GARP 2016-FRR Exam With Confidence Using Practice Dumps

Compound options are exotic options that have another option as their underlying asset, making them particularly complex to model. The complexity arises because the value of a compound option is derived from another option, which is already a derivative with its own set of valuation challenges. This nested structure introduces multiple layers of volatility and dependencies that are difficult to predict and model accurately using standard option pricing models.

Value-at-Risk (VaR) can be calculated using either parametric or non-parametric methods. Parametric methods, such as the variance-covariance approach, typically assume that returns follow a normal distribution. This assumption simplifies the calculations but may not always accurately reflect the true distribution of returns, especially in the presence of skewness and kurtosis.

On the other hand, non-parametric methods, such as historical simulation or Monte Carlo simulation, do not make any assumptions about the distribution of returns. Instead, they rely on actual historical return data or simulated data to estimate the VaR, allowing for more flexibility and potentially more accurate risk assessments in cases where the return distributions deviate significantly from normality.

Day 1:

Bank Milo has $4 million in cash.

$5 million in loans coming due with an expected default rate of 1%.

The proceeds from the loans will be $5 million * (1 - 0.01) = $4.95 million.

Total cash available at the end of Day 1 = $4 million + $4.95 million = $8.95 million.

No outflows on Day 1.

Cumulative liquidity = $8.95 million (positive).

Day 2:

No cash inflow.

$9 million is due for a securities purchase.

Cumulative liquidity = $8.95 million - $9 million = -$0.05 million (negative).

Day 3:

No cash inflow.

$8 million due for commercial paper pay off.

Cumulative liquidity = -$0.05 million - $8 million = -$8.05 million (negative).

Therefore, Bank Milo faces negative cumulative liquidity on Days 2 and 3.

References:Based on the financial risk and regulation analysis, these calculations align with standard liquidity management practices detailed in the provided materials.