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Passing the GARP 2016-FRR Exam is an important milestone for any financial risk professional. It not only demonstrates a thorough understanding of the topics covered on the exam but also shows a commitment to professional development and ongoing learning. In addition, earning the FRR certification can open doors to new opportunities and career advancement within the financial risk industry. Employers value this certification because it indicates that an individual has the knowledge and skills necessary to manage risk effectively.
NEW QUESTION # 171
Which one of the following four statements regarding bank's exposure to credit and default risk is INCORRECT?
- A. Default risk cannot be hedged away fully, and it will always exist for the holder of the credit or for the person insuring against the credit or default event.
- B. The more the bank diversifies its credit portfolio, the better spread its credit risks become.
- C. In debt management, the value of any loan exposure will change typically in a fashion similar the same way that an equity investment can.
- D. In debt management, the goal is to minimize the effect of any defaults.
Answer: C
Explanation:
* While diversifying a bank's credit portfolio helps spread out credit risks, the goal in debt management is to minimize the impact of defaults, and default risk cannot be fully hedged away, meaning it will always exist for the credit holder or the person insuring against it.
* However, it is incorrect to state that the value of loan exposure changes similarly to equity investments.
Loan exposures are generally less volatile compared to equities, and their value is typically more stable.
References:
* How Finance Works: "Debt management aims to minimize the effect of any defaults and while diversifying the credit portfolio helps, default risk cannot be fully hedged away." .
NEW QUESTION # 172
The skewness of ABC company's stock returns equal -1.5. What is the correct interpretation of this?
- A. It indicates higher relative probability of extreme events than non-extreme events compared to estimates from a normal distribution.
- B. It indicates higher relative probability of negative returns compared to estimates derived from a normal distribution.
- C. It indicates lower probability of extreme negative events compared to the normal distribution.
- D. It indicates that the returns are indeed normally distributed.
Answer: B
Explanation:
Skewness measures the asymmetry of the return distribution. A negative skewness value, such as -1.5, indicates that the left tail (negative returns) of the distribution is longer or fatter than the right tail (positive returns). This suggests that there is a higher relative probability of observing negative returns compared to what would be expected under a normal distribution, which is symmetric. In this case, the negative skewness implies a higher chance of experiencing extreme negative returns, making option A the correct interpretation.
NEW QUESTION # 173
What is a difference between currency swaps and interest rate swaps?
- A. Currency swaps generate foreign exchange rate risk in addition to interest rate risk.
- B. Currency swaps allow banks and customers to obtain the risk/reward profile of long-term interest rates
without having to use long-term funding. - C. Currency swaps do not require the exchange of notional principal on maturity.
- D. Currency swaps are OTC derivative contracts.
Answer: A
NEW QUESTION # 174
Which one of the following four statements correctly defines chooser options?
- A. These options represent a variation of the plain vanilla option where the underlying asset is a basket of
currencies. - B. These options give the holder the right to exchange one asset for another.
- C. These options pay an amount equal to the power of the value of the underlying asset above the strike
price. - D. The owner of these options decides if the option is a call or put option only when a predetermined date
is reached.
Answer: D
NEW QUESTION # 175
Which one of the following four regulatory drivers for operational risk management includes risk and control requirements for financial statements in the United States?
- A. The Sarbanes-Oxley Act
- B. The Markets in Financial Instruments Directive
- C. Solvency II
- D. Basel II Accord
Answer: A
Explanation:
The Sarbanes-Oxley Act includes risk and control requirements for financial statements in the United States. It mandates strict reforms to improve financial disclosures from corporations and prevent accounting fraud. This Act directly impacts operational risk management by setting standards for all U.S. public company boards, management, and public accounting firms.
NEW QUESTION # 176
A proprietary trading desk for a large bank hedges an Arab light OTC forward position with Brent crude oil forwards. The trading desk benefits from using the most liquid OTC market to hedge, the market for the Brent crude, but hedging its using the Brent contract, exposes itself to the following type of risk:
- A. Term risk
- B. Correlation risk
- C. Seasonality risk
- D. Basis risk
Answer: D
Explanation:
When a proprietary trading desk hedges an Arab light OTC forward position with Brent crude oil forwards, they face basis risk. This is because the underlying commodities (Arab light and Brent crude oil) are different and may not move perfectly in sync, leading to a potential mismatch in the hedge.
References
Verified based on the discussion of basis risk in commodity trading provided in the book "How Finance Works".
NEW QUESTION # 177
The operational risk policy should include:
I. The firm's definition of risk
II. The governance of operational risk including who owns it, what it owns, and how issues should be escalated III. The main activities and elements that are managed by the operational risk function
- A. I, II, III
- B. II, III
- C. I, III
- D. I, II
Answer: A
Explanation:
An operational risk policy should include:
* The firm's definition of risk: Clearly defining what constitutes operational risk for the organization.
