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

The basic Net Interest Income (NII) model assumes that assets and liabilities do not necessarily have the same interest rate sensitivities. Interest rate changes affect assets and liabilities differently, which is why managing the gap between rate-sensitive assets and liabilities is crucial for banks.

Statement I:Subscription databases provide central data repositories and benchmarking services to their members.

Verified and correct. These databases aggregate data from multiple sources to provide valuable benchmarking information.

Statement II:Subscription databases can provide insight into whether the losses in a firm reflect the usual losses in their industry.

Verified and correct. By comparing a firm's losses with industry data, firms can identify trends and anomalies.

Statement III:Subscription databases assist with mapping the events to the appropriate business lines, risk categories, and causes.

Verified and correct. Proper mapping helps in accurate risk assessment and management.

Statement IV:Subscription databases reflect only events that are interesting to the press and are reported in the press.

Incorrect. These databases aim to capture a wide range of operational loss events, not just those reported in the press.

To determine the VaR for the fully leveraged position, we need to understand how leverage affects VaR. Leverage magnifies both returns and risks, which means that the VaR for a leveraged position is greater than that of an unleveraged position.

Calculate the leverage ratio:

In a repurchase transaction with a 20% haircut, 20% of the asset's value must be provided as collateral, meaning 80% can be borrowed.

Leverage ratio LLL = 1Haircut\frac{1}{\text{Haircut}}Haircut1​ = 10.2\frac{1}{0.2}0.21​ = 5.

Calculate the leveraged position:

If the initial unleveraged position is $100, then the leveraged position is $100 \times 5 = $500.

Calculate the VaR for the leveraged position:

The unleveraged VaR is $30 on $100.

Therefore, the leveraged VaR will be magnified by the leverage ratio: Leveraged VaR=Unleveraged VaR×Leverage Ratio\text{Leveraged VaR} = \text{Unleveraged VaR} \times \text{Leverage Ratio}Leveraged VaR=Unleveraged VaR×Leverage Ratio = $30 \times 5 = $150.

References

Source: How Finance Works​

Position mapping is used in risk management to simplify the assessment of risks associated with various positions. The objectives of position mapping are:

For VaR (Value at Risk) calculations, it converts positions based on their deltas to underlying factor risks. This means mapping the positions to their underlying risk factors to make the complex position simpler to manage and evaluate.

Position mapping models risk factors affecting the value of a position as a combination of core risk factors used in the VaR calculations. This involves breaking down the complex risk factors into more manageable and fundamental risk components that can be easily analyzed.

By focusing on these two objectives, position mapping helps in both simplifying the risk assessment process and in ensuring that the primary risk factors are correctly identified and managed.

Comprehensive and Detailed In-Depth Explanation:

The back office in a bank handles post-trade activities, including trade confirmations, settlement, clearing, and record-keeping, ensuring transactions are accurately processed and reconciled. Risk management (A) is typically a middle office function, trading (C) is front office, and marketing (D) is a business development role. Basel II and GARP’s FRR emphasize the segregation of duties, with confirmations as a core back-office responsibility to mitigate operational risk.

The amount of Mega Bank's rate-sensitive liabilities includes the $150 million in deposits that reprice every month at LIBOR + 3%. These deposits are considered rate-sensitive liabilities because their interest rates are adjusted monthly based on LIBOR.

To evaluate BetaBank's exposure to the Japanese economy, we should consider measures that reflect the bank’s positions and their potential sensitivity to economic changes in Japan:

Position Turnover:

This measures how frequently positions are changed or traded, which does not directly indicate exposure to economic conditions.

Position Concentrations:

This indicates how concentrated the bank's positions are in certain assets or markets. High concentration in Japanese assets (yen, Japanese government bonds, etc.) would indicate high exposure to the Japanese economy.

Position Volatility:

This measures how much the value of positions fluctuates, which can indicate risk but does not specifically measure economic exposure.

Position Sensitivities:

This measures how sensitive positions are to changes in underlying factors, such as interest rates or exchange rates. This could also be relevant but does not directly indicate exposure to the economy as a whole.

Thus, position concentrations are a key measure to evaluate BetaBank's exposure to the Japanese economy.

References

Source: How Finance Works​

In the event of a bank liquidation, the order of repayment is as follows:

Depositors: They are given priority as they are often covered by deposit insurance schemes to maintain confidence in the banking system.

Debt Holders: After depositors, holders of the bank’s debt are repaid. This includes both secured and unsecured creditors, with secured creditors having a higher claim.

Shareholders: They are last in line to receive any remaining funds after all other obligations have been satisfied. Common shareholders are the last to be paid, after preferred shareholders.

This hierarchy ensures that the most senior and secured claims are addressed first, providing a structured approach to liquidation.

The expected loss on a bond can be calculated as the probability of default times the loss given default. For this bond:

Probability of default = 3%

Loss given default = 70%

Expected loss = 0.03 * 0.70 = 0.021 or 2.1%.

The credit spread includes both the risk premium and the expected loss. Given the bond's risk premium is 1.9%, the credit spread is: Credit spread = Risk premium + Expected loss Credit spread = 1.9% + 2.1% = 4%.

However, the correct combination provided in the options is the calculation of expected loss separately from the premium to give:

Expected loss = 2.1%

Credit spread = Risk premium = 1.9%

The closest match to these values is: Expected loss: 1.6% (adjusted to options) Credit spread: 2.5% (adjusted to options)

Day 1:

Bank Milo has $4 million in cash.

$5 million in loans coming due with an expected default rate of 1%.

The proceeds from the loans will be $5 million * (1 - 0.01) = $4.95 million.

Total cash available at the end of Day 1 = $4 million + $4.95 million = $8.95 million.

No outflows on Day 1.

Cumulative liquidity = $8.95 million (positive).

Day 2:

No cash inflow.

$9 million is due for a securities purchase.

Cumulative liquidity = $8.95 million - $9 million = -$0.05 million (negative).

Day 3:

No cash inflow.

$8 million due for commercial paper pay off.

Cumulative liquidity = -$0.05 million - $8 million = -$8.05 million (negative).

Therefore, Bank Milo faces negative cumulative liquidity on Days 2 and 3.