M. Examination

Global Association of Risk Professionals
2001 Financial Risk Manager Exam
2001 Financial Risk Manager Examination Session I Saturday, November 17, 2001 9:00 a.m. 11:30 a.m.
Abu Dhabi Bahrain Boston Chicago Frankfurt Hong Kong Houston Istanbul Johannesburg Kuala Lumpur London Lugano Madrid Minneapolis Montreal Moscow Mumbai/Bombay New York City Prague Rio de Janeiro Sao Paulo San Francisco Seoul Singapore Sydney Taipei Tel Aviv Tokyo Toronto Utrecht Vancouver Winnipeg Zurich
November 17, 2001
2001 GARP
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The Global Association of Risk Professionals would like to thank the following individuals for their generous contributions of professional time and effort in the compilation of the 2001 Financial Risk Manager Examination: Marcelo Cruz Antonio Duarte Neels Erasmus Dan Galai Lisa Godar Manos Hatzakis Ken Kapner George Montgomery Gary Pickholz Nick Reed Jean-Paul St. Germain Sorin Straja Andrew Street Fred Vacelet And The Members of the FRM Committee of GARP: Sandeep Arora, John Paul Broussard, Steve Lerit, Susan Mangiero, Elliot Noma, Sergey Smirnov, Michael C.S. Wong
November 17, 2001
2001 GARP
Table of Contents
Session I (9:00 a.m. 11:30 a.m.) Credit Risk Management (32 Questions) ................................................. I - 2 Regulation and Compliance (13 Questions)........................................... I - 11 Operational and Integrated Risk Management (20 Questions).............. I - 16
November 17, 2001
I-1
2001 GARP
Credit Risk Management

