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

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).

Risk reports are used for:

Identification of exceptional situations that require managerial attention: Highlighting issues that need immediate response.

Display the relative risk among different trades: Providing a comparative view of risk levels.

Estimate the overall risk levels of the bank: Summarizing the total risk exposure.

These functions are essential for effective risk management within a financial institution.

In the event of an extreme liquidity crisis, a bank would resort to the "discount window" as a lender of last resort. This facility is provided by central banks (like the Federal Reserve) to offer loans to banks facing liquidity shortages, thereby stabilizing the financial system.

ReferencesStandard financial practice and the role of central banks in providing emergency liquidity​​.

Under Basel II, Tier 1 capital, also known as core capital, includes:

Equity Capital: This includes common stock and retained earnings. It is the highest quality of capital because it is fully available to cover losses.

Accrued Profits to Reserves: Profits that are retained and not distributed as dividends are added to reserves, increasing the bank's capital base.

This combination of equity capital and retained earnings ensures that Tier 1 capital is robust and able to absorb significant losses, thereby providing a strong financial cushion.References: How Finance Works, sections on regulatory capital requirements and the components of Tier 1 capital​​.

For American options, exercising an in-the-money call option before the ex-dividend date can be beneficial if the option is deep in the money and the dividend is significant. This is because the holder would receive the dividend payment, which can make early exercise profitable.

When a bank hedges with futures contracts, it needs to maintain margin accounts which are settled daily to reflect market changes:

Margin Calls: If the market moves against the position of the futures, the bank must add funds to the margin account to cover potential losses. This can create significant liquidity risk if large sums are needed quickly.

Daily Settlements: Futures markets require daily mark-to-market settlements which means that any adverse movement in prices necessitates immediate liquidity to meet the margin requirements.

Market Volatility: In times of high volatility, the daily margin requirements can be substantial, potentially causing a scramble for liquidity if the bank has not pre-arranged sufficient liquidity buffers.

Thus, the need for daily margin settlements exposes the bank to liquidity risk as it must be able to provide cash on short notice.References: How Finance Works, relevant sections on liquidity risks in derivative markets​​.

Market timing trading involves making buy or sell decisions of financial assets by attempting to predict future market price movements. This strategy:

Long positions when markets are rising: The trader buys securities expecting their prices to increase.

Short positions when markets are falling: The trader sells securities expecting their prices to decrease.

This behavior aligns with market timing, which is an active trading strategy based on the anticipated direction of market prices.

ReferencesSource: How Finance Works​

Gamma is an important measure in options trading, representing the sensitivity of the delta of the option to changes in the price of the underlying asset. The correct statements about gamma are:

III. Gamma is the second derivative of the value function with respect to the price of the underlying instrument. This means that gamma measures the rate of change of delta (the first derivative) as the price of the underlying asset changes. IV. Gamma is the rate of change of the option delta with respect to changes in the underlying price. This highlights that gamma captures the curvature in the relationship between the option price and the underlying asset price, making it crucial for understanding how the delta will change as the underlying asset price changes.

The key difference between customer loans and interbank loans is related to creditworthiness and yield. Customers are generally less credit-worthy than banks, leading to higher yields on customer loans compared to interbank loans. This higher yield compensates lenders for the increased risk associated with lending to less credit-worthy borrowers.

Asset and liability management (ALM) in banks is concerned with several key activities:

Maintaining the desired liquidity structure of the bank (I): Ensuring that the bank has enough liquid assets to meet its short-term obligations.

Managing the factors affecting the structure and composition of a bank's balance sheet (II): This includes managing the mix of assets and liabilities to optimize returns and minimize risks.

Focusing on the circumstances impacting the stability of income the bank generates over time (IV): Ensuring that the bank's income is stable and sustainable by managing interest rate risk, credit risk, and other factors that could affect profitability.

References: No specific reference found in the document for this question. The provided answer is based on standard ALM practices in banking.