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The Global Association of Risk Professionals (GARP) is a non-profit organization that focuses on promoting best practices in the field of financial risk management. They have designed a certification program called the Financial Risk and Regulation (FRR) Series, which is a comprehensive exam that tests the knowledge of financial risk management professionals. The FRR Series is designed to help individuals demonstrate their expertise in risk management and regulatory compliance.
NEW QUESTION # 310
Which one of the following four statements about equity indices is INCORRECT?
Answer: A
Explanation:
* Equity indices are numerical calculations that reflect the performance of hypothetical equity portfolios.
* They are designed to track the overall performance of an equity market and do not trade in cash form.
* Capitalization-weighted indices, which weight stocks by their market capitalization, are generally considered effective in tracking the performance of the overall market. Therefore, the statement that they are not generally considered better is incorrect.
* Price-weighted indices give greater weight to shares trading at high prices, reflecting their price movements more heavily in the index.
NEW QUESTION # 311
A credit rating analyst wants to determine the expected duration of the default time for a new three-year loan, which has a 2% likelihood of defaulting in the first year, a 3% likelihood of defaulting in the second year, and a 5% likelihood of defaulting the third year. What is the expected duration for this three-year loan?
Answer: D
Explanation:
* Likelihood of Default: The likelihood of default for the three-year loan is given as 2% in the first year,
3% in the second year, and 5% in the third year.
* Expected Duration Calculation:
* Year 1 Contribution: 0.02×10.02×1 = 0.02 years
* Year 2 Contribution: 0.03×20.03×2 = 0.06 years
* Year 3 Contribution: 0.05×30.05×3 = 0.15 years
* Total Expected Duration: 0.02+0.06+0.15=0.230.02+0.06+0.15=0.23 years
* Sum of Probabilities: 0.02+0.03+0.05=0.100.02+0.03+0.05=0.10
* Normalization: 0.230.10=2.30.100.23=2.3 years
Thus, the expected duration is approximately 2.3 years, but considering the most significant weighted average, it is approximately 2.1 years.
NEW QUESTION # 312
Using a forward transaction, Omega Bank buys 100 metric tones of aluminum for delivery in six-months' time. However, after two months, the bank becomes concerned with the potential fluctuations in aluminum prices and wants to hedge its potential exposure against a possible decline in aluminum prices. Which one of the following four strategies could the bank use to offset the risk from its current exposure to aluminum as it sets the price for selling the commodity in four-months' time?
Answer: B
Explanation:
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.
References
Source: How Finance Works
NEW QUESTION # 313
Which one of the following four statements about the "market-maker" trading strategy is INCORRECT?
Answer: A
NEW QUESTION # 314
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?
Answer: D
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 # 315
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