1. Which of the following is usually regarded as a credit event under ISDA definitions? a. b. c. d. The calling back of a bond that has a borrower call option provision The upgrading of the borrowers credit rating Failing to pay a coupon on another bond Announcing that projected future earnings are going to be much lower than before
2.
Which of the following is the best-rated country according to the most important ratings agencies: a. b. c. d. Argentina Brazil Mexico Peru
3.
Suppose you are given the current value of firms assets as 200 million, the current value of its liabilities as 160 million and the standard deviation of asset values as 20 million. What would KMV calculate as the approximate distance from default? (This question did not count when the exam was graded) a. b. c. d. 1 standard deviation 2 standard deviations 2.5 standard deviations Cannot not be determined from the information given.
4.
Assume two companies of a similar rating and credit risk profile, based in two different countries. What is most likely to invalidate the comparison between default swaps on these two companies? a. b. c. d. Currency risk Differences in recovery rates Cultural differences Different jurisdiction for the contract
I-2 2001 GARP
November 17, 2001
5.
What is the approximate probability of exactly one default over the next year from a portfolio of 20 BBB-rated obligors? (Assume the 1-year probability of default for a BBB-rated counterparty to be 4% and obligor defaults to be independent from one another) (This question did not count when the exam was graded) a. b. c. d. 2% 4% 45% 96%
6.
Standard and Poors rating agency have compiled actual default rates using data over the last twenty years, what are their approximate computed odds for the default of a CCC rated bond over a five year period? a. b. c. d. 1 in 100 1 in 50 1 in 10 1 in 2
7.
Choose the most complete answer that describes the type of events that cause a bond to exit from the original population. a. b. c. d. Default Default, call and sinking fund Default, coupon and time to maturity Default, lower interest rate, sinking fund
8.
Which of the following 10-year swaps has the highest potential credit exposure? a. b. c. d. A cross-currency swap after 2 years A cross-currency swap after 9 years An interest rate swap after 2 years An interest rate swap after 9 years
November 17, 2001
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2001 GARP
9.
A BB bond has a probability of default of 1% over the next year, assuming an even spread of default probability over the year what is the probability of default in the first month? a. b. c. d. 0.084% 0.84% 0.009% 1%
10.
Consider two bonds, one AA rated and the other B rated. Which of the following is true? a. b. c. d. The marginal default rate of the B rated bond declines over a long time period (say 10 years) compared with the AA rated bond The marginal default rate of the B rated bond increases over a long time period (say 10 years) compared with the AA rated bond The marginal rates of default stay roughly the same over all time scales The ratio of marginal default rate between the two bonds stays constant at all times
11.
A money market fund invests in Treasury bills. What is the principal risk that the fund manager must hedge for? a. b. c. d. Interest rate risk Default risk Funding liquidity risk Asset liquidity risk
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2001 GARP
12.
A pool of high yield bonds is placed in an SPV and three tranches (including the equity tranche) of bonds are issued collateralized by the bonds to create a Collateralized Bond Obligation (CBO). Which of the following is true? a. b. c. d. At fair value the value of the issued bonds should be less than the collateral At fair value the total default probability, weighted by size of issue, of the issued bonds should equal the default probability of the collateral pool The equity tranche of the CBO has the least risk of default The yield on the low risk tranche must be greater than the yield on the collateral pool
13.
A US bank makes a loan to a Mexican company of $250m, which collateralized at 110% with Mexican Government Bonds. For unsecured loans, the bank uses 1yr 95% VaR which comes to $25m. Also, there is a 1% probability of the company defaulting. Assuming a very strong correlation between collateral value and company default, what is the fair value amount the bank should charge to cover the risk of taking a loss on the deal assuming a zero recovery rate and collateral value after default? a. b. c. d. $2,500,000 $25,000,000 $5,000,000 $25,000
14.
To what sort of option on the counterpartys assets can the current exposure of a credit-risky position better be compared? a. b. c. d. A short call A short put A short knock-in call A binary option
November 17, 2001
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2001 GARP
15.
Which expression for determining a market risk factor is correct? a. b. c. d. RAROC risk factor = 2.33 X weekly volatility X 52 X (1 - tax rate) RAROC risk factor = 2.33 X weekly volatility X 52 X (1 - tax rate) RAROC risk factor = 2.33 X weekly volatility X 52 X tax rate RAROC risk factor = 2.33 X weekly volatility X 52 X tax rate
16.
A portfolio consists of 20 well diversified A rated bonds, assuming a default probability of 1% per annum, what is the approximate probability of sustaining no losses on the portfolio over the next 12 months? a. b. c. d. 80% 82% 85% 99%
17.
For a given bank, which framework is less likely to convince regulators of a good credit risk exposure management system? a. b. c. d. Mertons model Raroc KMV system Mac Kinseys Credit Portfolio View
18.
The US Government Bond Zero Curve give a 1-year semi-annual yield of 4%, on the same basis a corporate security has a yield of 5%. What is the market implied 1-year default probability of the corporate security? The recovery rate is 88.6%. a. b. c. d. 0.974% 1.000% 9.000% 0.184%
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19.
You work for a bank that lends to lots of different companies. Your boss asks you to quantify the impact of diversifying credit risk across industries. Which statement is true? a. The dollar standard deviation of a loan portfolio goes down as the number of loans in the portfolio goes up, as long as the loans are negatively correlated with each other. The dollar standard deviation of a loan portfolio goes down as the number of loans in the portfolio goes up, as long as the loans are positively correlated with each other. The dollar standard deviation of a loan portfolio goes down as the number of loans in the portfolio goes up, as long as the loans are independent of each other. The dollar standard deviation of a loan portfolio does not depend on correlation among the loans.
b.
c.
d.
20.
Credit-linked notes contain, more typically, as an embedded instrument, a: a. b. c. d. Credit spread option Guarantee Total return swap Credit default swap
21.
The current exposure to credit risk of a financial obligation is best defined as: a. b. c. d. The mark to market value or replacement value of the obligation The current value plus potential future exposure of the obligation The mark to market value times the recovery rate Depends on the credit rating of the obligor
November 17, 2001
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2001 GARP
22.
The current mark to market value of a 5y Interest Rate Swap is positive $2m with a counterparty whose S&P credit rating is BB, which of the following schematic equations best describes the credit risk of this position over a one year horizon? a. b. c. d. $2m x 5y x 1 = $10m $2m x default rate (0.01) = $20,000 $2m x default rate (0.01) x recovery rate (0.4) = $8,000 $2m x default rate (0.01) x {1 recovery rate} (0.6) = $12,000
23.
What is the central assumption made by CreditMetrics? a. b. c. d. An asset or portfolio should be thought of in terms of its diversification. An asset or portfolio should be thought of in terms of the likelihood of default. An asset or portfolio should be thought of in terms of the likelihood of default and in terms of changes in credit quality over time. An asset or portfolio should be thought in terms of changes in credit quality over time.
24.
In the credit risk model of KMV which of the following best describes the basic methodology? a. b. c. d. Modified method of Merton to deduce the net value of the firm as an option using equity price volatility as a proxy for asset price volatility Uses bond yield credit spread to determine default probability Uses historical studies of actual default rates from S&P Uses GARCH forecasting techniques based on industry sector performance
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2001 GARP
25.
The market trades a 1-year bond at 50bp credit spread, and a 3-year bond at 60bp. In the USD market conditions as of fall 2001 and with a recovery rate of 50%, what is the implicit probability of default before year 3? a. b. c. d. 1% 2% 3% 4%
26.
If the incremental annual default probability of an obligor is 10% in year one and 20% in year two, what is the survival rate at the end of year two assuming a recovery rate of zero? a. b. c. d. 72% 70% 80% 90%
27.
What can be said about default correlations in CreditMetrics? a. b. c. d. Default correlations can be estimated by ratings changes Firm-specific aspects are more important than correlation Past history is insufficient to judge default correlations Default correlations can be estimated by equity valuation
28.
What element is not directly part of the CAMEL approach to determining country risk? a. b. c. d. Asset quality of the country's natural, human and economic resources Current account balance of payments Country's access to hard, convertible currency from reserves Legal framework for foreign companies doing business in that country
November 17, 2001
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2001 GARP
29.
Which of the following models can least be used to price credit derivatives? a. b. c. d. Madan-Unal Heath-Jarrow-Morton Duffie-Singleton Jarrow-Turnbull
30.
Moodys and Standard & Poors ratings at investment grade means that default probability is less than: a. b. c. d. 5% 3% 1% 0.1%
31.
What is the main issue in modeling a credit spreads stochastic process like that of an equity? a. b. c. d. Dividends Influence of interest rates A credit-spread process shows jumps In case of equity split or other operations
32.
Which of the following input is NOT common to the most widely used portfolio credit risk models: a. b. c. d. Spread curves Recovery rates Default correlations Credit exposures
November 17, 2001
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2001 GARP
Regulation and Compliance Risk Management

