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GARP 2016-FRR Sample Question Answers

Question # 1

A large multinational bank is concerned that their duration measures may not be accuratesince the yield curve shifts are not parallel. Which of the following statements would betypically observed regarding variability of interest rates?

A. Short-term rates are more variable than long-term rates.
B. Short-term rates are less variable than long-term rates.
C. Short-term rates are equally variable as long-term rates.
D. Short-term rates and long-term rates always move in opposite directions.

Question # 2

Which of the following statements about the option gamma is correct? Gamma is the I. Second derivative of the option value with respect to the volatility.II. Percentage change in option value per percentage change in the price of the underlyinginstrument.III. Second derivative of the value function with respect to the price of the underlyinginstrument.IV. Rate of change of the option delta with respect to changes in the underlying price.

A. I only
B. II and III
C. III and IV
D. II, III, and IV

Question # 3

A portfolio consists of two floating rate bonds and one fixed rate bond. Based on the information below, modified duration of this portfolio is

A. 2.64
B. 3.00
C. 4.28
D. 4.44

Question # 4

John owns a bond portfolio worth $2 million with duration of 10. What positions must hetake to hedge this portfolio against a small parallel shifts in the term structure.

A. Long position worth $2 million with duration of 10.
B. Long position worth $20 million with duration of 1.
C. Short position worth $2 million with duration of 10.
D. Short position worth $20 million with duration of 1.

Question # 5

Returns on two assets show very strong positive linear relationship. Their correlationshould be closest to which of the following choices?

A. 15%
B. 45%
C. 60%
D. 100%

Question # 6

Oliver McCarthy owns a portfolio of bonds. Which of the following choices equals themodified duration of Oliver's portfolio?

A. Minimum of the modified durations of the component bonds
B. Value-weighted average modified duration of the component bonds
C. Coupon-weighted average modified duration of the component bonds
D. Maximum of the modified durations of component bonds

Question # 7

From a risk point of view, which of the following factors will generally lead to the fluctuation of equity values with industry P/E levels and a company's individual earnings?I. SalesII. Cost managementIII. Commercial success of the companyIV. Market sentiment

A. I, II
B. II, IV
C. III, IV
D. I, II, III

Question # 8

What do option deltas measure?

A. The rate of change of the option value with respect to changes in volatility of theunderlying instrument.
B. The sensitivity of the option value to changes risk free interest rate.
C. The rate of change of the option value with respect to changes in the price of theunderlying instrument.
D. The sensitivity of the option value to the passage of time.

Question # 9

James Johnson purchased a plain vanilla bond that has modified duration of 10 andconvexity of 0.5. If yields increase by 1%, its modified duration is expected to

A. increase by 0.5.
B. increase by 1.5.
C. decrease by 0.5.
D. decrease by 1.5.

Question # 10

Which one of the following four statements about equity indices is INCORRECT?

A. Equity indices are numerical calculations that reflect the performance of hypotheticalequity portfolios.
B. Equity indices do not trade in cash form, rather, they are meant to track the overallperformance of an equity market.
C. Capitalization-weighted equity indices are not generally considered better to track theperformance of an overall market.
D. Price-weighted equity indices give greater weight to shares trading at high prices.

Question # 11

On January 1, 2010 the TED (treasury-euro dollar) spread was 0.9%, and on January 31,2010 the TED spread is 0.4%. As a risk manager, how would you interpret this change?

A. The decrease in the TED spread indicates a decrease in credit risk on interbank loans.
B. The decrease in the TED spread indicates an increase in credit risk on interbank loans.
C. Increase in interest rates on both interbank loans and T-bills.
D. Increase in credit risk on T-bills.

Question # 12

What is a common implicit assumption that is made when computing VaR using parametricmethods?

A. The expected returns are constant, but the standard deviation changes over time.
B. The standard deviations of returns are constant, but the mean changes over time.
C. The mean of and the standard deviations of returns are both constant.
D. The mean and standard deviation of returns change periodically in response to crises.

