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

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"​​.

The statement that "commodity markets are more liquid than debt markets" is incorrect. Commodity markets can be less liquid compared to the highly developed and widely traded debt markets. Banks typically do not have direct exposure to commodities but engage in OTC contracts to serve clients and facilitate hedging.

Option A:Use of benchmarked data reflects similar data collection standards.

Incorrect. Benchmarking ensures that data is collected using similar standards, enhancing comparability and reliability.

Option B:External events are usually not of interest to senior management.

Incorrect. External events provide valuable insights and lessons that are often of significant interest to senior management.

Option C:If the external data is gathered from news sources, it may only reflect events that are interesting to the press.

Verified and correct. Data sourced from news can be biased towards more sensational events, potentially missing out on less newsworthy but equally important incidents.

Option D:They provide a source of data on what operational loss events will occur.

Incorrect. External databases provide historical data that can inform risk assessments but do not predict future events directly.

Forward rate agreements (FRAs) are over-the-counter (OTC) derivative contracts that allow banks and other parties to hedge or speculate on future movements in interest rates. They provide a means to lock in an interest rate for a future period, thus allowing parties to manage their interest rate exposure.

Short selling in physical commodities markets involves borrowing the commodity and selling it with the hope of buying it back at a lower price. The right combination of characteristics that generally allows short selling without making the transaction prohibitively expensive includes factors like liquidity, storage costs, and ease of borrowing.

Oil:While the oil market is highly liquid, storage costs and logistical challenges can make short selling more expensive.

Natural Gas:Similar to oil, natural gas involves significant storage and transportation costs, making short selling less attractive.

Grain:Grain markets can have high volatility and storage costs that could complicate short selling.

Gold:Gold has the ideal combination of characteristics for short selling. It is highly liquid, has relatively low storage costs, and is easy to borrow. These factors make short selling gold less prohibitively expensive compared to other commodities.

Operational risk events are categorized based on the nature of the incident.

Alfred Fall's injury due to falling on the marble floors of the bank and subsequent personal injury claim aligns with incidents related to workplace safety.

Option A:Business Disruption and System Failures - Incorrect, as this category relates to disruptions in business operations, not physical injuries.

Option B:Employment Practices and Workplace Safety - Correct. This category includes incidents related to safety within the workplace.

Option C:Not qualifying as an operational risk event is incorrect, as it clearly involves a risk incident.

Option D:Legal Risk is more about legal exposures due to contractual breaches or legal actions unrelated to workplace safety.

Securitization helps banks make their retail assets highly liquid and their balance sheet easier to manage through the following mechanisms:

I.Accommodating Lack of Capital:By securitizing assets, any lack of capital can be accommodated by selling the securitized bonds. This process enables banks to raise funds quickly by selling bonds backed by their assets.

II.Diversifying Credit Risk:Banks can achieve credit risk diversification by selling their own securitized bonds and buying other bonds that increase diversification. This helps spread the risk across different types of assets and reduces the overall credit risk exposure of the bank.

III.Promoting Hedging:Securitization can be used to promote hedging by using limited market instruments. By securitizing assets, banks can better hedge their positions and manage the risks associated with their assets more effectively.

Value at Risk (VaR) at a 95% confidence level means that there is a 95% chance that the bank's losses will not exceed USD 10 million in a year. Conversely, this implies that there is a 5% chance that the bank's losses will exceed USD 10 million in a year.

The change in equity value per 1% change in yield can be calculated using the formula:

ΔE=(Dl×MDl−Dd×MDd)×Δy\Delta E = (D_l \times \text{MD}_l - D_d \times \text{MD}_d) \times \Delta yΔE=(Dl​×MDl​−Dd​×MDd​)×Δy

Where DlD_lDl​ and DdD_dDd​ are the dollar amounts of loans and deposits, respectively, and MDl\text{MD}_lMDl​ and MDd\text{MD}_dMDd​ are their modified durations. For Gamma Bank:

ΔE=(300×2−200×1)×0.01=600−200=400×0.01=−2 million\Delta E = (300 \times 2 - 200 \times 1) \times 0.01 = 600 - 200 = 400 \times 0.01 = -2 \text{ million}ΔE=(300×2−200×1)×0.01=600−200=400×0.01=−2 milli

Currency swaps and interest rate swaps differ primarily in the risks they manage and generate. While both are OTC derivative contracts, currency swaps involve the exchange of principal and interest payments in one currency for principal and interest payments in another currency. This not only involves managing interest rate risk but also introduces foreign exchange rate risk, as fluctuations in currency exchange rates can affect the value of the payments exchanged.