33. Which of the following types of financial contracts do the BIS require a specific risk charge a. b. c. d. 34. Forward Foreign exchange contract Interest rate swap contract FRA contract Debt security future contract
Which of the following proposals was implemented in the New Basle Capital Accord. a. b. c. d. The use of advanced credit portfolio models for setting capital requirements The use of mark-to-model/market accounting in the determination of minimum capital requirements Introduction of risk bucketing approaches, with differentiated capital charges tied to ratings Increased weights for cross border lending to private companies
35.
The Bank of International Settlements promotes cooperation and financial stability of: a. b. c. d. All European countries No countries, it is an advisory organ to central banks Most countries in the world OECD countries
November 17, 2001
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2001 GARP
36.
Which of the following most reflects the Basle Committee on Banking Supervisions approach to calculating regulatory capital for operational risk? a. b. Operational risk capital charge would be linked to fixed percentage of a single risk indicator. Operational risk capital charge would be determined from a decomposition of business into standardized lines associated with broadly defined risk exposure weighted by a beta factor. Operational risk capital charge would be determined from a decomposition of business into standardized lines associated with risk exposures and a gamma term taking into account the operational loss of the institution. All of the above.
c.
d. 37.
Which of the following is least likely to be a principle use for the buyer of a credit default swap? a. b. c. d. Reduction of regulatory capital Portfolio adjustments Protection for mark-to-market exposures Hedging counterparty credit exposure
38.
A Bank subject to the Basel Accord makes a loan of $100m to a firm with a risk weighting of 50%. What is the basic on balance credit risk charge? a. b. c. d. $8m $4m $2m $1m
November 17, 2001
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2001 GARP
39.
The June 1999 Basle Committee on Banking Supervision issued proposals for reform of its 1988 Capital Accord (the Basle II Proposals). These proposals contained MAINLY: I. II. III. IV. V. VI. a. b. c. d. Settlement risk management Capital requirements Supervisory review The handling of hedge funds Contingency plans Market discipline I, III and VI II, IV and V I, IV and V II, III and VI
40.
What is the Internal Models Approach? a. b. c. d. A method of calculating regulatory capital using a firms own internal market risk model and data. Using standardized models from the regulatory to calculate capital. Making forecasts on credit ratings using inside information. Using the FEDs own propriety risk model to calculate capital requirements.
41.
Which of the following qualitative standards must be met in an Internal Models Approach? a. b. c. d. Comprehensive stress testing of the portfolio with back testing Independent review of the trading units Involvement of senior management All of the above
November 17, 2001
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2001 GARP
42.
Which of the following best describes the quantitative parameters of the Internal Models Approach? a. b. c. d. 10 day trading horizon, 99% confidence interval, minimum 1 years data, minimum quarterly updates. 1 day trading horizon, 95% confidence interval, 5 years data, updated weekly. 1 day trading horizon, 99% confidence interval, minimum 1 years data, updated monthly. 10 day trading horizon, 97.5% confidence interval, minimum 5 years data, updated daily.
43.
The value of the VaR calculated under the Internal Models Approach is subject to a multiplicative factor. What is it? a. b. c. d. 3 A minimum of 3, but can be higher 4 1
44.
In the Internal Models Approach, an exception occurs when an actual P&L results exceeds the VaR forecast. How many times may this occur before the model falls into the penalty Red Zone? (This question did not count when the exam was graded) a. b. c. d. 4 times a year 6 times a year 9 times a year 10 times a year
November 17, 2001
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2001 GARP
45.
The Basel Accord computes the credit exposure of derivatives using both replacement cost and an add-on to cover potential future exposure, which of the following is the correct credit risk charge for a purchased 7 y OTC equity index option of $50m notional with a current mark to market of $15m with no netting and a counterparty weighting of 100%? a. b. c. d. $1.6m $1.2m $150,000 $1m
November 17, 2001
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2001 GARP
Operational and Integrated Risk Management