Question # 13

Which one of the following statements regarding collateralized mortgage obligations (CMO)is incorrect?

A. CMOs have senior tranches which are considered short-term, low-risk instruments bybanks
B. CMOs are asset-backed securities that have pools of collateralized debt obligations(CDOs) as underlying collateral.
C. CMOs are generally less risky investment than CDOs.
D. CMOs are pools of mortgages that are divided according to the timing of cash flows.

Question # 14

James Johnson manages a bond portfolio with all investment grade bonds. Adding whichof the following bonds would minimize the credit risk of his portfolio?

A. A
B. B
C. C
D. D

Question # 15

A corporate bond gives a yield of 6%. A same maturity government bond yields 2%. Theprobability of the corporate bond defaulting is 2.5%. In case of default, investors expect tolose 60% of their investment. The risk premium in the credit spread is:

A. 1.5%
B. 4.5%
C. 2.5%
D. 0.5%

Question # 16

James Johnson bought a coupon bond yielding 4.7% for $1,000. Assuming that the pricedrops to $976 when yield increases to 4.71%, what is the PVBP of the bond.

A. $26.
B. $76.
C. $870.
D. $976.

Question # 17

Which one of the four following statements about back testing the VaR models is correct?Back testing requires

A. Plotting VaR forecasts against the proportion of daily losses exceeding the average loss.
B. Comparing the predictive ability of VaR on a daily basis to the realized daily profits andlosses.
C. Plotting the daily profit and losses along with the ranges predicted by VaR models
D. Determining the proportion of daily profits exceeding those predicted by VaR.

Question # 18

Gamma Bank estimates its monthly portfolio volatility at 5%.The portfolio's annual volatilityis closest to which of the following?

A. 8%
B. 17%
C. 30%
D. 35%

Question # 19

Which type of risk does a bank incur on loans that are in the "pipeline", i.e loans that are inthe process of origination but not yet originated?

A. Interest rate risk and credit risk
B. Interest rate risk only
C. Credit Risk only
D. The bank does not incur any risk since the loan is not yet originated

Question # 20

An options trader for a large institutional investor takes a long equity option position. Whichof the following risks need to be considered when taking this position?I. All the risks of underlying equitiesII. Perceived volatility changesIII. Future dividends yieldsIV. Risk-free interest rates

A. I, II
B. II, III
C. III, IV
D. I, II, III, IV

Question # 21

Which one of the following four statements regarding commodity exchanges isINCORRECT?

A. Banks have no natural direct exposure to commodities.
B. Banks trade in OTC contracts primarily to serve clients and facilitate client hedging andlending.
C. Customers rarely trade physical commodities with banks.
D. Commodity markets are mot liquid than debt markets.

Question # 22

Which one of the following four relationships should be used to price equity forwards orfutures?

A. Equity forward or futures price = market equity price + (1 + risk-free rate – expecteddividend rate)t
B. Equity forward or futures price = market equity price x (1 - risk-free rate – expecteddividend rate)t
C. Equity forward or futures price = market equity price x (1 + risk-free rate – expecteddividend rate)t
D. Equity forward or futures price = market equity price + (1 + risk-free rate + expecteddividend rate)t

Question # 23

Which one of the following is a reason for a bank to keep a commercial loan in its portfoliountil maturity?I. Commercial loans usually have attractive risk-return profile.II. Commercial loans are difficult to sell due to non standard features.III. Commercial loans could be used to maintain good relations with important customers.IV. The credit risk in commercial loans is low.

A. I, II and III
B. III and IV
C. II and IV
D. IV only

Question # 24

James Johnson bought a 3-year plain vanilla bond that has yield of 4.7% and 4% couponpaid annually, for $87,139. Macauley's duration of the bond is 2.94 years. Rate volatility is20% of the yield. The bond's annualized volatility is therefore:

A. 3.15%.
B. 2.90%.
C. 2.81%.
D. 2.64%.

Question # 25

A corporate bond was trading with 2%probability of default and 60% loss given default. Dueto the credit crisis the probability of default increased to 10% and the loss given defaultincreased to 100%. Assuming that the risk premium remained the same how did the creditspread change?