* The governance of operational risk including who owns it, what it owns, and how issues should be escalated: Establishing roles and responsibilities for managing operational risk.
* The main activities and elements that are managed by the operational risk function: Outlining the key processes and controls that are in place to manage operational risks.
NEW QUESTION # 178
Bank Muri has $4 million in cash and $5 million in loans coming due tomorrow with an expected default rate
of 1%. The proceeds will be deposited overnight. The bank owes $ 9 million on a securities purchase that
settles in two days and pays off $8 million in commercial paper in three days that is not expected to renew. On
day 2, $1 million in loans is coming in with an expected default rate of 1% and on day 3, $2 million in loans is
coming in with expected default rate of 2%. How much should the bank plan to raise in order to avoid liquidity
problems?
- A. $550 million
- B. $500 million
- C. $508 million
- D. $510 million
Answer: D
NEW QUESTION # 179
A hedge fund trader buys options to establish an exposure in the currency market, thereby effectively
removing the risk of being able to participate in a gapping market. In this case the options premium represents
the price paid for eliminating the execution risk of
- A. The vega-hedging strategy.
- B. The delta-hedging strategy.
- C. The gamma-hedging strategy.
- D. The theta-hedging strategy.
Answer: B
NEW QUESTION # 180
Which of the following factors is included within the Basel definition of operational risk?
- A. Legal risk
- B. Strategic risk
- C. Reputational risk
- D. Pandemic risk
Answer: A
Explanation:
Comprehensive and Detailed In-Depth Explanation:
Basel II defines operational risk as "the risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events," explicitly including legal risk (e.g., lawsuits, regulatory fines) but excluding strategic and reputational risks. Pandemic risk (A) is an external event but isn't separately categorized-it falls under operational risk only if it disrupts processes. Strategic risk (B) relates to business decisions, and reputational risk (C) affects perception, not direct losses. Legal risk (D) is a core component, often arising from operational failures (e.g., non-compliance).
Exact Extract from Official Source:
* BCBS, "Basel II: International Convergence of Capital Measurement and Capital Standards," June
2006, para. 644: "Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk, but excludes strategic and reputational risk."
* GARP FRR Study Notes, Operational Risk Section: "Legal risk, encompassing losses from litigation or regulatory penalties, is explicitly included in Basel's operational risk definition, unlike reputational or strategic risks, which are managed separately." Reference:BCBS, "Basel II," para.644; GARP FRR Study Notes, Operational Risk Section.
NEW QUESTION # 181
Banks duration match their assets and liabilities to manage their interest risk in their banking book. A bank has
$100 million in interest rate sensitive assets and $100 million in interest rate sensitive liabilities. Currently the
bank's assets have a duration of 5 and its liabilities have a duration of 2. The asset-liability management
committee of the bank is in the process of duration-matching. Which of the following actions would best
match the durations?
- A. Decrease the duration of liabilities by 1 and decrease the duration of assets by 1.
- B. Decrease the duration of liabilities by 1 and increase the duration of assets by 1.
- C. Increase the duration of liabilities by 2 and increase the duration of assets by 1.
- D. Increase the duration of liabilities by 2 and decrease the duration of assets by 1.
Answer: D
NEW QUESTION # 182
Which of the following are conclusions that could be drawn from the shape of the statistical distribution of losses that a bank might incur over a future time period?
I. In most years a bank would look more profitable than it will be on average.
II. Most of the time a sufficiently well capitalized bank will appear over-capitalized.
III. Bad years do not come along very often, but when they do they lead to enormous losses.
- A. I, II, III
- B. II, III
- C. I, III
- D. I, II
Answer: A
Explanation:
From the statistical distribution of bank losses over a future period, several conclusions can be drawn:
* I. In most years a bank would look more profitable than it will be on average: This indicates that most years will show better-than-average profitability because the distribution of losses includes infrequent but severe loss events.
* II. Most of the time a sufficiently well-capitalized bank will appear over-capitalized: Because banks prepare for rare but significant losses, in normal years, their capital reserves may seem excessive.
* III. Bad years do not come along very often, but when they do they lead to enormous losses: This reflects the heavy-tailed nature of the loss distribution, where extreme losses are rare but severe.
All three statements correctly reflect the characteristics of the loss distribution for banks.References: How Finance Works, sections covering statistical analysis of losses and capital adequacy.