46. From the regulators point of view, operational risk is concerned with: a. b. c. d. 47. Events that affect the cost basis and foregone revenue Events that affect exclusively the foregone revenue Events that affect the cost basis directly Events that affect the cost basis directly and, in some cases, indirectly
To avoid rogue traders, what policy is most appropriate? a. b. c. d. Set compensation and incentives for the performance the bank wants, according to the bank's risk appetite Pay traders well enough for them not to need to behave unreasonably Set enough control processes for traders (phone-tapping, audits, performance measurement, etc.) Get traders throughout the bank to share their bonuses
48.
Which of the following most reflect an operational risk faced by a bank a. b. c. d. A counterparty invokes force majuere on a swap contract. The Federal Reserve unexpectedly cuts interest rates by 100 bps. A power outage shuts down the trading floor indefinitely with no back-up facility. The rating agencies downgrade the sovereign debt of the bank sovereign counterparty.
49.
Which of the below is the term used within the insurance industry to refer to the effect of a reduction in control of losses by an individual insured due to the protection provided by insurance? a. b. c. d. Control trap Moral hazard Adverse selection Control hazard
November 17, 2001
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2001 GARP
50.
The MAIN challenge of banks (as of fall 2001) in operational risk is to: a. b. c. d. Comply with BIS requirements. Recruit enough competent people for this function. Use the best quantitative model for operational risk. Define an operational risk framework.
51.
Which of the terms below refers to the situation where the various buyers of insurance have different expected losses, however, the insurer (or the capital market, as the seller of insurance) is unable to distinguish between the different types of hedge buyer and is therefore unable to charge differentiated premiums? a. b. c. d. Moral hazard Average insurance Adverse selection Control hazard
52.
Who should assess operational risk of operating units? a. b. c. d. Management Operating divisions External consultants Regulators
53.
The causes and effects of the operational events are very often confused. For example, it is very common to see operational risk types as human or people risk or even system risk, although these types of events are, in general, merely the causes of the risk and not the effect, the latter being the monetary consequence (or the impact in the P&L). Identify below a correct set of causeeffect relationship in operational risk: a. b. c. d. Earthquake penalty paid to the regulators Lost legal suit lawyers fees plus legal charges Interest claims human error Fines paid to the stock exchange- frauds
November 17, 2001
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2001 GARP
54.
What can be used to manage reputational risk? I. II. III. IV. a. b. c. d. Elimination of external communication by employees Strong ethical values at all levels of hierarchy As much transparency as possible An efficient public relations department I only II and IV II and III I and IV
55.
Which of the following affirmations is TRUE? Operational risk: a. b. c. d. Does not impact market and credit risk measurement. Does not impact market risk measurement but has some impact in credit risk measurement. Does not impact credit risk measurement but has some impact in market risk measurement. Impacts both market and credit risk measurement.
56.
The concepts of potential risk versus real risk: a. b. c. d. Are related to mathematical modeling: Extreme Value Theory applies better to potential risks. Are defined by BIS (1988). Mean little more than an attitude: potential risks can be accepted, real risks are to be eliminated. Potential risks have a less than 1% probability of occurring.
November 17, 2001
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2001 GARP
57.
Unlike credit risk, when the calculated expected credit losses might be covered by general and/or specific provisions in the balance sheet, in operational risk, due to its multidimensional nature, the treatment of expected losses is more complex and restrictive. Recently, with the issuing of IAS37 by the International Accounting Standards Board, the rules have become clearer as to what can (or cannot) be subject to provisions. Which of the operational risk types below can clearly be provisioned (given that a figure can be reasonably estimated)? a. b. c. d. Transaction processing risk Legal risk Systems risk Interest expenses
58.
What is the percentage of minimum regulatory capital that, according to the Basel Committee on Banking Supervision September 2001 paper, would provide a reasonable cushion and produce required capital amounts in line with the risks faced by large, complex organizations? a. b. c. d. 10% 12% 15% 20%
59.
The success of information technology projects is defined as a use of the project in a banking production environment. The impact of failure includes implementers loss of credibility, disruption to business and cost of software. How can project risk be best assessed? Probability of success is: a. b. c. d. More than half, impact of failure is limited, success brings a minor direct return. More than half, impact of failure is high, as is impact of success. Less than half, impact of failure is low, impact of success is high. Less than half, impact of failure is high, as is impact of success.
November 17, 2001
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2001 GARP
60.
What is kurtosis? What is its role in statistical distributions? a. Kurtosis measures the nature of the spread of the values around the mean. It represents the 4th moment of a distribution. A small kurtosis indicates a sharp peak in the middle of a distribution. A population with high kurtosis is usually called leptokurtic. The kurtosis plays an important role in distinguishing those distributions that place additional probability on larger values. Kurtosis represents the 3rd moment of a distribution. A small kurtosis indicates flatness in the middle of the distribution. A population with low kurtosis is usually called leptokurtic. Skewness (and not kurtosis) plays an important role in distinguishing those distributions that place additional probability on larger values. Kurtosis can be verified in the four initial moments of a distribution and measures the mean of a distribution. Kurtosis can be seen in the second and fourth moments of a distribution and measures the standard deviation of a distribution.
b.
c. d.
61.
How is the risk of so-called catastrophic losses dealt with? a. b. c. d. Through Raroc models. Only insurance companies can offer a partial cover. Through VaR, preferably delta-gamma approach. By mitigation, with reserves in capital.
62.
Which of the below are methods to estimate parameters of operational loss distributions? I. II. III. IV. a. b. c. d. Moments Probability-weighted moments Maximum likelihood Econometric I and III I, II and III IV III and IV
November 17, 2001
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2001 GARP
