2016-FRR Financial Risk and Regulation (FRR) Series Questions and Answers

The pricing of credit default swaps is a function of all of the following EXCEPT:

Alpha Bank determined that Delta Industrial Machinery Corporation has 2% change of default on a one-year no-payment of USD $1 million, including interest and principal repayment. The bank charges 3% interest rate spread to firms in the machinery industry, and the risk-free interest rate is 6%. Alpha Bank receives both interest and principal payments once at the end the year. Delta can only default at the end of the year. If Delta defaults, the bank expects to lose 50% of its promised payment. What interest rate should Alpha Bank charge on the no-payment loan to Delta Industrial Machinery Corporation?

A credit analyst wants to determine a good pricing strategy to compensate for credit decisions that might have been made incorrectly. When analyzing her credit portfolio, the analyst focuses on the spreads in each loan to determine if they are sufficient to compensate the bank for all of the following costs and risks EXCEPT.

In analyzing market option pricing dynamics, a risk manager evaluates option value changes throughout the entire trading day. Which of the following factors would most likely affect foreign exchange option values?

I. Change in the value of the underlying

II. Change in the perception of future volatility

III. Change in interest rates

IV. Passage of time

Counterparty credit risk assessment differs from traditional credit risk assessment in all of the following features EXCEPT:

All of the following performance statistics typically benefit country's creditworthiness EXCEPT:

A multinational bank just bought two bonds each worth $10,000. One of the bonds pays a fixed interest of 5% semi-annually and the other pays LIBOR semi-annually. The six month LIBOR is at 5% currently. The risk manager of the bank is concerned about the sensitivity to interest rates. Which of the following statements are true?

To estimate the responsiveness of a particular equity portfolio to the overall market, a trader should use the portfolio's

Which one of the following statements describes Macauley's duration?

James Arthur is a customer of a bank who has taken a floating rate loan from the bank. He is concerned that the rates may rise in the future increasing his payment amount. Which of the following instruments should he buy to hedge against the rise in interest rates?

Which one of the following four relationships should be used to price equity forwards or futures?

Which one of the following four statements describes the advantage of using delta-gamma method of mapping options positions over delta-normal method?

Delta-gamma method

Which of the following statements about a bank's behavior regarding Risk Adjusted Return on Capital (RAROC) is correct?

I. A bank should always seek to maximize their overall RAROC.

II. A bank should consider investing in a business even with negative RAROC if it increases the RAROC of the bank as a whole.

III. A bank should minimize its overall RAROC by controlling the absolute and relative amount of risk of its businesses.

IV. A bank should maximize its RAROC by always investing in a new business that maximizes the RAROC for that business unit.

Securitization is the process by which banks

I. Issue bonds where the payment of interest and repayment of principal on the bonds depends on the cash flow generated by a pool of bank assets.

II. Issue bonds where the bank has transferred its legal right to payment of interest and repayment of principal to bondholders.

III. Sell illiquid assets.

BetaFin has decided to use the hybrid RCSA approach because it believes that it fits its operational framework. Which of the following could be reasons to use the hybrid RCSA method?

I. BetaFin has previously created series of RCSA workshops, and the results of these workshops can be used to design the questionnaires.

II. BetaFin believes that using the questionnaire approach should be more useful.

III. BetaFin had used the questionnaire approach successfully for certain businesses and the workshop approach for others.

IV. BetaFin had already implemented a sophisticated RCSA IT-system.

A customer asks a broker employed by AlphaBank to buy Eureka Corporation bonds for her account. While this trade was executed correctly and the bonds were bought, the trade was mistakenly accounted for as a sell order. If the price of Eureka Corporation bonds goes up, this trade would result in a significantly larger loss than if the market had remained stable. However, if the market drops, the customer will benefit from the incorrect accounting and gain from this trade. This trading scenario can serve as an example that

Using the definitions used by JPMorgan Chase in their annual report, which of the following exposure types would be considered as a non-trading risk exposure?

I. Short term equity investments

II. Loans held to maturity

III. Mortgage servicing rights

IV. Derivatives used to manage asset/liability exposure.

A risk associate responsible for the operational risk function wants to evaluate the upward reporting governance structure and to assess its critical features. Which one of the four attributes does not represent a critical feature of the upward reporting governance structure?

Which of the following bank events could stress the bank's liquidity position?

