Free GARP 2016-FRR Practice Exam with Questions & Answers | Set: 4

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.

Profit and loss (P&L) calculations in trading are typically made by comparing the current market value to the purchase price or the previous day's closing price, not the intrinsic value. Here are the correct statements:

Cash settled instruments: The final market value is used to settle the transaction with the counterparty.

Margin calls: Futures exchanges base margin calls on the current market value.

Credit risk calculations: Analyzing the current values of all deals with the same counterparty is crucial for assessing counterparty credit risk.

The incorrect statement is that P&L calculations are made by comparing current values to intrinsic values, which are theoretical and not always reflective of market conditions.

References

Source: How Finance Works​

The Sarbanes-Oxley Act includes risk and control requirements for financial statements in the United States. It mandates strict reforms to improve financial disclosures from corporations and prevent accounting fraud. This Act directly impacts operational risk management by setting standards for all U.S. public company boards, management, and public accounting firms.

The statement that "commodity markets are more liquid than debt markets" is incorrect. Commodity markets can be less liquid compared to the highly developed and widely traded debt markets. Banks typically do not have direct exposure to commodities but engage in OTC contracts to serve clients and facilitate hedging.

Non-statistical risk measures typically used to quantify market risk include:

Option Sensitivities:

Measures such as delta, gamma, vega, and theta which indicate how option prices are affected by various factors.

Convexity:

This measures the sensitivity of the duration of a bond to changes in interest rates, an important factor in bond risk management.

Basis Point Values (BPV):

This measures the change in the value of a financial instrument or portfolio for a one basis point change in yield, used to assess interest rate risk.

Net Closed Positions:

This is not typically used to quantify market risk. It simply represents the net value of positions that have been offset or closed out and does not provide a measure of risk exposure.

Thus, net closed positions are not typically used to quantify market risk.

References

Source: How Finance Works​

The Sarbanes-Oxley Act includes requirements for financial institutions in the United States regarding risk and control. It aims to enhance corporate governance and strengthen the internal controls and financial reporting processes. The other options such as market discipline requirements, capital allocation requirements, and regulatory response to systemic risk requirements are not specifically covered by the Sarbanes-Oxley Act.

Risk and control self-assessments (RCSA) have several advantages:

They provide insight into risks that exist in a firm but may not have occurred before (II).

They allow each department to take ownership of its own risks and controls (IV). However, RCSA may not always provide very accurate scoring of risks and controls due to its subjective nature (I), and while it can produce biased operational risk reporting, the primary advantage is the transparency it offers, not the bias (III).

When a bank is going bankrupt, it faces several additional losses beyond the immediate operational and financial losses. These include:

I.The discount accepted by the bank for selling its assets in a fire sale:In a fire sale, assets are sold quickly and often at a significantly reduced price, resulting in substantial losses.

II.The increased cost of funding liabilities in a financially distressed situation:As the bank's financial condition deteriorates, its cost of borrowing increases due to higher perceived risk, leading to increased expenses.

III.The reduction in the present value of future growth opportunities:Financial distress often means the bank cannot invest in future opportunities, significantly impacting its long-term profitability and growth potential.

IV.Loss of goodwill and intangible assets:The bank's reputation, brand value, and other intangible assets suffer significantly during bankruptcy, leading to additional losses.

VaR calculations depend heavily on the confidence level chosen. Bank G's 1-year VaR of USD 20 million is calculated at a 99% confidence level, while Bank H's 1-year VaR of USD 10 million is calculated at a 95% confidence level. These different confidence levels mean that the probabilities associated with the potential losses are not directly comparable. The 99% confidence level implies a more conservative risk estimate compared to the 95% confidence level, hence no direct risk comparison can be accurately made.

The Basel II Accord's operational risk definition specifically includes legal risk. Operational risk under Basel II is defined as the risk of loss resulting from inadequate or failed internal processes, people, andsystems, or from external events. This definition explicitly includes legal risk but excludes strategic and reputational risks.