Pass the GARP Financial Risk and Regulation 2016-FRR Questions and answers with ExamsMirror

Market risk tolerance refers to the maximum loss the bank is willing to bear due to fluctuations in market prices and rates. It defines the extent to which the bank is prepared to accept risk in its operations and investment strategies, helping to align its risk appetite with its strategic objectives.

An operational risk coordinator (ORC) needs to provide the main communication contact with the operational risk department (I), coordinate the collection of key risk indicators in her area (III), and coordinate training and awareness activities in her area (IV). The main reporting contact with the audit department (II) is not typically an ORC responsibility.

Funding liquidity risk and trading liquidity risk are two distinct types of liquidity risks faced by financial institutions, particularly banks.

Funding Liquidity Risk:This type of risk pertains to a bank's ability to meet its financial obligations as they come due without incurring unacceptable losses. It primarily concerns the bank's ability to fund withdrawals, meet depositor demands, and other liabilities when they come due. If a bank cannot manage its funding liquidity, it may be forced to sell assets at fire sale prices, which can further deteriorate its financial condition.

Trading Liquidity Risk:This risk, on the other hand, deals with the market liquidity of the bank's assets. It involves the risk of being unable to buy or sell assets at or near their market value due to inadequate market depth or market disruptions. It is more concerned with the bid-offer spreads and the ability to execute trades without significantly impacting the market price of the asset.

Market risk is the exposure to an adverse change in the market value of portfolios and financial instruments caused by a change in market prices or rates. This definition encompasses the variability in market prices, such as interest rates, foreign exchange rates, and equity prices, which can impact the value of financial instruments and portfolios.

Kurtosis measures the "tailedness" of the return distribution. High kurtosis indicates "fat tails," meaning there is a higher probability of extreme returns (both positive and negative) compared to a normal distribution. This measure is particularly useful for identifying distributions with more frequent extreme deviations from the mean, which is characteristic of fat tails. Therefore, kurtosis is the appropriate measure to use when analyzing the probability of extreme returns, making option D correct.

Comprehensive and Detailed In-Depth Explanation:

In a single-name Credit Default Swap (CDS), the protection seller (who assumes the credit risk) often posts collateral to the buyer to mitigate counterparty risk. The amount of collateral is typically determined by:

Credit standing of the protection seller:If the seller’s creditworthiness declines (e.g., lower credit rating), more collateral is required to secure the buyer against the seller’s potential default.

Collecting internal operational risk event and loss information serves several purposes:

Assessing the risk of specific areas of concern (I).

Evaluating risk events and outcomes (II).

Collecting data for capital modeling (III). Getting insight into risk events in other firms in the industry (IV) typically involves external data collection rather than internal event collection.

The delta-gamma method improves upon the delta-normal method by incorporating the gamma of the options, which accounts for the curvature in the price relationship of the option to the underlying asset. This method better captures the non-linear aspects of option pricing, especially for extreme price movements. Gamma measures the rate of change of delta with respect to the price of the underlying asset, thus allowing for a more accurate reflection of the option's risk profile. By including gamma, the delta-gamma method can more accurately represent the risks associated with both small and large movements in the underlying asset's price, making it particularly effective for capturing the full spectrum of option price risk.

To calculate the Risk-Adjusted Return on Capital (RAROC), we use the formula:RAROC=Net IncomeValue at Risk (VaR)RAROC=Value at Risk (VaR)Net Income​

Here, the net income from the transaction is the fees minus the financing costs:Net Income=$2,000,000−$600,000=$1,400,000Net Income=$2,000,000−$600,000=$1,400,000

The VaR is given as $8,000,000. So, the RAROC is:RAROC=$1,400,000$8,000,000=0.175 or 17.5%RAROC=$8,000,000$1,400,000​=0.175 or 17.5%

Risk and control self-assessments (RCSA) have several advantages:

They provide insight into risks that exist in a firm but may not have occurred before (II).

They allow each department to take ownership of its own risks and controls (IV). However, RCSA may not always provide very accurate scoring of risks and controls due to its subjective nature (I), and while it can produce biased operational risk reporting, the primary advantage is the transparency it offers, not the bias (III).