63.
What is likely to be the most appropriate policy to manage technology risk? a. b. c. d. Have regular technology audits performed by an external consultant. Stick to proven technologies. Outsource as many technology functions as possible. Make sure every area is password-protected.
64.
The operational VaR is generated through the aggregation of the following general stochastic processes: a. b. c. d. Region and severity Brownian motion and frequency Poisson and frequency Severity and frequency
65.
Testing the fitness of the operational loss distributions to the data is fundamental. Which one of the below is NOT a goodness-of-fitness test? a. b. c. d. Kolmogarov-Smirnov Anderson-Darling Macaulay Cramer-Von Mises
November 17, 2001
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2001 GARP
2001 Financial Risk Manager Examination Session II Saturday, November 17, 2001 12:30 p.m. 3:00 p.m.
Abu Dhabi Bahrain Boston Chicago Frankfurt Hong Kong Houston Istanbul Johannesburg Kuala Lumpur London Lugano Madrid Minneapolis Montreal Moscow Mumbai/Bombay New York City Prague Rio de Janeiro Sao Paulo San Francisco Seoul Singapore Sydney Taipei Tel Aviv Tokyo Toronto Utrecht Vancouver Winnipeg Zurich
November 17, 2001
2001 GARP
Table of Contents
Session II (12:30 p.m. 3:00 p.m.) Quantitative and Fixed Income Analysis (19 Questions)......................... II - 2 Capital Markets and Market Risk Management (39 Questions).............. II - 7 Legal, Accounting and Tax Risk Management (7 Questions) ............... II - 17
November 17, 2001
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2001 GARP
Quantitative Analysis
66. Calculate the duration of a two-year bond paying a annual coupon of 6% with yield to maturity of 8%. Assume par value of the bond to be $1,000: a. b. c. d. 67. 2.00 years 1.94 years 1.87 years 1.76 years
Consider the following currency swap: Counterparty A swaps 3% on 25 million USD for 7.5% on 20 million Sterling. There are now 18 months remaining in the swap, the term structures of interest rates are flat in both countries with USD rates currently at 4.25% and Sterling rates currently at 7.75%. The current Sterling/USD exchange rate is 1.65. Calculate the value of the swap. Use continuous compounding. Assume 6 months until the next annual coupon and use current market rates to discount. a. b. c. d. -1,237,500 USD -4,893,963 USD -7,422,044 USD -8,250,000 USD
68.
EVT, Extreme Value Theory, helps quantify two key measures of risk. a. b. c. d. The magnitude of an X year return in the loss in excess VaR The magnitude of VaR and the level of risk obtained from scenario analysis The magnitude of market risk and the magnitude of operational risk The magnitude of market risk and the magnitude of credit risk.
November 17, 2001
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2001 GARP
69.
An option trader is pricing a 1-year option; he is quoted an interest rate of 6% with semi-annual compounding. In order to price the option correctly he must convert this rate to a continuously compounded rate. Calculate the continuously compounded equivalent. a. b. c. d. 6.00% 5.91% 5.76% 5.63%
70.
Consider the following 6x9 FRA. Assume the buyer of the FRA agrees to a contract rate of 6.35% on a notional amount of 10 million USD. Calculate the settlement amount of the seller if the settlement rate is 6.85%. Assume a 30/360 day count basis. a. b. c. d. 12,500 12,290 +12,500 +12,290
71.
Calculate the Modified Duration of a bond with a Macauley duration of 13.083 years. Assume market interest rates are 11.5% and the coupon on the bond is paid semi-annually. a. b. c. d. 13.083 12.732 12.459 12.371
72.
The lognormal distribution is a. b. c. d. Positively skewed Negatively skewed Not skewed, i.e., its skew equals 2 Not skewed, i.e., its skew equals 0
November 17, 2001
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2001 GARP
73.
The following instruments are traded, on an ACT/360 basis: 3-month deposit (91 days), at 4.5% 3-6 FRA (92 days), at 4.6% 6-9 FRA (90 days), at 4.8% 9-12 FRA (92 days), at 6% What is the 1-year interest rate on an ACT/360 basis? a. b. c. d. 5.19% 5.12% 5.07% 4.98%
74.
Options on the Nikkei 225 from Osaka Exchange are traded on a multiplier of 1000. Volatility of the index is expected to be less than 15%. The index is at 12,000. Which of the following positions has the highest credit exposure? a. b. c. d. 400 call contracts at an 11,800 strike maturing in 1 month 400 put contracts at a 12,200 strike maturing in 1 month A FRN in JPY issued by an AAA corporate, for 100M JPY Not enough information to tell.
75.
A path-dependent option is priced with a variable-node trinomial lattice. What should be done to reduce computational time without losing too much precision? a. b. c. d. Set the model to binomial Use same-length time intervals Trim the tree of extreme prices with low probability of occurring Reduce the number of steps
76.
A martingale is a: a. b. c. d. Zero-drift stochastic process. Chaos-theory-related process. Type of time series. Mean-reverting stochastic process.
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November 17, 2001
77.
Given the following volatilities for foreign exchange rates: JPY/USD at 9% JPY/EUR at 11% EUR/USD at 7%, What is the correlation between JPY/EUR and EUR/USD? a. b. c. d. -58% 62% 34% -34%
78.
What is the Net Present Value of a yearly payment starting at 100 and increasing 2% yearly for 15 years when the discount rate is 4%? (rounded to the nearest tenth) a. b. c. d. 1,120 1,260 1,470 1,620
79.
A bank has sold USD 300,000 of call options on 100,000 equities. The equities trade at 50, the option strike price is 49, the maturity is in 3 months, volatility is 20%, and the interest rate is 5%. How does it the bank delta hedge? (round to the nearest thousand share) a. b. c. d. Buy 65,000 shares Buy 100,000 shares Buy 21,000 shares Sell 100,000 shares
80.
Which position is most risky? a. b. c. d. Gamma-negative, delta-neutral Gamma-positive, delta-positive Gamma-negative, delta-positive Gamma-positive, delta-neutral
II - 5 2001 GARP
November 17, 2001
81.
When pricing an FX option, what factor must be used, on top of the factors used for Black-Scholes pricing? The: a. b. c. d. Correlation between currencies. Interest rate differential with USD. Domestic interest rate. Foreign interest rate.
82.
The VaR of one asset is100; the VaR of another asset is 150. If their combined VaR is 220, what is their correlation? a. b. c. d. 0.92 0.53 0.53 0.92
83.
The volatility of an asset, over 1.5 years, is 35%. What is its 1-year volatility if it is derived from the 1.5 year value? a. b. c. d. 43% 35% 29% 23%
84.
If a counterparty defaults before maturity, which of the following situations will cause a credit loss? a. b. c. d. You are short EUR in a 1-year EUR/USD forward FX contract and the EUR has appreciated. You are short EUR in a 1-year EUR/USD forward FX contract and the EUR has depreciated. You sold a 1-year OTC EUR call option and the EUR has appreciated. You sold a 1-year OTC EUR call option and the EUR has depreciated.
November 17, 2001
II - 6
2001 GARP
Capital Markets and Market Risk Management