NEW QUESTION # 183
To estimate a partial change in option price, a risk manager will use the following formula:
- A. Partial change in option price = Delta x Gamma x Change in underlying price
- B. Partial change in option price = Delta x Gamma x (1+ Change in underlying price)
- C. Partial change in option price = Delta x Change in underlying price
- D. Partial change in option price = Delta x (1+ Change in underlying price)
Answer: C
Explanation:
The formula to estimate a partial change in an option's price based on the change in the underlying asset's price is primarily dependent on the option's Delta. Delta represents the sensitivity of the option's price to changes in the price of the underlying asset. Therefore, the most straightforward and widely used formula to estimate this partial change is:
Partial change in option price=#×Change in underlying pricePartial change in option price=#×Change in underly This formula directly utilizes Delta to measure the immediate rate of change in the option's price relative to a small change in the underlying asset's price. The other options involving Gamma are more complex and not typically used for simple partial changes.
NEW QUESTION # 184
All of the following performance statistics typically benefit country's creditworthiness EXCEPT:
- A. Low degrees of savings
- B. Low inflation
- C. High degrees of investment
- D. Low unemployment
Answer: A
Explanation:
A country's creditworthiness is typically influenced by various performance statistics that indicate the overall health of its economy. Here's a detailed analysis of each option:
* A. Low unemployment: Low unemployment indicates a healthy labor market, suggesting economic stability and growth, which positively impacts creditworthiness.
* B. Low inflation: Low inflation reflects price stability, which helps maintain the purchasing power of the currency and economic stability, thus benefiting creditworthiness.
* C. High degrees of investment: High levels of investment indicate confidence in the economy and potential for future growth, positively affecting creditworthiness.
* D. Low degrees of savings: Low savings rates can indicate potential issues with financial stability, as it suggests that households and the economy might lack a financial buffer against economic shocks. This can negatively impact creditworthiness, making it the exception in this list.
NEW QUESTION # 185
To achieve leverage in long positions, a bank can use the following strategy:
I. Securities may be purchased with borrowed funds using a bank loan from the broker.
II. Securities may be borrowed on margin by taking a loan from a broker.
III. Securities may be purchased and used in a repo transaction to generate cash for further security purchases.
IV. The bank may enter into a derivative transaction, such as a total return swap, that requires little to no
collateral but mimics the performance of a long or short position in the underlying instrument.
- A. II, IV
- B. I, II, III, IV
- C. I, III
- D. I, II
Answer: B
NEW QUESTION # 186
The market risk manager of SigmaBank is concerned with the value of the assets in the bank's trading book.
Which one of the four following positions would most likely be not included in that book?
- A. $10,000,000 bond issued by IBM worth $11,000,000.
- B. 10,000 shares of IBM worth $10,000,000.
- C. $10,000,000 loan to IBM worth $9,800,000.
- D. 300,000 options on IBM shares worth $10,000,000.
Answer: C
NEW QUESTION # 187
To ensure good risk management which of the following should be true about the CRO role and function?
- A. The CRO should report to the CEO or the Board of Directors.
- B. The CRO should not be involved with the setting of risk limits.
- C. To ensure efficient flow of information the CRO should not be independent of business units.
- D. The CRO should receive compensation that is directly determined by the profit of the trading desk.
Answer: A
Explanation:
The Chief Risk Officer (CRO) should report to the CEO or the Board of Directors. This ensures that the CRO maintains independence from the business units whose activities they are monitoring and managing, which is critical for unbiased risk assessment and management.
NEW QUESTION # 188
Which of the following attributes are typical for early models of statistical credit analysis?
- A. These models assumed the default of any obligor was independent of the default of any other.
- B. The underlying default assumptions were analytically inconvenient.
- C. These models effectively incorporated herd behavior.
- D. The underlying default assumptions failed to develop relatively simple formulas for the determination of portfolio credit risk.
Answer: A
Explanation:
Early models of statistical credit analysis typically operated under the assumption that the default of any given obligor was independent of the default of any other. This simplification made the models more tractable but less realistic, as it did not account for potential correlations between defaults (e.g., economic downturns affecting multiple obligors simultaneously).
NEW QUESTION # 189
A bank considers issuing new capital to increase its Tier 1 capital levels. Which of the following financial instruments would most likely to be considered?
- A. Short-term debt convertible to non-cumulative preferred shares
- B. Convertible preferred shares
- C. Short-term callable debt
- D. Long-term and callable debt convertible to equity
Answer: B
Explanation:
When a bank looks to issue new capital to increase its Tier 1 capital levels, the following instrument is most likely considered:
* Convertible Preferred Shares: These shares can be converted into common stock. They are considered part of Tier 1 capital because they have characteristics of equity, such as absorbing losses while the bank remains a going concern.
Long-term and callable debt, short-term callable debt, and short-term debt convertible to non-cumulative preferred shares do not typically qualify as Tier 1 capital because they do not provide the same level of loss absorption as equity instruments.References: How Finance Works, sections discussing the components of Tier
1 capital and the suitability of different financial instruments.
