GARP Updated 2016-FRR Exam Questions and Answers by hailey

Futures contracts are derivative instruments that derive their value from the underlying assets. Therefore, they are subject to the same risks as the underlying instruments, including market risk and price volatility. Statement I is correct. Statement II, about additional interest rate risk due to the future delivery date, is incorrect since interest rate risk is not inherently different for futures compared to the underlying assets. Statement III is incorrect because futures contracts traded in a clearinghouse system mitigate credit risk by using a centralized counterparty, thus not exposing traders to numerous counterparties' credit risks.

Range options, also known as "corridor options" or "double no-touch options," have two strike prices. The payoff for a range option depends on the price of the underlying asset remaining within a specified range between the two strike prices during the life of the option. This dual strike price structure is what distinguishes range options from other types of options.

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.

A carry trade typically involves borrowing in a currency with low-interest rates and investing in a currency with high-interest rates to profit from the difference in interest rates.

Identify the currencies:

Low-interest currency: Typically, these are currencies of countries with low-interest rates, such as Japan (JPY) or Switzerland (CHF).

High-interest currency: These are currencies of countries with high-interest rates, such as emerging market currencies or certain developed countries during specific periods.

Mechanics of carry trade:

The bank borrows in a low-interest currency.

The bank then converts these funds into a high-interest currency.

The funds are deposited or invested in high-yield instruments denominated in the high-interest currency.

The profit arises from the differential between the interest paid on the borrowed currency and the interest earned on the invested currency.

This strategy benefits from interest rate differentials and can yield significant profits if exchange rates remain stable or move favorably.

References

Source: How Finance Works​