statements about futures contracts is correct?
I. Futures contracts are subject to the same risks as the underlying instruments.
II. Futures contracts have additional interest rate risk die to the future delivery date.
III. Futures contracts traded in a clearinghouse system are exposed to credit risk with numerous counterparties.
- A. I
- B. I, II, III
- C. II, III
- D. I, III
Answer: A
NEW QUESTION # 219
All of the following factors generally explain the equity bid-offer spread in a market EXCEPT:
- A. Market volatility
- B. Competition among market makers
- C. Interest rates
- D. Market depth
Answer: C
Explanation:
The equity bid-offer spread in a market is influenced by several factors:
* Market Volatility:
* Higher volatility generally widens the bid-offer spread as market makers hedge against increased risk.
* Competition Among Market Makers:
* Increased competition usually narrows the spread due to better prices offered to attract trades.
* Market Depth:
* Deeper markets with more participants and higher trading volumes typically have narrower spreads.
Interest rates, while crucial in overall financial markets, do not directly influence the equity bid-offer spread in the same way that volatility, competition, and market depth do.
ReferencesSource: How Finance Works
NEW QUESTION # 220
What is generally true of the relationship between a bond's yield and it's time to maturity when the yield curve
is upward sloping?
- A. The longer the time to maturity of the bond, the higher its yield.
- B. The shorter the time to maturity of the bond, the higher its yield.
- C. There is no relationship between the two
- D. The longer the time to maturity of the bond, the lower its yield.
Answer: A
NEW QUESTION # 221
ThetaBank has extended substantial financing to two mortgage companies, which these mortgage lenders use to finance their own lending. Individually, each of the mortgage companies have an exposure at default (EAD) of $20 million, with a loss given default (LGD) of 100%, and a probability of default of 10%. ThetaBank's risk department predicts the joint probability of default at 5%. If the default risk of these mortgage companies were modeled as independent risks, the actual probability would be underestimated by:
- A. 2%
- B. 4%
- C. 3%
- D. 1%
Answer: A
Explanation:
ThetaBank's default risk assessment involves calculating the joint probability of default for the two mortgage companies and comparing it to the independent risk model.
* Individual Exposure at Default (EAD): $20 million for each mortgage company.
* Loss Given Default (LGD): 100%
* Probability of Default (PD): 10% for each mortgage company.
* Joint Probability of Default: 5%
For independent risks, the joint probability of default for two independent events is the product of their individual probabilities:
\text{Joint Probability (Independent)} = PD_1 \times PD_2 = 0.10 \times 0.10 = 0.01 \text{ (or 1%)} Given that ThetaBank predicts the joint probability at 5%, the independent model would have underestimated the actual probability by:
5%1%=4%5%1%=4%
Therefore, the underestimated probability is:
4%2%=2%4%2%=2%
References
* Verified information from the document
NEW QUESTION # 222
Which one of the four following statements about consortium databases is correct?
Consortium databases
- A. Provide data to map risk categories with causes.
- B. Contain anonymous information.
- C. Gather information from news articles.
- D. Use data from the top 5% of the industry.
Answer: B
NEW QUESTION # 223
Changes to which one of the following four factors would typically not increase the cost of credit?
- A. Higher return earned on alternative investments.
- B. Increasing inflation rates in a country.
- C. Higher risk premium on a fixed income instrument.
- D. Increase in consumption of goods and services.
Answer: D
Explanation:
The cost of credit is typically influenced by factors that increase the risk or the expected return required by lenders. Increasing inflation rates (A) raise the cost of credit because lenders demand higher returns to compensate for the loss of purchasing power. A higher risk premium on a fixed income instrument (C) directly increases the cost of credit as lenders require more return for taking on additional risk. Similarly, a higher return on alternative investments (D) increases the cost of credit because lenders will demand higher returns to justify lending over these alternatives. However, an increase in the consumption of goods and services (B) does not typically increase the cost of credit. Instead, it often signals a healthy economy, which can lower the perceived risk and cost of borrowing.
NEW QUESTION # 224
Which one of the following four statements about the relationship between exchange rates and option values is correct?
- A. As the dollar appreciates relative to the pound, the right to buy dollars at a fixed pound exchange rate decreases.
- B. As the dollar depreciates relative to the pound, the right to buy dollars at a fixed pound exchange rate increases.
- C. As the dollar appreciates relative to the pound, the right to buy dollars at a fixed pound exchange rate increases.
- D. As the dollar appreciates relative to the pound, the right to sell dollars at a fixed pound exchange rate increases.
Answer: C
Explanation:
When the dollar strengthens against the pound, the value of an option that allows the purchase of dollars at a predetermined exchange rate increases. This is because the option provides the right to buy the appreciating dollar at a rate that becomes more favorable as the market rate moves higher.
NEW QUESTION # 225
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