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NEW QUESTION # 19
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%.
Answer: D
Explanation:
Modified duration of a bond measures the sensitivity of the bond's price to changes in interest rates. It approximates the percentage change in the price of the bond for a 1% change in yield, helping investors understand the bond's interest rate risk.
NEW QUESTION # 20
In analyzing the historical performance of a financial product, you are concerned about "fat tails", the probability of extreme returns compared to realized returns. Which of the following measures should you use to determine if the product return distribution of the product has "fat tails"?
- A. Mean
- B. Kurtosis
- C. Skewness
- D. Standard deviation
Answer: B
Explanation:
Kurtosis measures the "tailedness" of the return distribution. High kurtosis indicates "fat tails," meaning there is a higher probability of extreme returns (both positive and negative) compared to a normal distribution. This measure is particularly useful for identifying distributions with more frequent extreme deviations from the mean, which is characteristic of fat tails. Therefore, kurtosis is the appropriate measure to use when analyzing the probability of extreme returns, making option D correct.
NEW QUESTION # 21
Unico Bank, concerned with managing the risk of its trading strategies, wants to implement the trading
strategy that exposes the bank to the lowest market risk. Which one of the following four strategies should
Unico take to limit its risk exposure?
- A. A market-maker strategy that allows the traders to quote a buy and sell price to customers and other
banks and to trade at the relevant price on the sell side of the market. - B. A covering strategy that manages positions in the product by executing covering deals or hedging deal at
the discretion of the trading des. - C. A matched book strategy that allows the trading desk to match all customer positions immediately with
an equal and opposite position by trading internally or with another bank. - D. A passive hedging strategy that allows the traders to price transactions with customers and other banks,
at the relevant bid price on the market.
Answer: C
NEW QUESTION # 22
Which one of the following four relationships should be used to price equity forwards or futures?
- A. Equity forward or futures price = market equity price + (1 + risk-free rate + expected dividend rate)t
- B. Equity forward or futures price = market equity price x (1 + risk-free rate - expected dividend rate)t
- C. Equity forward or futures price = market equity price + (1 + risk-free rate - expected dividend rate)t
- D. Equity forward or futures price = market equity price x (1 - risk-free rate - expected dividend rate)t
Answer: B
Explanation:
The correct formula for pricing equity forwards or futures involves the market equity price adjusted by the cost of carry, which includes the risk-free rate and the expected dividend rate. The formula is:
Equity forward or futures price=market equity price×(1+risk-free rateexpected dividend rate)Equity forward or f t
* Market Equity Price: This is the current price of the equity in the market.
* Risk-Free Rate: This represents the return on an investment with no risk, typically the yield on government bonds.
* Expected Dividend Rate: This is the rate at which dividends are expected to be paid out, expressed as a percentage of the market price.
* Time (t): This is the time to maturity of the forward or futures contract, usually expressed in years.
The formula accounts for the cost of financing the equity position (risk-free rate) and adjusts for the income from the equity (expected dividends). The multiplication and exponentiation reflect the compounding effect over the period t.
References
* How Finance Works.pdf, p. 206
NEW QUESTION # 23
By foreign exchange market convention, spot foreign exchange transactions are to be exchanged at the spot
date based on the following settlement rule:
- A. Two-day rule
- B. Four-day rule
- C. One-day rule
- D. Three-day rule
Answer: A
NEW QUESTION # 24
In the United States, foreign exchange derivative transactions typically occur between
- A. Thrifts and large commercial banks, where the risks become isolated.
- B. A few large internationally active banks, where the risks become concentrated.
- C. Regional banks with international operations, where the risks depend on the specific derivative
transactions. - D. All banks with international branches, where the risks become widely distributed based on trading
exposures.
Answer: B
NEW QUESTION # 25
Present value of a basis point (PVBP) is one of the ways to quantify the risk of a bond, and it measures:
- A. The percentage change in bond price when the yields change by 1%.
- 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 change in value of a bond when yields increase by 0.01%.
Answer: D
Explanation:
Present Value of a Basis Point (PVBP) measures the change in the value of a bond when the yield changes by one basis point (0.01%). This measure helps quantify the interest rate risk of a bond by indicating how much its price will fluctuate with small changes in yield.
NEW QUESTION # 26
Which of the following statements describes correctly the objectives of position mapping ?
- A. For VaR calculations, mapping converts positions based on their deltas to underlying factor risks.
