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

Minimizing credit risk in a bond portfolio involves selecting bonds with the highest credit quality. Investment-grade bonds are classified from AAA to BBB. Bonds rated AAA have the lowest default risk, which is a key factor in minimizing credit risk in a portfolio. When managing a bond portfolio composed of investment-grade bonds, adding bonds with the highest rating (AAA) will effectively minimize credit risk.

Bank customers trade commodity futures for various reasons including expressing their own price views, reversing undesired short-term exposure from fixed commodity sales, and reaching short-term budgetary targets.

Each of these goals involves managing price risk or speculative opportunities, which are fundamental uses of futures contracts in commodity markets.

A drawdown quantifies the peak-to-trough decline of an investment over a known time period. This measure is used to understand the maximum loss an investment has suffered from a peak to a subsequent trough, which is critical for risk assessment.

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.

Comprehensive and Detailed In-Depth Explanation:

Key Risk Indicators (KRIs) are metrics used to monitor operational, credit, or market risks, providing early warnings of potential issues. Basel II’s operational risk framework and GARP’s FRR guidelines specify that KRIs require:

Method of calculation:Defines how the KRI is computed (e.g., number of failed transactions).

Owner of the KRI:Assigns responsibility for monitoring and acting on the indicator.

Method of reporting:Specifies how and to whom the KRI is communicated (e.g., dashboards).

Red flag threshold:While critical for actionability, it is an outcome of KRI design, not a mandatory criterion for compliance with KRI standards. Thresholds vary by institution and risk appetite, making C the exception.Options A, B, and D are foundational to KRI establishment, whereas C is a subsequent application.

Exact Extract from Official Source:

BCBS, "Basel II: International Convergence of Capital Measurement and Capital Standards," June 2006, para. 664: "A bank’s operational risk measurement system must include the use of key risk indicators… These should include clear definitions, ownership, and reporting mechanisms, tailored to the bank’s risk profile."

GARP FRR Study Notes, Operational Risk Section: "KRIs require a calculation methodology, an assigned owner, and a reporting structure. Thresholds, such as red flags, are set based on risk tolerance but are not a universal requirement for KRI definition."

Regulatory standards impose formulaic capital calculations for all of the bank's activities to ensure:

Comparability Across Banks: Different models used by banks would make it difficult for regulators to compare results across banks.

Comprehensive Risk Assessment: Standardized calculations help ensure that banks are not missing key risks in their calculations.

Avoiding Gaming of the System: Standardized calculations prevent banks from using capital calculations to game the banking regulation system, ensuring consistency and fairness.

References

Source: How Finance Works​

The FDIC has suggested that banks produce certain reports in addition to the usual probabilistic analysis and stress tests to better gauge liquidity issues. These include:

I.Cash Flow Gaps:This report helps identify mismatches between incoming and outgoing cash flows, enabling the bank to address potential shortfalls proactively.

II.Funding Availability:This report assesses the bank's ability to access funding sources, both short-term and long-term, to meet its liquidity needs.

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

Comprehensive and Detailed In-Depth Explanation:

Mark-to-market (MtM) involves valuing positions at current market prices daily, primarily for the trading book (e.g., securities, derivatives). Option C—obtaining and verifying market prices for trading book instruments—is the core MtM activity under Basel III’s market risk rules. Option A applies to the banking book (not typically MtM), Option B describes settlement, and Option D is a profitability analysis, not MtM.

Exact Extract from Official Source:

BCBS, "Basel III: A Global Regulatory Framework," December 2010, para. 688: "Mark-to-market requires banks to obtain current market prices and verify them daily for all trading book positions to reflect fair value."

GARP FRR Study Notes, Market Risk Section: "The MtM process entails collecting and validating market prices for trading book instruments to determine their current value."

Comprehensive and Detailed In-Depth Explanation:

Loan loss reserves (LLR) are provisions set aside from earnings to cover expected credit losses (ECL), reflecting anticipated defaults under accounting standards (e.g., IFRS 9, CECL). Capital (B) and equity (D) absorb unexpected losses per Basel rules, while deposits (C) are a funding source, not a loss buffer. GARP’s FRR and Basel distinguish LLR for expected losses versus capital for unexpected losses.