I. Maturing of bank debt

II. Repurchase agreements

III. Futures margins

IV. Staff turnover

A key function of treasuries in commercial/retail banks is:

I. To manage the interest margin of the banks.

II. To focus on underwriting risk.

III. To ensure strong earnings.

IV. To increase profit margins.

Which one of the four following statements about Basis point values is correct?

Basis point value:

Using a forward transaction, Omega Bank buys 100 metric tones of aluminum for delivery in six-months' time. However, after two months, the bank becomes concerned with the potential fluctuations in aluminum prices and wants to hedge its potential exposure against a possible decline in aluminum prices. Which one of the following four strategies could the bank use to offset the risk from its current exposure to aluminum as it sets the price for selling the commodity in four-months' time?

Which one of the following four statements about hedging is INCORRECT?

Which one of the four following statements about the Risk Adjusted Return on Capital (RAROC) is correct?

RAROC is the ratio of:

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?

Which one of the following four statements about the "market-maker" trading strategy is INCORRECT?

US based Alpha Bank holds European corporate bonds and US inflation–indexed Treasury notes in its investment portfolio. This investment portfolio is not exposed to changes in which of the following?

Asset and liability management is typically concerned with all of the following activities:

I. Maintaining the desired liquidity structure of the bank.

II. Managing the factors affecting the structure and composition of a bank's balance sheet.

III. Effectively transferring the interest rate risk in the banking book to the investment bank at a fair transfer price.

IV. Focusing on the circumstances impacting the stability of income the bank generates over time.

What is the role of market risk management function within a bank?

I. Control and minimize the risks the bank should take.

II. Establish a comprehensive market risk policy framework.

III. Define, approve and monitor risk limits.

IV. Perform stress tests and other qualitative risk assessments.

Which of the following risk measures are based on the underlying assumption that interest rates across all maturities change by exactly the same amount?

I. Present value of a basis point.

II. Yield volatility.

III. Macaulay's duration.

IV. Modified duration.

A bank customer can use either a plain vanilla option or an option contract with volumetric flexibility to reduce the following risks:

I. Market Risk

II. Basis Risk

III. Operational Risk

Which one of the following four statements regarding commodity derivative risks is INCORRECT?

In the United States, stock investors must comply with the Regulation T of the Federal Reserve Bank and may borrow up to ___ of the value of the securities from their brokers.

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:

Alpha Bank estimates that the annualized standard deviation of its portfolio returns equal 30%; The daily volatility of the portfolio is closest to which of the following?

Which one of the following four physical commodities markets has the right combination of characteristics that generally allows short selling in the market, without making the short-selling transaction prohibitively expensive?

The exercise for an American type option prior to expiration day is virtually certain in the following case:

A corporate bond was trading with 2%probability of default and 60% loss given default. Due to the credit crisis the probability of default increased to 10% and the loss given default increased to 100%. Assuming that the risk premium remained the same how did the credit spread change?

Rising TED spread is typically a sign of increase in what type of risk among large banks?

I. Credit risk

II. Market risk

III. Liquidity risk

IV. Operational risk

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?

An options trader is assessing the aggregate risk of her currency options exposures. As an options buyer, she can potentially ___ lose more than the premium originally paid. As an option seller, however, she has a ___ risk on the contract and always receives a premium.

After entering the securitization business, Delta Bank increases its cash efficiency by selling off the lower risk portions of the portfolio credit risk. This process ___ risk on the residual pieces of the credit portfolio, and as a result it ___ return on equity for the bank.

Which one of the following four options is NOT a typical component of a currency swap?

A credit portfolio manager analyzes a large retail credit portfolio. Which of the following factors will represent typical disadvantages of market-linked credit risk drivers?

I. Need to supply a large number of input parameters to the model

II. Slow computation speed due to higher simulation complexity

III. Non-linear nature of the model applicable to a specific type of credit portfolios

IV. Need to estimate a large number of unknown variable and use approximations

Which of the following factors can cause obligors to default at the same time?

I. Obligors may be harmed by exposures to similar risk factors simultaneously.

II. Obligors may exhibit herd behavior.

III. Obligors may be subject to the sampling bias.

IV. Obligors may exhibit speculative bias.

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?

Of all the risk factors in loan pricing, which one of the following four choices is likely to be the least significant?

A large energy company has a recurring foreign currency demands, and seeks to use options with a pay-off based on the average price of the underlying asset on either a few specific chosen dates or all dates within a specific pricing window. Which one of the following four option types would most likely meet these specific foreign currency demands?