Free Practice Questions for GARP 2016-FRR Exam

To quantify the aggregate average loss for the credit portfolio and its possible constituent subportfolios, a credit portfolio manager should use the expected loss metric. This measure captures the average anticipated loss due to defaults and is essential for understanding the baseline risk of the portfolio.

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A decrease in inflation rates typically leads to an increase in the price of fixed income instruments like bonds. Lower inflation increases the real value of the fixed payments received from bonds, making them more attractive to investors and driving up their prices.

Range options, also known as "corridor options" or "double no-touch options," have two strike prices. The payoff for a range option depends on the price of the underlying asset remaining within a specified range between the two strike prices during the life of the option. This dual strike price structure is what distinguishes range options from other types of options.

In the United States, the largest component of securitized debt is represented by real estate loans. Securitization involves pooling various types of debt instruments, including mortgages, auto loans, credit card debt, and others, and selling them as bonds to investors. The largest portion of this market is dominated by mortgage-backed securities (MBS), which are based on real estate loans. These securities were especially prominent leading up to the 2008 financial crisis and continue to represent a significant share of the securitization market.

The pricing of credit default swaps (CDS) is primarily influenced by:

Probability of Default:The likelihood that the underlying entity will default on its obligations.

Duration:The term or maturity of the CDS contract.

Loss Given Default:The expected loss if the underlying entity defaults.

Market spreads, while relevant to bond pricing and other instruments, are not a direct factor in the calculation of the pricing of CDS contracts.

References

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Herd behavior in the context of credit defaults refers to a situation where the stigma of default decreases, leading more borrowers to default as they see others doing the same. This creates a pattern of increasing defaults in the neighborhood as more borrowers follow the trend.

DeltaBank is likely to engage in securitization to create a new profit center, release risk and regulatory capital for redeployment, and generate cash for additional debt origination. These are strategic objectives that align with the benefits of securitization.

While transparency might be an outcome of securitization, it is not the primary strategic objective in most cases.

According to the principles of the Basel II Accord, the implementation and relative weights of the elements of the operational risk framework depend on the culture of the financial institution (I), regulatory drivers (II), and business drivers (III). The bank's reporting currency (IV) is not relevant to the implementation of the operational risk framework under Basel II.

Comprehensive and Detailed In-Depth Explanation:

The Basic Indicator Approach (BIA) under Basel II is a simple method to calculate operational risk capital. It requires banks to hold capital equal to 15% of the average annual gross income over the previous three years, where gross income is defined as net interest income plus net non-interest income (excluding extraordinary items). Only positive gross income years are included in the average. The formula is:

Operational Risk Capital = 15% × (Average Gross Income over 3 years).

This is explicitly stated in the Basel II framework, making C (three years multiplied by 15%) correct. Other options do not align with the BIA requirements.

The PVBP (Present Value of a Basis Point) can be calculated by taking the change in the bond's price and dividing it by the change in yield (expressed in basis points). Here, the bond's price drops from $1,000 to $976 when the yield increases from 4.7% to 4.71%, which is a 1 basis point increase. The change in price is $1,000 - $976 = $24. Therefore, the PVBP is $24 / 1 = $24.