85. Consider the following single stock portfolio: Stock ABC has a market position of $200,000 and an annualized volatility of 30%. Calculate the linear VaR with 99% confidence level for a 10 business day holding period. Assume normal distribution and round to the nearest dollar. a. b. c. d. 86. $11,952 $27,849 $60,000 $88,066
If two securities have the same volatility and a correlation equal to 0.5, their minimum variance hedge ratio is: a. b. c. d. 1:1 2:1 4:1 16:1
87.
You would expect the ratio of premiums for two at-the-money call options on the same underlying equity with the same strike price, one expiring 12 months and the other 1 month from now, to be close to: a. b. c. d. 12 6 3.5 2
88.
A 3 month European call option on DEF stock with a strike price of $50 is trading for $2.25. The risk free rate is 10%. The current stock price of DEF stock is $48. Calculate the value of a corresponding put with the same strike and maturity. a. b. c. d. $2.00 $2.25 $3.02 $3.57
II - 7 2001 GARP
November 17, 2001
89.
Estimate the forward rate of a 6-month EUR/USD foreign exchange rate contract. USD LIBOR is 6% and EURIBOR is 4%. The current exchange rate is 0.8800 USD per EUR. a. b. c. d. 0.9240 0.9064 0.8976 0.8888
90.
Which of the following is the riskiest form of speculation using options contracts? a. b. c. d. Setting up a spread using call options Buying put options Writing naked call options Writing naked put options
91.
Using the Black-Scholes model calculate the value of a European call option given the following information: Spot rate = 100 Strike price = 110 Risk- free rate = 10% Time to expiry = 0.5 years N(d1) = 0.457185 N(d2) = 0.374163 a. b. c. d. $10.90 $9.51 $6.57 $4.92
92.
Under usually accepted rules of market behavior, the relationship between parametric delta-normal VaR and historical VaR will tend to be: a. b. c. d. Parametric VaR will be higher Parametric VaR will be lower It depends on the correlations None of the above
II - 8 2001 GARP
November 17, 2001
93.
Calculate the price of a 1-year forward contract on gold. Assume the storage cost for gold is $5.00 per ounce with payment made at the end of the year. Spot gold is $290 per ounce and the risk free rate is 5%. a. b. c. d. $304.86 $309.87 $310.12 $313.17
94.
An option trader constructs the following position: buys 1 call with a strike price at X , buys 1 call with a strike price at X and sell 2 calls with a strike X . Where X < X < X and X = *( X + X ). This strategy is referred to as a a. b. c. d. Butterfly Spread Bull Spread Strap Spread Strip Spread
95.
The option-adjusted duration of a callable bond will be close to the duration of a similar non-callable bond when the: a. b. c. d. Bond trades above the call price. Bond has a high volatility. Bond trades much lower than the call price. Bond trades above parity.
96.
A company anticipates the purchase British pounds in 6 months. The standard deviation of the change in British pounds over a 6-month period is calculated to be 9%. The company chooses to hedge their exposure by buying future contracts on EUR. The standard deviation of the change in the futures price over a 6month period is calculated to be 10% and the correlation coefficient between British pounds and EUR is 0.70. Calculate the optimal hedge ratio. a. b. c. d. 1.0 0.90 0.70 0.63
II - 9 2001 GARP
November 17, 2001
97.
Which of the following is NOT a reason why corporates should hedge their exposures? To: a. b. c. d. Facilitate optimal investment. Lower the cost of financial distress. Lower transaction costs. Lower the cost of corporate management.
98.
What is the most typical underlying used for weather derivatives? a. b. c. d. The hourly average of temperatures at daylight. Heating/cooling degrees during working days. The average of the daily minimum and maximum temperatures. The number of days of rain.
99.
A long position in a put option can be synthetically reproduced by: a. b. c. d. Long position in the underlying and a short position in a call. Short position in the underlying and a long position in a call. Long position in the underlying and a long position in a put. Short position in the underlying and a short position in a put.
100.
Stress testing is best defined as: a. b. c. d. The absolute maximum loss that a portfolio can incur. As alternative to risk measurement to replace VaR. A 99% confidence level of risk. A way of identifying extreme price changes on a portfolio.
November 17, 2001
II - 10
2001 GARP
101.
What is the scenario most used for stress-test of firm-wide positions? a. b. c. d. The 1987 equity crash Money tightening by central banks Failure of a specific country Widening of credit spreads
102.
A fund manager owns a 50 million USD growth portfolio that has a beta of 1.6 relative to the S&P 500. The S&P 500 Index is trading at 1190. Calculate the number of futures contracts the fund manager needs to sell to hedge the portfolio. (The multiplier of the S&P 500 is 250) a. b. c. d. 105 168 269 283
103.
Suppose that at the maturity of futures contracts, the fund manager of the previous question experiences a decline in value of his portfolio of 15%. The market index is trading at 1078 and the risk free rate is 3%. Calculate the effectiveness of the hedge. a. b. c. d. No Gain, small loss Gain of 32K Gain of 424K Gain of 1500K
104.
When the maturity of a plain coupon bond increases, its duration increases: a. b. c. d. Indefinitely and regularly Up to a certain level Indefinitely and progressively In a way dependent on the bond being priced above or below par
November 17, 2001
II - 11
2001 GARP
105.
Assume that the current spot exchange rate is 0.8950 USD per 1 EUR. An American bank pays 3.5 percent annual interest rate for a dollar deposit and a European bank pays 2.75 percent annual interest rate for a EUR deposit. Both rates are compounded annually. If the interest-rate parity theory holds true, calculate the no arbitrage forward exchange rate for EUR/USD one year from now: a. b. c. d. 0.9015 0.8990 0.8975 0.8950
106.
Consider a non-dividend paying stock currently priced at $37. It is known with certainty that over the next two 3-month periods, the price will either rise by 5% or fall by 5%. The continuously compounded risk free rate is 7%. Calculate the value of a six-month European call option with a strike price at $38. a. b. c. d. $1.065 $1.234 $1.856 $2.710
107.
An operator has bought a short condor. His position is: a. b. c. d. Delta-negative, vega-negative Delta-negative, vega-positive Delta-neutral, vega-negative Delta-neutral, vega-positive
108.
What yield curve interpolation method is least indicated? a. b. c. d. Cubic splines Step-wise interpolation Log-linear interpolation Linear interpolation
November 17, 2001
II - 12
2001 GARP
109.
What instrument makes a convexity correction necessary for a yield curve? a. b. c. d. Option-based instruments FRAs Futures Swaps
110.
Consider a European call option on a non-dividend paying stock. The current market price is $100, the strike price is $102, the time to maturity is 9 months and the risk free rate is 7.25%. Calculate the lower bound of the option price. a. b. c. d. $3.40 $3.22 $2.75 $2.00
111.
Consider the following bearish option strategy of buying one at-the-money put with a strike price of $43 for $6, selling two puts with a strike price of $37 for $4 each and buying one put with a strike price of $32 for $1. If the stock price plummets to $19 at expiration, calculate the net profit/loss per share of the strategy. a. b. c. d. 2.00 per share Zero no profit or loss 1.00 per share 2.00 per share
112.
Which of the following is most true about American options? a. b. c. d. Early exercise is never optimal. Early exercise of an American call on a non-dividend paying stock is never optimal. Early exercise of an American put on a non-dividend paying stock is never optimal. Prior to exercise the value of the American call is always equal to the European call.
II - 13 2001 GARP
November 17, 2001
113.
An option portfolio exhibits high unfavorable sensitivity to increases in implied volatility and while experiencing significant daily losses with the passage of time. Which strategy would the trader most likely employ to hedge his portfolio? a. b. c. d. Sell short dated options and buy long dated options. Buy short dated options and sell long dated options. Sell short dated options and sell long dated options. Buy short dated options and buy long dated options.
114.
Rank the following portfolios from least risky to most risky. Assume 252 trading days a year and there are 5 trading days per week. (This question did not count when the exam was graded)
Holding Period in Days 5 5 10 10 15 15 Confidence Interval 99 95 99 95 99 95
Portfolio 1 2 3 4 5 6
VaR 10 10 10 10 10 10
a. b. c. d. 115.
5,3,6,1,4,2 3,4,1,2,5,6 5,6,1,2,3,4 2,1,5,6,4,3
Consider the following call option with 6-months till expiry. The strike price is $50, the current stock price is $55 and the value of the option is $5. What does this imply about the level of 6-month interest rates? a. b. c. d. Interest rates are positively sloped around the 6-month period. Interest rates are negatively sloped around the 6-month period. Interest rates are at zero for the - month period. Cannot be determined from the information given.
November 17, 2001
II - 14
2001 GARP
116.
Which one of the following statements is FALSE about Latin American stock markets? a. b. c. d. The Chilean stock index IPSA is usually less volatile than the Argentinean stock index MERVAL. The market capitalization of the Brazilian stock market is much larger than the market capitalization of the Venezuelan stock market. You can only find derivatives contracts on Latin American stock indexes listed in derivatives exchange in the United States. Two of most important stock indexes in the region are the Argentinean MERVAL and the Brazilian IBOVESPA.
117.
What is the main reason why convertible bonds are generally issued with a call? a. b. c. d. To make their analysis less easy for investors. To protect against unwanted takeover bids. To reduce duration. To force conversion if in-the-money.
118.
When pricing an option with a discrete time model using the same volatility assumption, as compared to a continuous time model, the value will tend to go: a. b. c. d. Up Down Up or down, according to the in-the-moneyness of the option Up or down, no rules
119.
A corporate bond is convertible at 40 and the corporation has called it for redemption at 106. The bond is currently selling at 115 and the stock's current market price is 45. Which of the following would a bondholder most likely do? a. b. c. d. Sell the bond. Convert the bond into common stock. Allow the corporation to call the bond at 106. None of the above.
November 17, 2001
II - 15
2001 GARP
120.
A trader buys a swaption on a 10-year Libor to 5% semiannual swap, and, to keep the delta neutral, shorts government bonds. What can be said about the position? a. b. c. d. Volatility risk remains, as well as basis risk and interest rate risk Interest rate risk is completely eliminated The position is delta-neutral and gamma-positive, hence profit is locked Basis risk should first be hedged
121.
In what case is a position to be revalued with accrual methods instead of markto-market? a. b. c. d. When the market prices are too volatile When interest accrued is more remunerative than price differences For OTC trades, or when market prices are difficult to get When the position is intended to be kept until maturity, or is matched with non-financial instruments
122.
What is the most important consequence of an option having a discontinuous payoff function? a. b. c. d. An increase in operational risks, as the expiry price can be contested or manipulated if close to a point of discontinuity When the underlying is close to the points of discontinuity, a very high gamma Difficulties to assess the correct market price at expiry None of the above
123.
Which of the following Greeks contributes most to the risk of an option that is close to expiration and deep in the money? a. b. c. d. Vega Rho Gamma Delta
November 17, 2001
II - 16
2001 GARP
Legal, Accounting and Tax Risk