A. Increased by 1120 basis points
B. Increased by 880 basis points
C. Increased by 1000 basis points
D. Decreased by 880 basis points

Question # 26

Which one of the following four statements regarding commodity derivative risks isINCORRECT?

A. Because of the different demand/supply balance in each region and the cost oftransporting the oil between regions, a tanker of Brent crude oil in the UK will have adifferent value to a UK buyer than a tanker of Arab light crude oil in Singapore, whichresults in the basis risk.
B. Calendar spreads represent a special case of basis risk and occur when the relativeprices of commodity futures do not come in alignment and the trader becomes exposed tothe absolute price movements.
C. In most commodities, the longest term contracts are the most volatile, while the shortestterm forward contract are the least volatile.
D. Some commodities can be both in backwardation and a have a strong seasonalelement.

Question # 27

A multinational bank just bought two bonds each worth $10,000. One of the bonds pays afixed interest of 5% semi-annually and the other pays LIBOR semi-annually. The six monthLIBOR is at 5% currently. The risk manager of the bank is concerned about the sensitivityto interest rates. Which of the following statements are true?

A. The price of the bond paying floating interest is more sensitive to interest rates than thebond paying fixed interest.
B. The price of the bond paying fixed interest is more sensitive to interest rates than thebond paying floating interest.
C. Both bond prices are equally sensitive to interest rates.
D. The given information is not enough to determine the sensitivity of the bond prices.

Question # 28

Which of the following statements regarding CDO-squared is correct?I. CDO-squared use other CDOs and CMOs as collateral.II. Risk assessment of CDO-squared is almost impossible due to their complexity.III. CDO-squared have lower credit risk than CMOs but higher than CDOs.

A. I only
B. I and II
C. II and III
D. I, II, and III

Question # 29

To protect the oranges harvest price level, a farmer needs to take a hedge position.Provided that he produces the amount he hedged, which one of the following fourstrategies will allow the farmer to accomplish his goal?

A. Going short on oranges futures contracts
B. Going long on oranges futures contacts
C. Entering into a customized forward contract with the bank
D. Negotiating a credit line facility

Question # 30

To estimate the responsiveness of a particular equity portfolio to the overall market, atrader should use the portfolio's

A. Alpha
B. Beta
C. CVaR
D. VaR

Question # 31

Which of the following statements is a key difference between customer loans andinterbank loans?

A. Customers are less credit-worthy than banks on average and hence yields are higher onaverage for customer loans as compared to interbank loans
B. Customer loans are of shorter duration than interbank loans
C. Customer loans are easier to sell than interbank loans
D. Interbank loans are more customized than commercial loans

Question # 32

The skewness of ABC company's stock returns equal -1.5. What is the correctinterpretation of this?

A. It indicates higher relative probability of negative returns compared to estimates derivedfrom a normal distribution.
B. It indicates that the returns are indeed normally distributed.
C. It indicates lower probability of extreme negative events compared to the normaldistribution.
D. It indicates higher relative probability of extreme events than non-extreme eventscompared to estimates from a normal distribution.

Question # 33

Which of the following statements about parametric and nonparametric methods forcalculating Value-at-risk is correct?

A. Parametric methods generally assume returns are normally distributed, and nonparametricmethods make no assumptions about return distributions.
B. Parametric methods make no assumptions about return distributions, and nonparametricmethods assume returns are normally distributed.
C. Both parametric and nonparametric methods assume returns are normally distributed.
D. Both parametric and nonparametric methods make no assumptions about returndistributions.

