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

Equity indices are numerical calculations that reflect the performance of hypothetical equity portfolios.

They are designed to track the overall performance of an equity market and do not trade in cash form.

Capitalization-weighted indices, which weight stocks by their market capitalization, are generally considered effective in tracking the performance of the overall market. Therefore, the statement that they are not generally considered better is incorrect.

Price-weighted indices give greater weight to shares trading at high prices, reflecting their price movements more heavily in the index.

When a trader inadvertently books a trade with incorrect information and a subsequent market move results in a gain for the bank, the event should be included in the operational loss event data program because:

Indication of Control Failure (II):The gain indicates that a control failed or a process is flawed. Even if the outcome was a gain, the underlying issue was a mistake, pointing to a weakness in the bank's operational controls that needs to be addressed.

Recording the Event as a Loss (III):Although the event resulted in a gain, it should be included in the operational loss event data program and recorded as a loss. The principle behind this is to ensure that all operational risk events are tracked, irrespective of their financial outcome, to provide a complete picture of operational risk exposures and to improve risk management practices.

Including such events helps in identifying and correcting process flaws to prevent future incidents that could result in actual losses.

References

How Finance Works.pdf, Index section​

Regulatory capital is the minimum amount of capital that a bank is required to hold by financial regulators. These rules are imposed by outside authorities such as central banks or financial supervisory bodies to ensure the stability and solvency of financial institutions. This differs from economic capital, which is determined internally by the bank to cover its own estimated risk exposures.

To estimate the forward price of gold, the cost of holding physical gold and the cost of shorting it must be considered. The formula to calculate the forward price (F) is:

????=????×(1+????????−????????)F=S×(1+rf​−rl​)

where????Sis the spot price,????????rf​is the risk-free rate, and????????rl​is the lease rate.

Given:

Physical gold spot price (????S) = $1,000

Annual risk-free rate (????????rf​) = 5% or 0.05

Gold lease rate (????????rl​) = 2% or 0.02

Plugging in the values:

????=1000×(1+0.05−0.02)=1000×1.03=1030F=1000×(1+0.05−0.02)=1000×1.03=1030

Therefore, the best estimate of the gold forward price is $1030.

To determine the risk premium, we first calculate the credit spread. The yield difference between the corporate bond and the government bond gives the credit spread: Corporate bond yield = 6% Government bond yield = 2%

Credit spread = Corporate bond yield - Government bond yield Credit spread = 6% - 2% = 4%.

Next, we account for the expected loss. The expected loss is the probability of default times the loss given default: Probability of default = 2.5% Loss given default = 60%

Expected loss = 0.025 * 0.60 = 0.015 or 1.5%.

Risk premium = Credit spread - Expected loss Risk premium = 4% - 1.5% = 2.5%.

Therefore, the risk premium included in the credit spread is 2.5%.

This question appears to be similar to Question 295 but uses "external" instead of "exogenous."

Statement I: "Endogenous liquidity is the liquidity inherent in the bank's assets themselves." Correct.

Statement II: "External liquidity is the liquidity provided by the bank's liquidity structure to fund its assets and maturing liabilities." Correct.

Statement III: Incorrect for the same reasons as mentioned in Question 295.

Statement IV: Incorrect as endogenous liquidity is not the same as funding liquidity.

References

Based on the consistent use of definitions and explanations of endogenous and exogenous liquidity​​.

An asset-sensitive bank has more rate-sensitive assets than rate-sensitive liabilities. This results in a positive cumulative gap, meaning the bank will benefit from rising interest rates. As interest rates increase, the income from rate-sensitive assets will increase more than the expense on rate-sensitive liabilities, improving the bank's net interest income.

Forward rate agreements (FRAs) are over-the-counter (OTC) derivative contracts that allow banks and other parties to hedge or speculate on future movements in interest rates. They provide a means to lock in an interest rate for a future period, thus allowing parties to manage their interest rate exposure.

The pricing of wholesale products is primarily driven by prevailing market prices. Unlike retail products, where marketing and customer retention strategies might influence pricing, wholesale products are priced based on the current market conditions, supply and demand dynamics, and competitive landscape. This ensures that the prices reflect the true market value and risks associated with the products.

Sales and cost management are fundamental factors affecting a company's earnings, directly influencing equity values.

The commercial success of the company significantly impacts its earnings, thus affecting the industry P/E levels.

Market sentiment also plays a crucial role in the fluctuation of equity values as it influences investor perceptions and market dynamics.

Therefore, sales, cost management, and commercial success are factors that will generally lead to the fluctuation of equity values with industry P/E levels and a company's individual earnings.