124. Most credit derivatives contracts: (This question did not count when the exam was graded) a. b. c. d. 125. Are based upon English law Are written on a one-off basis Have a clause about restructuring Are based upon ISDA agreement
What is the most general way accounting discrepancies are dealt with? These are: a. b. c. d. Imperatively corrected within the day Transferred to other books Corrected within the day if significantly affecting daily P&L Generally corrected if discrepancies are big, otherwise left in suspense accounts
126.
Which is closer to a definition of money laundering? Money laundering is the process to: a. b. c. d. Make money from vice appear in more tolerant countries. Make money used for weapons trade more discrete, for political. purposes Make proceeds of crime into apparently legitimate capital. Get drugs-related proceeds to escape tax.
127.
Convertible bonds are justified as a financial instrument because: a. b. c. d. For an investor there is an upside but limited downside; for the issuer, the equity is sold at a higher price. Both investor and issuer benefit from a better tax and regulatory treatment. The investor can buy the equity with a trial period; the issuer can spread the dilution effect in time, which is better against unwanted takeovers. The issuer can sell the volatility of the equity, which he knows better than the investor does.
II - 17 2001 GARP
November 17, 2001
128.
Compared to traditional ways to invest, hedge funds generally are, as a vehicle for investment: a. b. c. d. More risky, because they are smaller and less diversified. Less risky, because they are managed by small, more efficient teams. More risky, because they are more leveraged. Less risky, because they hedge their positions.
129.
FASB's latest decision about banks' losses related to the events of 11th September 2001 is that these: a. b. c. d. Losses must appear as capital losses. Are an extraordinary item. Must be shown as a separate item within extraordinary items. Must appear in the relevant places in the P&L, according to their nature.
130.
Liquidity risk is the risk that: I. II. III. IV. a. b. c. d. The markets get less active, making it difficult to exit The offices get flooded It becomes difficult to borrow money The process for settlement becomes less smooth I and II II and III I and III I and IV
November 17, 2001
II - 18
2001 GARP
Answer Key
Question 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30
November 17, 2001 A-1
Answer c c b b a d b a a a c b a b a b b c c d a d c a b&c a a d b c
2001 GARP
31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63
c a d c c d c b d a d a b d a d a c b d c a b b d c b b c a b b a
2001 GARP
64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96
d c b c a b b d a c c a&c a a b a c d b c b b b c c d c c b b a c d
2001 GARP
97 98 99 100 101 102 103 104 105 106 107 108 109 110 111 112 113 114 115 116 117 118 119 120 121 122 123 124 125 126 127 128 129
c c b d a c b b a b c&d b c a d b a a c c d b a a d b d c d c d c d
2001 GARP
130
November 17, 2001
A-5
2001 GARP