Question # 34

A proprietary trading desk for a large bank hedges an Arab light OTC forward position with Brent crude oil forwards. The trading desk benefits from using the most liquid OTC marketto hedge, the market for the Brent crude, but hedging its using the Brent contract, exposesitself to the following type of risk:

A. Basis risk
B. Term risk
C. Correlation risk
D. Seasonality risk

Question # 35

Over a long period of time DeltaBank has amassed a large equity option position. Which ofthe following risks should be considered in this transaction?I. Counterparty risk on long OTC option positionsII. Counterparty risk on short OTC option positionsIII. Counterparty risk on long exchange-traded option positionsIV. Counterparty risk on short exchange-traded option positions

A. I
B. I, II
C. II, III
D. II, III, IV

Question # 36

James Johnson has a $1 million long position in ThetaGroup with a VaR of 0.3 million, and$1 million long position in VolgaCorp with a VaR of 0.4 million. The returns of the twocompanies have zero correlation. What is the portfolio VaR?

A. $1 million
B. $0.7 million
C. $0.5 million
D. $0.4 million

Question # 37

Which of the following statements regarding collateralized debt obligations (CDOs) iscorrect?I. CDOs typically have loans or bonds as underlying collateral.II. CDOs generally less risky than CMOs.III. There is a correlation among defaults in the CDO collateral which should be consideredin valuation of these complex instruments.

A. I only
B. I and III
C. II and III
D. I, II, and III

Question # 38

Unico Delta stock is trading at $20 per share, its annualized dividend yield is 5% and the12-month LIBOR is 3%. Given these statistics, the 12-month futures contact will trade at:

A. $10.08
B. $20.04
C. $30.04
D. $40.08

Question # 39

Which one of the following four physical commodities markets has the right combination ofcharacteristics that generally allows short selling in the market, without making the shortsellingtransaction prohibitively expensive?

A. Oil
B. Natural Gas
C. Grain
D. Gold

Question # 40

Banks duration match their assets and liabilities to manage their interest risk in theirbanking book. A bank has $100 million in interest rate sensitive assets and $100 million ininterest rate sensitive liabilities. Currently the bank's assets have a duration of 5 and itsliabilities have a duration of 2. The asset-liability management committee of the bank is inthe process of duration-matching. Which of the following actions would best match thedurations?

A. Increase the duration of liabilities by 2 and increase the duration of assets by 1.
B. Increase the duration of liabilities by 2 and decrease the duration of assets by 1.
C. Decrease the duration of liabilities by 1 and increase the duration of assets by 1.
D. Decrease the duration of liabilities by 1 and decrease the duration of assets by 1.

Question # 41

If the yield on the 3-month risk free bonds issued by the U.S government is 0.5%, and the3-month LIBOR rate is 2.5%, what is the TED spread?

A. 0.5%
B. -2.0%
C. 2.0%
D. 3.0%

Question # 42

If the yield on the 3-month risk free bonds issued by the U.S government is 0.5%, and the3-month LIBOR rate is 2.5%, what is the TED spread?

A. 0.5%
B. -2.0%
C. 2.0%
D. 3.0%

Question # 43

In analyzing the historical performance of a financial product, you are concerned about "fattails", the probability of extreme returns compared to realized returns. Which of thefollowing measures should you use to determine if the product return distribution of the product has "fat tails"?

A. Mean
B. Standard deviation
C. Skewness
D. Kurtosis

Question # 44

Sam has hedged a portfolio of bonds against a small parallel shift in the yield curve usingthe duration measure. What should Sam do to ensure that the portfolio is hedged againstlarger parallel shifts in the yield curve?

A. Take positions to reduce the duration
B. Take positions to increase the duration
C. Take positions to make the convexity zero
D. Since the portfolio is duration hedged Sam does not need to take additional positions.

Question # 45

In early March, an energy trader takes a long position in natural gas futures for delivery inJune, and hedges this exposure by taking a position in futures for July delivery. Thesetrades were executed on the expectation that over time, the relative prices of the June andJuly contracts will come into alignment, the movement in these two contracts will largelymirror each other, and as a result of this, the net exposure is minimized and the position isprotected against absolute price movements. However, if the two relative prices do notcome into alignment with each other due to the scarcity of any of the two traded contractsin the futures market, the trader is likely to become exposed to the

A. Location basis
B. Quality basis
C. Product basis
D. Calendar spreads basis

Question # 46

In the United States, stock investors must comply with the Regulation T of the FederalReserve Bank and may borrow up to ___ of the value of the securities from their brokers.

