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

The delta-normal method, which uses the delta to approximate the change in the price of an option, has limitations when dealing with options. This method can significantly misrepresent the risks associated with options, particularly because it only considers the linear component of the price change (delta) and ignores the convexity (gamma). Specifically, it tends to understate the risks of long positions in calls because it does not fully account for the increasing delta as the underlying asset price rises, leading to potential underestimation of the risk. Conversely, it overstates the risks of short positions in puts, as the delta of puts decreases less dramatically when the price of the underlying asset falls.

The portfolio VaR when the returns of two assets are uncorrelated can be calculated using the formula:

Portfolio VaR=(VaR of ThetaGroup)2+(VaR of VolgaCorp)2Portfolio VaR=(VaR of ThetaGroup)2+(VaR of VolgaCorp)2​

Plugging in the values:

Portfolio VaR=(0.3)2+(0.4)2=0.09+0.16=0.25=0.5Portfolio VaR=(0.3)2+(0.4)2​=0.09+0.16​=0.25​=0.5

So, the portfolio VaR is $0.5 million.

Value at Risk (VaR) is a statistical measure used to assess the risk of loss on a specific portfolio of financial assets. In this case, Bank G has a 1-year VaR of USD 20 million at 99% confidence level, while Bank H has a 1-year VaR of USD 10 million at the same confidence level. The VaR figure indicates the maximum potential loss over a given period (1 year) at a certain confidence level (99%). Therefore, Bank G is taking twice the risk of Bank H as the VaR is double that of Bank H.

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.

References:Based on the financial risk and regulation analysis, these calculations align with standard liquidity management practices detailed in the provided materials.