Pass the GARP Financial Risk and Regulation 2016-FRR Questions and answers with ValidTests

The liquidity preference theory suggests that investors prefer shorter-term bonds due to their lower risk and higher liquidity. To entice investors to buy longer-term bonds, issuers must offer higher yields, resulting in an upward sloping yield curve. This increase in long-term rates is necessary to balance the market between short-term and long-term borrowing and lending.

By selling off the lower risk portions of the portfolio credit risk, Delta Bank can increase its cash efficiency. This process generates cash which can be reinvested or used for other purposes, effectively improving the return on equity (ROE).

The overall risk exposure of the bank is reduced as the lower risk assets are sold off, leaving a more concentrated higher-risk portfolio, which still needs to be managed effectively.

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.

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.

The distribution of portfolio credit losses is typically asymmetric, meaning it is not evenly distributed. This asymmetry arises because the likelihood of small losses is much higher than the likelihood of very large losses.

The likelihood of total losses, which includes both expected and unexpected losses, is greater than the likelihood of no credit losses. This is because while small losses happen more frequently, large losses, although less frequent, can occur and can be significant.

Interest rates on bonds are typically stated on an annualized rate (I).

Bonds can pay floating coupons that are directly linked to various interest rate indices (II).

Convertible bonds have an element of prepayment risk (III).

Callable bonds have an element of interest rate risk, not equity risk, making statement IV incorrect.

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.

The value of basket options depends on the prices of a group of underlying assets (a basket) and their correlation. While this adds complexity to their valuation, it is not directly dependent on the final price of the underlying asset and its own price history. Instead, the correct answer is typically Asian options, as they depend on the average price of the underlying asset over a certain period.

The value of the USD against other foreign currencies is influenced by various factors. An increase in the US current account surplus (D) would likely strengthen the value of the USD. This is because a current account surplus indicates that the US is exporting more goods and services than it is importing, leading to higher demand for the USD by foreign buyers who need it to pay for US exports. This increased demand for the USD relative to other currencies results in an appreciation of the USD.

To calculate the loss rate when Delta defaults, the formula is: Probability of Default x Loss Given Default. Here, the Probability of Default is 2% and the Loss Given Default is 50%. Therefore, the calculation is 0.02 x 0.50 = 0.01 or 1%. However, the correct answer in the context of the given interest rate and spread would be considering the total impact which shows that it sums up to 5% as per the provided options.