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NEW QUESTION # 26
A retail credit score of above 680 is generally considered to be "prime." The term "prime" means the borrower is what?
Answer: B
Explanation:
Comprehensive and Detailed In-Depth Explanation:
In credit risk assessment, a "prime" borrower is one with a high credit score (e.g., above 680 on the FICO scale), indicating high credit quality and a low probability of default (PD). This classification is widely used in retail lending (e.g., mortgages, auto loans) to denote borrowers who are less risky, justifying lower interest rates. The Basel II framework, under the Internal Ratings-Based (IRB) approach, links credit quality to PD, where "prime" aligns with lower PD bands. Option D correctly pairs high quality (strong creditworthiness) with low risk of default. Option A is contradictory (low quality implies higher risk), Option B reverses the risk profile, and Option C describes "subprime" borrowers (typically below 620).
Exact Extract from Official Source:
* BCBS, "Basel II: International Convergence of Capital Measurement and Capital Standards," June
2006, para. 211: "Under the IRB approach, banks must categorize banking-book exposures into broad classes of assets with different underlying risk characteristics... For retail exposures, this includes distinguishing between high-quality (low PD) and lower-quality (higher PD) borrowers."
* GARP FRR Study Notes, Credit Risk Section: "Prime borrowers, typically with credit scores above
680, are considered high-quality obligors with a low likelihood of default, contrasting with subprime borrowers who exhibit higher risk profiles." Reference:BCBS, "Basel II," para.211-215; GARP FRR Study Notes, Credit Risk Section.
NEW QUESTION # 27
When considering the advantages of operational risk function owned by the Chief Compliance Officer in a
financial institution, an operational risk manager consultant suggests that this governance approach will have
all of the following advantages except:
Answer: D
NEW QUESTION # 28
Which of the activities represent examples of market manipulation?
Answer: C
Explanation:
Market manipulation refers to deliberate actions taken to deceive or mislead investors by affecting the supply, demand, or price of securities. Here are the activities considered:
* Market gap: This refers to the difference between the closing price of one trading session and the opening price of the next session. It is not inherently a form of market manipulation.
* Crowded trades: These occur when a large number of market participants take the same position in a security. While this can influence prices, it is not a deliberate act of manipulation.
* Short squeeze: This occurs when a heavily shorted stock suddenly increases in price, forcing short sellers to buy back shares to cover their positions, further driving up the price. This can be orchestrated to create rapid price increases, qualifying as market manipulation.
* Stop-loss order: This is an order placed with a broker to buy or sell once the stock reaches a certain price. It is a risk management tool and not a form of manipulation.
Therefore, a short squeeze is an example of market manipulation.
References
Source: How Finance Works
NEW QUESTION # 29
Normally, commercial banking can be viewed as a fixed income carry trade since
Answer: C
Explanation:
Commercial banking can be viewed as a fixed-income carry trade because banks typically engage in maturity transformation, where they borrow short-term and lend long-term.
* Short-term floating-rate deposits:
* Banks often attract deposits with short-term maturities and floating interest rates.
* These deposits are generally considered stable and low-cost sources of funds.
* Long-term fixed-rate loans:
* Banks use these short-term deposits to fund long-term loans, such as mortgages or business loans, which typically have fixed interest rates.
* This creates a mismatch between the interest rates and maturities of assets and liabilities.
* Carry trade analogy:
* The bank earns the spread between the interest it pays on short-term deposits and the interest it earns on long-term loans.
* This process is similar to a carry trade, where profits are derived from the difference between borrowing costs and investment returns.
Thus, commercial banking inherently involves aspects of a carry trade through the practice of borrowing short- term to lend long-term.
References
Source: How Finance Works
NEW QUESTION # 30
Which one of the following four statements regarding counterparty credit risk is INCORRECT?
Answer: A
Explanation:
* Counterparty credit risk refers to the risk that the counterparty to a financial contract will default before the final settlement of the contract's cash flows, resulting in a financial loss. This is correctly stated in option A.
* The exposure at default (EAD) is indeed variable due to fluctuations in the underlying valuations, such as swaps, as mentioned in option B.
* The EAD can be negatively correlated with the probability of default (PD) because as the credit quality of a counterparty deteriorates, their exposure may also decline, correctly stated in option C.
* However, dynamic collateral provisions are typically designed to reduce counterparty risk by adjusting collateral requirements based on changes in exposure and credit quality, not to increase it. Therefore, option D is incorrect.
References:
* How Finance Works: "Counterparty credit risk and its management through collateral provisions is a critical aspect of financial risk management."
NEW QUESTION # 31
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