A. 30%
B. 40%
C. 50%
D. 60%

Question # 47

Since most consumers of natural gas do not have the ability to store it, they contract withgas suppliers to receive a flow of natural gas equal to a specific number of MMBT's per day(MMBT is millions of British Termal Units, the unit in which gas futures are quoted on theU.S. markets). To protect against price increases with a bank, the natural gas consumer,concerned with the average price over the course of the month, will use the followingcontracts:

A. American options
B. Asian options
C. Compound options
D. Flexible volume options

Question # 48

Present value of a basis point (PVBP) is one of the ways to quantify the risk of a bond, andit measures:

A. The change in value of a bond when yields increase by 0.01%.
B. The percentage change in bond price when yields change by 1 basis point.
C. The present value of the future cash flows of a bond calculated at a yield equal to 1%.
D. The percentage change in bond price when the yields change by 1%.

Question # 49

Which one of the following four statements represents the advantages of the historical simulationmethod when calculating VaR?

A. Solve the problem caused by incorrectly assuming that asset returns are normallydistributed.
B. Rely on current market data to describe the distribution of returns and determinevolatilities.
C. Are believed to be superior in accuracy predicting future levels of realized volatility.
D. Are only using loss probabilities that can be found in tables of the standard normaldistribution.

Question # 50

To estimate the price of gold forwards, an investment analyst focuses on the cost ofholding physical gold (bullion) and the cost of shorting the same. Given that physical goldspot price is $1,000, the annual risk-free rate is 5%, and the gold lease rate equals 2%annually, the analyst's best estimate of the gold forward price to equal

A. $950
B. $1030
C. $1070
D. $1100

Question # 51

Unico Bank, concerned with managing the risk of its trading strategies, wants to implementthe trading strategy that exposes the bank to the lowest market risk. Which one of thefollowing four strategies should Unico take to limit its risk exposure?

A. A matched book strategy that allows the trading desk to match all customer positionsimmediately with an equal and opposite position by trading internally or with another bank.
B. A covering strategy that manages positions in the product by executing covering dealsor hedging deal at the discretion of the trading des.
C. A passive hedging strategy that allows the traders to price transactions with customersand other banks, at the relevant bid price on the market.
D. A market-maker strategy that allows the traders to quote a buy and sell price tocustomers and other banks and to trade at the relevant price on the sell side of the market.

Question # 52

Which of the following measure describes the symmetry of a statistical distribution?

A. Mean
B. Standard deviation
C. Skewness
D. Kurtosis

Question # 53

10 basis points are equal to:

A. 10%
B. 1%
C. 0.1%
D. 0.01%

Question # 54

What is a difference between currency swaps and interest rate swaps?

A. Currency swaps do not require the exchange of notional principal on maturity.
B. Currency swaps allow banks and customers to obtain the risk/reward profile of long-terminterest rates without having to use long-term funding.
C. Currency swaps are OTC derivative contracts.
D. Currency swaps generate foreign exchange rate risk in addition to interest rate risk.

Question # 55

To achieve leverage in long positions, a bank can use the following strategy:I. Securities may be purchased with borrowed funds using a bank loan from the broker.II. Securities may be borrowed on margin by taking a loan from a broker.III. Securities may be purchased and used in a repo transaction to generate cash for furthersecurity purchases.IV. The bank may enter into a derivative transaction, such as a total return swap, thatrequires little to no collateral but mimics the performance of a long or short position in theunderlying instrument.