M. Examination

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Global Association of Risk Professionals

2001 Financial Risk Manager Exam

November 17, 2001

Various download at www.PromoteCareer.com

Global Association of Risk Professionals

2001 Financial Risk Manager Exam

November 17, 2001

Various download at www.PromoteCareer.com

Global Association of Risk Professionals

2001 Financial Risk Manager Exam

November 17, 2001

Various download at www.PromoteCareer.com

Global Association of Risk Professionals

2001 Financial Risk Manager Exam

Credit Risk Management

November 17, 2001

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Global Association of Risk Professionals

2001 Financial Risk Manager Exam

November 17, 2001

Various download at www.PromoteCareer.com

Global Association of Risk Professionals

2001 Financial Risk Manager Exam

November 17, 2001

Various download at www.PromoteCareer.com

Global Association of Risk Professionals

2001 Financial Risk Manager Exam

November 17, 2001

Various download at www.PromoteCareer.com

Global Association of Risk Professionals

2001 Financial Risk Manager Exam

November 17, 2001

Various download at www.PromoteCareer.com

Global Association of Risk Professionals

2001 Financial Risk Manager Exam

November 17, 2001

Various download at www.PromoteCareer.com

Global Association of Risk Professionals

2001 Financial Risk Manager Exam

November 17, 2001

Various download at www.PromoteCareer.com

Global Association of Risk Professionals

2001 Financial Risk Manager Exam

November 17, 2001

Various download at www.PromoteCareer.com

Global Association of Risk Professionals

2001 Financial Risk Manager Exam

November 17, 2001

Various download at www.PromoteCareer.com

Global Association of Risk Professionals

2001 Financial Risk Manager Exam

Regulation and Compliance Risk Management

November 17, 2001

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Global Association of Risk Professionals

2001 Financial Risk Manager Exam

November 17, 2001

Various download at www.PromoteCareer.com

Global Association of Risk Professionals

2001 Financial Risk Manager Exam

November 17, 2001

Various download at www.PromoteCareer.com