2016-FRR Exam Dumps - GARP Financial Risk and Regulation Questions and Answers

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.

TIdentify the regulation:

Regulation T of the Federal Reserve Bank governs the amount of credit that brokers and dealers can extend to investors for the purchase of securities.

Borrowing limit:

Regulation T allows investors to borrow up to 50% of the value of the securities from their brokers.

Explanation:

This regulation is in place to limit the amount of leverage investors can use when buying securities, aiming to reduce the risk of significant market volatility and potential defaults.

An organization's enterprise risk management framework typically reflects its risk profile, which includes market and credit risks (I), operational and liquidity risks (II), and strategic and geopolitical risks (III). These categories encompass the broad spectrum of risks that an organization needs to manage as part of its enterprise risk management framework.

BetaFin decided to use the hybrid RCSA approach because:

They have previously created a series of RCSA workshops, and the results of these workshops can be used to design the questionnaires (I).

They have successfully used the questionnaire approach for certain businesses and the workshop approach for others (III).

A $10,000,000 loan to IBM worth $9,800,000 would most likely not be included in the trading book. Loans held to maturity are generally part of the banking book rather than the trading book, which typically includes assets intended for trading and short-term profit.

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.

When a bank enters into long-term fixed-rate loans and interest rates rise, the bank faces higher costs for its deposits and debt if these are linked to floating rates or have shorter maturities. This creates a mismatch between the fixed income from the loans and the increased cost of funds, potentially squeezing the bank's margins.

Modified duration is a key metric used to measure the sensitivity of a portfolio of assets and liabilities to changes in interest rates. It adjusts Macaulay duration to account for changes in yield, providing a moreaccurate reflection of the price sensitivity of a bond or a portfolio of bonds to interest rate changes. It is particularly useful for managing interest rate risk in a portfolio.

Comprehensive and Detailed In-Depth Explanation:

Risk models (e.g., VaR, stress testing) rely on historical data to estimate potential future outcomes, but they cannot predict the future with certainty due to inherent uncertainties and changing conditions. Option C correctly states that such models "estimate possible future market behavior," acknowledging their probabilistic nature. Option A and B are incorrect—models don’t inherently assume better or worse markets; they extrapolate based on data. Option D is false—historical data-based models are not guaranteed to be accurate, as past patterns may not repeat. This aligns with Basel’s emphasis on model limitations and the need for stress testing to complement historical estimates.

Exact Extract from Official Source:

BCBS, "Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems," December 2010, para. 718(xi): "Models relying on historical data provide estimates of possible future outcomes but do not predict future market behavior with certainty, necessitating the use of stress scenarios to capture tail risks."

GARP FRR Study Notes, Quantitative Analysis Section: "Risk models using historical data, such as VaR, offer probabilistic estimates of future market behavior, not definitive predictions, due to the limitations of assuming stationarity in financial markets."

A very strong positive linear relationship between the returns on two assets means that their correlation is close to 1, which is 100%. This indicates that the returns on the two assets move almost perfectly in tandem with each other.