Financial Risk and Regulation (FRR) Series Exam 2016-FRR Exam Questions

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Question #1 (Topic: Demo Questions)

Which one of the following four statements about the relationship between exchange rates and option values is correct?

As the dollar appreciates relative to the pound, the right to buy dollars at a fixed pound exchange rate decreases.

As the dollar appreciates relative to the pound, the right to buy dollars at a fixed pound exchange rate increases.

As the dollar depreciates relative to the pound, the right to buy dollars at a fixed pound exchange rate increases.

As the dollar appreciates relative to the pound, the right to sell dollars at a fixed pound exchange rate increases.

Correct Answer: B

Explanation:

When the dollar strengthens against the pound, the value of an option that allows the purchase of dollars at a predetermined exchange rate increases. This is because the option provides the right to buy the appreciating dollar at a rate that becomes more favorable as the market rate moves higher.

Question #2 (Topic: Demo Questions)

In its VaR calculations, JPMorgan Chase uses an expected tail-loss methodology which approximates losses at the 99% confidence level. This methodology consists of two subsequent steps to estimate the VaR. Which of the following explains this two-step methodology?

After VaR is computed at the 97% confidence level, the expected tail loss in excess of that confidence level is determined, which is then compared with the VaR estimate at the 99% confidence level.

After VaR is computed at the 99% confidence level, the expected tail loss in excess of that confidence level is determined, which is then compared with the VaR estimate at the 98% confidence level.

After VaR is computed at the 99% confidence level, the expected tail loss in excess of that confidence level is determined, which is then compared with the VaR estimate at the 99% confidence level.

After VaR is computed at the 1% confidence level, the expected tail loss in excess of that confidence level is determined, which and is then compared with the VaR estimate at the 98% confidence level.

Correct Answer: C

Explanation:

JPMorgan Chase's expected tail-loss methodology in VaR calculations involves:

First , computing VaR at the 99% confidence level.

Then , determining the expected tail loss in excess of that confidence level, which is then compared with the VaR estimate at the 99% confidence level.

This approach helps in understanding the potential extreme losses that might occur beyond the 99% confidence threshold.

Question #3 (Topic: Demo Questions)

A bank customer expecting to pay its Brazilian supplier BRL 100 million asks Alpha Bank to buy Australian dollars and sell Brazilian reals. Alpha bank does not hold Brazilian reals so it asks for a quote to buy Brazilian reals in the market. The market rate is 100. The bank quotes a selling rate of 101 to its customer, sells the reals, and receives AUD 1,010,000. To perform foreign exchange matched position trading, the banks should

Immediately buy the real at the market rate of 100 and pay AUD 1,000,000.

Immediately buy the real above the market rate of 105 and pay AUD 1,050,050.

Immediately sell the real at the market rate of 100 and receive AUD 1,000,000.

Immediately sell the real above the market rate of 105 and receive AUD 1,050,050

Correct Answer: A

Explanation:

To perform foreign exchange matched position trading, Alpha Bank should match the customer's transaction to eliminate currency risk. Here’s the breakdown:

Customer transaction : The customer buys AUD 1,010,000 at a rate of 101 for BRL 100 million.

Market transaction : To cover this, Alpha Bank should buy BRL at the market rate of 100, paying AUD 1,000,000 (BRL 100 million / 100 = AUD 1,000,000).

This ensures that the bank is not exposed to fluctuations in the BRL/AUD exchange rate.

References

Source: How Finance Works

Question #4 (Topic: Demo Questions)

An endowment asset manager with a focus on long/short equity strategies is evaluating the risks of an equity portfolio. Which of the following risk types does the asset manager need to consider when evaluating her diversified equity portfolio?

I. Company-specific projected earnings and earnings risk

II. Aggregate earnings expectations

III. Market liquidity

IV. Individual asset volatility

I, IV

II, III

I, II, IV

Correct Answer: D

Explanation:

When evaluating a diversified equity portfolio, an endowment asset manager should consider:

Company-specific projected earnings and earnings risk to understand the performance potential and variability of individual assets.

Aggregate earnings expectations to gauge the overall market outlook and economic conditions affecting the portfolio.

Individual asset volatility to assess the risk and potential fluctuations in the value of specific investments within the portfolio.

Market liquidity, while important, is not typically a primary concern for long/short equity strategies focused on diversified portfolios.

Question #5 (Topic: Demo Questions)

Typically, which one of the following four option risk measures will be used to determine the number of options to use to hedge the underlying position?

Vega

Rho

Delta

Theta

Correct Answer: C

Explanation:

Delta is the most commonly used risk measure to determine the number of options needed to hedge an underlying position. Delta measures the sensitivity of the option's price to changes in the price of the underlying asset. A delta-neutral portfolio, where the total delta is zero, effectively hedges against small movements in the underlying asset's price. Thus, risk managers frequently adjust their hedging strategies based on the delta of their positions.

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