NEW QUESTION # 190
How could a bank's hedging activities with futures contracts expose it to liquidity risk?
- A. The bank could get exposed to liquidity risk since futures trade on an exchange.
- B. Prices may move such that a loss results on the hedge.
- C. The futures hedge may not work due to the widening of basis which could result in a loss for the bank.
- D. Since futures require margins which are settled every day, the bank could find itself scrambling for funds.
Answer: D
Explanation:
When a bank hedges with futures contracts, it needs to maintain margin accounts which are settled daily to reflect market changes:
* Margin Calls: If the market moves against the position of the futures, the bank must add funds to the margin account to cover potential losses. This can create significant liquidity risk if large sums are needed quickly.
* Daily Settlements: Futures markets require daily mark-to-market settlements which means that any adverse movement in prices necessitates immediate liquidity to meet the margin requirements.
* Market Volatility: In times of high volatility, the daily margin requirements can be substantial, potentially causing a scramble for liquidity if the bank has not pre-arranged sufficient liquidity buffers.
Thus, the need for daily margin settlements exposes the bank to liquidity risk as it must be able to provide cash on short notice.
How Finance Works, relevant sections on liquidity risks in derivative markets.
NEW QUESTION # 191
Gamma Bank has a significant number of retail customers and finds its balance sheet shape and structure difficult to manage. Which one of the following characteristics of a bank with wide retail operations is INCORRECT?
- A. Attracting and retaining customers often involves offering retail products whose features are different from wholesale market products.
- B. The way retail customers behave in relation to the retail banking products they hold often results in the apparent contractual obligation of the parties providing a poor description of the actual nature of the obligations.
- C. Pricing of retail products often has more to do with marketing considerations rather than prevailing market price.
- D. Banks with a wide retail base are typically driven by contractual obligations and not simply relationship considerations.
Answer: D
Explanation:
Banks with a large number of retail customers often face complex balance sheet management issues due to the varied behaviors and preferences of retail customers. While attracting and retaining these customers often involves offering products with unique features, it is also true that the pricing of retail products is influenced more by marketing considerations rather than prevailing market prices. Additionally, retail customer behavior often deviates from the contractual terms, making the management of such operations challenging. Therefore, option A is incorrect because retail banks must balance both contractual obligations and relationship considerations.
NEW QUESTION # 192
The Sarbanes-Oxley Act includes one of the following four requirements for financial institutions in the United States:
- A. Capital allocation requirements
- B. Regulatory response to systemic risk requirements
- C. Market discipline requirements
- D. Risk and control requirements
Answer: D
Explanation:
The Sarbanes-Oxley Act includes requirements for financial institutions in the United States regarding risk and control. It aims to enhance corporate governance and strengthen the internal controls and financial reporting processes. The other options such as market discipline requirements, capital allocation requirements, and regulatory response to systemic risk requirements are not specifically covered by the Sarbanes-Oxley Act.
References:Sarbanes-Oxley Act requirements as outlined in Financial Risk and Regulation documents.
NEW QUESTION # 193
Which of the following statements regarding bonds is correct?
I. Interest rates on bonds are typically stated on an annualized rate.
II. Bonds can pay floating coupons that are directly linked to various interest rate indices.
III. Convertible bonds have an element of prepayment risk.
IV. Callable bonds have an element of equity risk.
- A. I and II
- B. I only
- C. I, II, and III
- D. II, III, and IV
Answer: C
Explanation:
* Interest rates on bonds are typically stated on an annualized rate (I).
* Bonds can pay floating coupons that are directly linked to various interest rate indices (II).
* Convertible bonds have an element of prepayment risk (III).
* Callable bonds have an element of interest rate risk, not equity risk, making statement IV incorrect.
NEW QUESTION # 194
A credit associate extending a loan to an obligor suspects that the obligor may change his behavior after the loan has been originated. The obligor in this case may use the loan proceeds for purposes not sanctioned by the lender, thereby increasing the risk of default. Hence, the credit associate must estimate the probability of default based on the assumptions about the applicability of the following tendency to this lending situation:
- A. Adverse selection
- B. Speculation
- C. Short bias
- D. Moral hazard
Answer: D
Explanation:
Moral hazard occurs when one party in a contractual relationship can take risks because the consequences of those risks will be borne by another party. In this scenario, the credit associate is concerned that the obligor might use the loan proceeds for purposes not sanctioned by the lender, thereby increasing the risk of default.
This situation is a classic example of moral hazard, where the obligor's behavior after receiving the loan could change in a way that increases the lender's risk without the lender having control over those actions.
NEW QUESTION # 195
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