Free Practice Questions for GARP 2016-FRR Exam

Credit risk refers to the risk that a borrower will default on any type of debt by failing to make required payments. It is typically a form of performance risk in a contractual relationship, where one party is at risk of loss due to another party's inability to fulfill financial obligations. This is distinguished from market risk (related to market prices), liquidity risk (related to the availability of funds), and other operational risks that companies might face.

The relationship that approximates the yield on a risk-free instrument, excluding the credit quality of the Credit Default Swap (CDS) protection seller, is given by the combination of a bond and a CDS. The bond provides the base yield, and the CDS offers protection against default, together creating an instrument that mimics the characteristics of a risk-free yield by hedging against credit risk.

References

Verified information on risk-free yield approximation from the document ​

The credit spread reflects the additional yield over the risk-free rate that investors demand to compensate for the risk of default. An increase in the probability of default of the issuer (I) would directly increase the credit spread as investors require more return for higher risk. Similarly, an increase in expected loss (IV) would increase the credit spread since the potential loss in the event of default is greater. On the other hand, a decrease in risk premium (II) or a decrease in loss given default (III) would typically lower the credit spread, not increase it.

Gamma Bank would typically accept the following as financial collateral:

Equities and Convertible Bonds:Included in a main market index due to their liquidity and value recognition.

Commercial Debts (Receivables):Owed to a company, which can be factored or used as collateral.

Mutual Fund Shares and Similar Investment Vehicles:Subject to daily quotes ensuring transparency and liquidity.

Unrated bonds, even if traded on a recognized exchange, carry higher uncertainty and lack the creditworthiness validation that rated bonds possess, making them less preferable as collateral.

References

Verified information on acceptable financial collateral from the document ​

As of April 2007, the three most widely traded currencies on the global foreign exchange market in decreasing order of market share were the United States dollar (USD), the European euro (EUR), and the Japanese yen (JPY). This ranking reflects the liquidity and trading volume associated with each currency, with the USD being the most traded, followed by the EUR and then the JPY.

The formula to estimate a partial change in an option's price based on the change in the underlying asset's price is primarily dependent on the option's Delta. Delta represents the sensitivity of the option's price to changes in the price of the underlying asset. Therefore, the most straightforward and widely used formula to estimate this partial change is:

Partial change in option price=Δ×Change in underlying pricePartial change in option price=Δ×Change in underlying price

This formula directly utilizes Delta to measure the immediate rate of change in the option's price relative to a small change in the underlying asset's price. The other options involving Gamma are more complex and not typically used for simple partial changes.

When an asset manager for a large mutual fund engages in forward exchange transactions traded in a clearinghouse system, the primary risks that arise are exchange rate risk and credit risk. Exchange rate risk is inherent in any foreign exchange transaction due to potential fluctuations in the currency's value over time. Credit risk is also significant as it involves the possibility that the counterparty may default on their contractual obligations.

A country's creditworthiness is typically influenced by various performance statistics that indicate the overall health of its economy. Here’s a detailed analysis of each option:

A. Low unemployment:Low unemployment indicates a healthy labor market, suggesting economic stability and growth, which positively impacts creditworthiness.

B. Low inflation:Low inflation reflects price stability, which helps maintain the purchasing power of the currency and economic stability, thus benefiting creditworthiness.

C. High degrees of investment:High levels of investment indicate confidence in the economy and potential for future growth, positively affecting creditworthiness.

D. Low degrees of savings:Low savings rates can indicate potential issues with financial stability, as it suggests that households and the economy might lack a financial buffer against economic shocks. This can negatively impact creditworthiness, making it the exception in this list.

Asian options are a type of derivative that have a payoff based on the average price of the underlying asset over a certain period or on specific dates. This averaging mechanism makes them particularly useful for companies with recurring foreign currency demands, as it helps smooth out volatility and provides a more stable hedge against currency fluctuations. Given the large energy company's need for an option that fits the description of averaging prices over specific dates or within a pricing window, Asian options are the most suitable choice.

Delta is a measure of how much the price of an option is expected to change when the price of the underlying asset changes by one unit. It is used to approximate the short-term change in the value of the option based on the price movement of the underlying asset. Therefore, Delta is best defined as the multiplier that approximates the short-term change in the value of an option.