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

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:

Which one of the following four interest rate related yield curves is used to revalue loan and deposit positions in banks?

What does correlation between two variables measure?

Which one of the four following statements about back testing the VaR models is correct?

Back testing requires

Gamma Bank estimates its monthly portfolio volatility at 5%.The portfolio's annual volatility is closest to which of the following?

What is a difference between currency swaps and interest rate swaps?

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?

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.

On January 1, 2010 the TED (treasury-euro dollar) spread was 0.4%, and on January 31, 2010 the TED spread is 0.9%. As a risk manager, how would you interpret this change?

An options trader for a large institutional investor takes a long equity option position. Which of the following risks need to be considered when taking this position?

I. All the risks of underlying equities

II. Perceived volatility changes

III. Future dividends yields

IV. Risk-free interest rates

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?

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.

What are some of the drawbacks of correlation estimates? Which of the following statements identifies major problems with correlation calculations?

I. Correlation estimates are not able to capture increases in factor co-movements in extreme market scenarios.

II. Correlation estimates tend to be unstable.

III. Historical correlations may not forecast future correlations correctly.

IV. Correlation estimates assume normally distributed returns.

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.

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

Which one of the following changes would typically increase the price of a fixed income instrument, such as a bond?

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.

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:

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

Which one of the following four metrics represents the difference between the expected loss and unexpected loss on a credit portfolio?

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. Six months after Alpha Bank provides USD $1 million loan to the Delta Industrial Machinery Corporation, a new competitor enters the machinery industry, causing Delta to adjust its prices and mark down the value of its inventory. Hence, the probability of default increases from 2% to 10% and the loss given default increases from 50% to 75%. If Alpha Bank can reprice the loan, what should the new rate be?

Typically, which one of the following four option risk measures will be used to determine the number of options to use to hedge the underlying position?

Which one of the following four statements on the seniority of corporate bonds is incorrect?

To hedge a foreign exchange exposure on behalf of a client, a small regional bank seeks to enter into an offsetting foreign exchange transaction. It cannot access the large and liquid interbank market open primarily to larger banks. At which one of the following exchanges can the smaller bank trade the currency futures contracts?

I. The Tokyo Futures Exchange

II. The Euronext-Liffe Exchange

III. The Chicago Mercantile Exchange

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?

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.

When trading exotic options, one needs to consider the following risks:

I. Spot foreign exchange risks

II. Forward foreign exchange risks

III. Plain vanilla options risks

IV. Option-specific risks

A risk manager has a long forward position of USD 1 million but the option portfolio decreases JPY 0.50 for every JPY 1 increase in his forward position. At first approximation, what is the overall result of the options positions?

Which one of the following four exotic option types has another option as its underlying asset, and as a result of its construction is generally believed to be very difficult to model?

Which one of the following four statements regarding bank's exposure to credit and default risk is INCORRECT?

Which one of the following four factors typically drives the pricing of wholesale products?

To quantify the aggregate average loss for the credit portfolio and its possible constituent subportfolios, a credit portfolio manager should use the following metric:

In its VaR calculations, JPMorgan Chase uses an expected tail-loss methodology which approximates losses at the 99% confidence level. This methodology consists of two subsequent steps to estimate the VaR. Which of the following explains this two-step methodology?

Financial regulators in a European country are considering banning trading in highly complex derivative instruments that are not settled through a centralized clearinghouse. This ban can result in:

I. The value of the country's currency dropping

II. Counterparties involved in trading of these derivative instruments failing to fulfill their obligations

III. The business model relying on these instruments failing

IV. Certain activities becoming illegal

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

An organization's enterprise risk management framework defines its risk profile and typically reflects the organization's

I. Market and credit risks

II. Operational and liquidity risks

III. Strategic and geopolitical risks

IV. Structural developments and industry position

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?

Which one of the following four statements regarding the current value of a transaction and its purposes is INCORRECT?

Gamma Bank has $300 million in loans and $200 million in deposits. If the modified duration of the loans is estimated to be 2, and the modified duration of the deposits is estimated to be 1, then the change in Gamma Bank's equity value per 1% change in yield will be:

Which one of the following four alternatives correctly identifies the purpose of a clearinghouse in trading activities?

According to the principles of the Basel II Accord, the implementation and relative weights of the elements of the operational risk framework depend on:

I. The culture of the financial institution

II. Regulatory drivers

III. Business drivers

IV. The bank's reporting currency

Alpha Bank, a small bank,has a long position with larger BetaBank and has an identical short position with another larger bank GammaBank. Each large bank requires a 20% initial collateral to support the trade. As prices fluctuate in either direction, one large bank will require additional collateral from the small bank, while the risk of loss to the other large bank will increase. By running the trades through a clearinghouse, the small bank can achieve all of the following objectives EXCEPT:

Company A needs to provide a risk probability/frequency score for its RCSA program. If the event is likely to happen once in 2 years, then the frequency score will be equal to:

Which one of the following four examples would not be considered a typical source of market risk?

BetaFin, a financial services firm, does not have retail branches, but has fixed income, equity, and asset management divisions. Which one of the four following risk and control self-assessment (RCSA) methods fits the firm's operational risk framework the best?

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.

Which one of the following four regulatory drivers for operational risk management includes risk and control requirements for financial statements in the United States?

What is the order in which creditors and shareholders get repaid in the event of a bank liquidation?