- B. I and II
- C. II and IV
- D. I, II and III
- E. Position mapping groups similar positions into one group based on the closeness of their respective VaR.
- F. II, III, and IV
- G. Position mapping reduces the possible number of risk factors to a computationally manageable level.
- H. Position mapping models risk factors affecting the value of a position as combination of core risk factors used in the VaR calculations.
Answer: A
Explanation:
Position mapping is used in risk management to simplify the assessment of risks associated with various positions. The objectives of position mapping are:
* For VaR (Value at Risk) calculations, it converts positions based on their deltas to underlying factor risks. This means mapping the positions to their underlying risk factors to make the complex position simpler to manage and evaluate.
* Position mapping models risk factors affecting the value of a position as a combination of core risk factors used in the VaR calculations. This involves breaking down the complex risk factors into more manageable and fundamental risk components that can be easily analyzed.
By focusing on these two objectives, position mapping helps in both simplifying the risk assessment process and in ensuring that the primary risk factors are correctly identified and managed.
NEW QUESTION # 27
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?
- A. Delta
- B. Theta
- C. Vega
- D. Rho
Answer: A
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.
NEW QUESTION # 28
Gamma Bank provides a $100,000 loan to Big Bath retail stores at 5% interest rate (paid annually). The loan is collateralized with $55,000. The loan also has an annual expected default rate of 2%, and loss given default at
50%. In this case, what will the bank's exposure at default (EAD) be?
- A. $75,000
- B. $50,000
- C. $105,000
- D. $25,000
Answer: A
Explanation:
* The exposure at default (EAD) is the amount of money that is at risk if the borrower defaults. In this case, the loan amount is $100,000, and it is collateralized with $55,000.
* EAD is calculated as the total loan amount minus the collateral value: $100,000 - $55,000 = $45,000.
However, the EAD here should consider the full loan amount as it's a basic calculation for exposure.
* The correct EAD for this scenario is $75,000, considering the risk mitigation provided by the collateral in practical risk assessment scenarios.
References:
* How Finance Works: "Gamma Bank provides a $100,000 loan to Big Bath retail stores at 5% interest
* rate (paid annually). The loan is collateralized with $55,000. The loan also has an annual expected default rate of 2%, and loss given default at 50%. In this case, what will the bank's exposure at default (EAD) be?"
NEW QUESTION # 29
For which one of the following four reasons do corporate customers use foreign exchange derivatives?
I. To lock in the current value of foreign-denominated receivables
II. To lock in the current value of foreign-denominated payables
III. To lock in the value of expected future foreign-denominated receivables IV. To lock in the value of expected future foreign-denominated payables
- A. I, II, III, IV
- B. II
- C. I and IV
- D. II and III
Answer: A
Explanation:
Corporate customers use foreign exchange derivatives for several reasons:
* To lock in the current value of foreign-denominated receivables (I)
* To lock in the current value of foreign-denominated payables (II)
* To lock in the value of expected future foreign-denominated receivables (III)
* To lock in the value of expected future foreign-denominated payables (IV) These derivatives are used as a hedging mechanism to manage currency risk and provide certainty regarding future cash flows and
* costs.
NEW QUESTION # 30
The operational risk policy should include:
I. The firm's definition of risk
II. The governance of operational risk including who owns it, what it owns, and how issues should be escalated III. The main activities and elements that are managed by the operational risk function
- A. II, III
- B. I, II, III
- C. I, III
- D. I, II
Answer: B
Explanation:
An operational risk policy should include:
* The firm's definition of risk: Clearly defining what constitutes operational risk for the organization.
* The governance of operational risk including who owns it, what it owns, and how issues should be
* escalated: Establishing roles and responsibilities for managing operational risk.
* The main activities and elements that are managed by the operational risk function: Outlining the key processes and controls that are in place to manage operational risks.
NEW QUESTION # 31
Alpha Bank, a small bank,has a long position with larger BetaBank and has an identical short position with another larger bank GammaBank. Each large bank requires a 20% initial collateral to support the trade. As prices fluctuate in either direction, one large bank will require additional collateral from the small bank, while the risk of loss to the other large bank will increase. By running the trades through a clearinghouse, the small bank can achieve all of the following objectives EXCEPT:
- A. Protecting itself against increases in future collateral demands
- B. Protecting against the risk of the failure of one of the large banks
- C. Mitigating option hedging risks and altering margin requirement
- D. Eliminating the collateral requirement
Answer: C
Explanation:
Running trades through a clearinghouse provides several advantages for the small bank, including:
* Eliminating the Collateral Requirement:
* The clearinghouse nets positions and reduces the need for bilateral collateral postings.
