2016-FRR Exam Dumps - Financial Risk and Regulation (FRR) Series

Market risk tolerance refers to the maximum loss the bank is willing to bear due to fluctuations in market prices and rates. It defines the extent to which the bank is prepared to accept risk in its operations and investment strategies, helping to align its risk appetite with its strategic objectives.

Securitization is a financial process used by banks to improve their liquidity and manage risk. The process involves the following steps:

I. Issuing Bonds: Banks issue bonds where the payment of interest and repayment of principal on the bonds depend on the cash flow generated by a pool of bank assets. This means that the assets (like loans) are used to back the bonds, and the revenue from these assets is used to pay bondholders.

II. Transfer of Legal Rights: When banks issue these bonds, they transfer their legal right to payment of interest and repayment of principal to bondholders. This transfer ensures that bondholders have a claim on the cash flows generated by the pooled assets, reducing the bank's risk exposure.

III. Selling Illiquid Assets: By securitizing assets, banks can sell off illiquid assets (like loans) and convert them into liquid securities (like bonds) that can be traded in the financial markets. This improves the bank's liquidity position by turning assets that are difficult to sell individually into marketable securities.

References: Based on "How Finance Works" document, securitization involves issuing bonds backed by asset pools, transferring legal payment rights, and selling illiquid assets to improve liquidity​​.

Statement I: DeltaFin can develop a control scoring method that assesses both the design and the performance of the control.

Verified and correct. It is essential to assess both design and performance to ensure that controls are not only well-designed but also effectively implemented.

Statement II: DeltaFin can combine the design and performance scores for each control to produce an overall control effectiveness score.

Verified and correct. Combining both scores provides a comprehensive measure of control effectiveness.

Statement III: DeltaFin can use the control performance scores to compute an overall risk severity score.

This is not accurate as the risk severity score typically considers the inherent risk and the residual risk after considering the controls, not just the performance scores.

Statement IV: DeltaFin can determine its own appropriate control scoring method.

Verified and correct. Organizations have the flexibility to develop their own scoring methods that best fit their operational risk profiles and needs.

A drawdown quantifies the peak-to-trough decline of an investment over a known time period. This measure is used to understand the maximum loss an investment has suffered from a peak to a subsequent trough, which is critical for risk assessment.

BetaFin decided to use the hybrid RCSA approach because:

They have previously created a series of RCSA workshops, and the results of these workshops can be used to design the questionnaires (I).

They have successfully used the questionnaire approach for certain businesses and the workshop approach for others (III).

To hedge against potential declines in aluminum prices, Omega Bank should take a position that benefits from a price drop. Here are the steps and strategies:

Current Position:

Omega Bank has bought 100 metric tons of aluminum for delivery in six months.

Hedging Strategy:

To protect against a decline in aluminum prices, the bank should take a short position in the aluminum futures market. This involves selling aluminum futures contracts.

Execution:

By selling an aluminum futures contract, Omega Bank locks in a price for selling aluminum in the future, thus offsetting the risk of price declines.

The correct strategy is to sell an aluminum futures contract, which effectively hedges the bank’s exposure to a potential drop in aluminum prices.

ReferencesSource: How Finance Works​

T Identify the regulation:

Regulation T of the Federal Reserve Bank governs the amount of credit that brokers and dealers can extend to investors for the purchase of securities.

Borrowing limit:

Regulation T allows investors to borrow up to 50% of the value of the securities from their brokers.

Explanation:

This regulation is in place to limit the amount of leverage investors can use when buying securities, aiming to reduce the risk of significant market volatility and potential defaults.

References:

From the search results and standard financial regulations knowledge, the limit specified in Regulation T is consistent with 50% of the value of the securities.

opic 3, Volume C

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​