A. I, II
B. I, III
C. II, IV
D. I, II, III, IV

Question # 56

A bank customer can use either a plain vanilla option or an option contract with volumetricflexibility to reduce the following risks:I. Market RiskII. Basis RiskIII. Operational Risk

A. I
B. II
C. I, II
D. II, III

Question # 57

Which one of the following four statements describes the advantage of using delta-gammamethod of mapping options positions over delta-normal method?Delta-gamma method

A. Converts options into underlying factor risks according to their deltas and the gammas tothose factors.
B. Fully captures option price risk, particularly for extreme price movements.
C. Overstates the risk of long option positions, but understate the risk of short optionpositions.
D. Approximates more accurately the non-linear relationship of option values and risk.

Question # 58

Which one of the following statements is an advantage of using implied volatility as an inputwhen calculating VaR?

A. Implied volatility assumes volatilities are constant which makes it easy to implement inmodels.
B. Current market data is used to determine implied volatilities, which makes them forwardlooking measures
C. Implied volatilities are better at predicting actual volatilities
D. Loss probabilities from the standard normal distribution are used to compute impliedvolatilities, which makes it easy to compute the.

Question # 59

Which one of the four following activities is NOT a component of the daily VaR computingprocess?

A. Updating individual risk factor models.
B. Computing portfolio risk by delta-normal or delta-gamma method.
C. Updating factor interrelationships.
D. Producing the VaR report.

Question # 60

Which one of the following statements describes Macauley's duration?

A. The change in value of a bond when yields increase by 1 basis point.
B. The weighted average life of the bond payments.
C. The present value of the future cash flows of a bond calculated at a yield equal to 1%.
D. The percentage change in a bond price when the yields change by 1%.

Question # 61

Samuel Teng owns a portfolio of bonds and is trying to compute the convexity of hisportfolio. Which of the following choices equals the convexity of Samuel's portfolio?

A. Minimum of the convexities of the component bonds
B. Value-weighted average convexity of the component bonds
C. Coupon-weighted average convexity of the component bonds
D. Maximum of the convexities of the component bonds

Question # 62

When the cost of gold is $1,100 per bullion and the 3-month forward contract trades at$900, a commodity trader seeks out arbitrage opportunities in this relationship. Tocapitalize on any arbitrage opportunities, the trader could implement which one of thefollowing four strategies?

A. Short-sell physical gold and take a long position in the futures contract
B. Take a long position in physical gold and short-sell the futures contract
C. Short-sell both physical gold and futures contract
D. Take long positions in both physical gold and futures contract

Question # 63

The probability of default on a bond is 3%, and in the case of default, investors expect tolose 70% of their investment. The bond's risk premium is 1.9%. The expected loss and thecredit spread of the bond are, respectively:

A. 1.6% and 2.5%.
B. 2.1% and 3%.
C. 1.6% and 3.5%.
D. 2.1% and 4%.

Question # 64

A bank owns a portfolio of bonds whose composition is shown below. What is the modified duration of the portfolio?

A. 1.30
B. 8.5
C. 2.30
D. 0.5

Question # 65

Which one of the following four interest rate related yield curves is used to revalue loan anddeposit positions in banks?

A. Derivative
B. Bond
C. Cash
D. Basis

Question # 66

A risk associate is trying to determine the required risk-adjusted rate of return on a stockusing the Capital Asset Pricing Model. Which of the following equations should she use tocalculate the required return?

A. Required return = risk-free return + beta x market risk
B. Required return = (1-risk free return) + beta x market risk
C. Required return = risk-free return + beta x (1 – market risk)
D. Required return = risk-free return + 1/beta x market risk

Question # 67

Modified duration of a bond measures:

A. The change in value of a bond when yields increase by 1 basis point.
B. The percentage change in a bond price when yields increase by 1 basis point.
C. The present value of the future cash flows of a bond calculated at a yield equal to 1%.
D. The percentage change in a bond price when the yields change by 1%.

Question # 68

By lowering the spread on lower credit quality borrowers, the bank will typically achieve allof the following outcomes EXCEPT:

A. Aggressively courting of new business
B. Lower probability of default
C. Rapid growth
D. Higher losses in case of default