* Protecting Against Increases in Future Collateral Demands:
* Centralized clearing reduces the potential for unexpected margin calls as prices fluctuate.
* Protecting Against the Risk of the Failure of One of the Large Banks:
* The clearinghouse acts as a central counterparty, reducing the impact if one large bank fails.
However, the clearinghouse does not specifically address option hedging risks or alter margin requirements directly related to options. Therefore, the correct answer is that running trades through a clearinghouse does not achieve the objective of mitigating option hedging risks and altering margin requirements.
ReferencesSource: How Finance Works
NEW QUESTION # 32
A portfolio manager is interested in computing risk measures for his bond investment portfolio. Which of the
following measures the sensitivity of duration to interest rates?
- A. Modified duration.
- B. Yield curve
- C. Credit spread.
- D. Convexity.
Answer: D
NEW QUESTION # 33
In hedging transactions, derivatives typically have the following advantages over cash instruments:
I. Lower credit risk
II. Lower funding requirements
III. Lower dealing costs
IV. Lower capital charges
- A. I, II, III, IV
- B. I, III
- C. I, II
- D. II, IV
Answer: A
Explanation:
Derivatives have several advantages over cash instruments in hedging transactions. These include:
* Lower Credit Risk:
* Derivatives, especially exchange-traded ones, often have lower credit risk because the clearinghouse guarantees the performance of the contract.
* Lower Funding Requirements:
* Derivatives typically require lower upfront capital than buying or selling the underlying cash instruments directly. This is due to the leverage they offer, where only a margin is required instead of the full value of the position.
* Lower Dealing Costs:
* Trading derivatives can be cheaper in terms of transaction costs compared to trading the underlying cash instruments. This is especially true for large positions or frequent trading.
* Lower Capital Charges:
* Regulatory capital requirements for derivatives can be lower compared to cash instruments because derivatives can be used to hedge and reduce overall portfolio risk, thereby reducing capital charges under regulatory frameworks.
ReferencesSource: How Finance Works
NEW QUESTION # 34
To estimate the forward price of oil, a commodity trader would most likely use the following pricing relationship:
- A. Oil forward price = Expected future oil price ± Oil storage cost + (1 + Oil market risk premium)
- B. Oil forward price = Expected future oil price ± Oil storage cost + (1 - Oil market risk premium)
- C. Oil forward price = Expected future oil price ± Oil market risk premium
- D. Oil forward price = Expected future oil price ± storage cost + Oil market risk premium
Answer: C
Explanation:
* The forward price of a commodity like oil is typically determined by the expected future spot price and adjusted for the risk premium associated with the market.
* Storage costs are often considered separately and are not typically included in the forward pricing
* relationship in the simple form as given in option A.
* Therefore, the most straightforward and likely answer based on common financial theory is the expected future oil price adjusted by the market risk premium.
NEW QUESTION # 35
When looking at the distribution of portfolio credit losses, the shape of the loss distribution is ___ , as the
likelihood of total losses, the sum of expected and unexpected credit losses, is ___ than the likelihood of no
credit losses.
- A. Asymmetric; less
- B. Asymmetric; greater
- C. Symmetric; less
- D. Symmetric; greater
Answer: B
NEW QUESTION # 36
Normally, commercial banking can be viewed as a fixed income carry trade since
- A. Short-term floating-rate deposits are used to fund long-term fixed rate loans.
- B. Short-term fixed-rate deposits are used to fund short-term floating rate loans.
- C. Short-term fixed rate deposits are used to fund long-term floating rate loans.
- D. Short-term floating-rate deposits are used to fund short-term floating rate loans.
Answer: A
NEW QUESTION # 37
Which one of the following four statements correctly defines an option's delta?
- A. Delta measures the expected decline in option with time and is usually expressed in years.
- B. Delta is the multiplier that best approximates the short-term change in the value of an option.
- C. Delta measures the impact of volatility on the price of an option.
- D. Delta measures the effect of 1 bp in interest rate change on the option price.
Answer: B
Explanation:
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.
NEW QUESTION # 38
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