2016-FRR Exam Results

Stabilizing Net Income in Volatile Interest Environments:

Shifting from interest rate-sensitive sources to less sensitive sources is the key strategy to stabilize income.

Strategies:

Charging bank fees for underwriting loans: Generates fee income, which is less sensitive to interest rates.

Providing trust, asset management, and trading services: Fee-based services and trading revenue are less sensitive to interest rates.

Extending different types of credit: This strategy can diversify risk but does not directly reduce interest rate sensitivity.

Incorrect Strategy:

Originate more floating interest rate loans: This increases sensitivity to interest rate changes, opposite of the desired stabilization goal.

ReferencesSource: How Finance Works​

Current VaR: The bank has an existing VaR estimate of $100 million.

Standalone VaR for New Transaction: The standalone VaR of the new transaction is $5 million.

Correlation with Current Portfolio: The correlation of the new transaction with the current portfolio is 0.35.

Formula for Combined VaR:

New VaR=(Current VaR2)+(Standalone VaR2)+2×Correlation×Current VaR×Standalone VaR\text{New VaR} = \sqrt{(\text{Current VaR}^2) + (\text{Standalone VaR}^2) + 2 \times \text{Correlation} \times \text{Current VaR} \times \text{Standalone VaR}}New VaR=(Current VaR2)+(Standalone VaR2)+2×Correlation×Current VaR×Standalone VaR​

Plugging in the values:

New VaR=(1002)+(52)+2×0.35×100×5=10000+25+350=10375≈101.86\text{New VaR} = \sqrt{(100^2) + (5^2) + 2 \times 0.35 \times 100 \times 5} = \sqrt{10000 + 25 + 350} = \sqrt{10375} \approx 101.86New VaR=(1002)+(52)+2×0.35×100×5​=10000+25+350​=10375​≈101.86

ReferencesSource: How Finance Works​

When evaluating the upward reporting governance structure in the context of operational risk, critical features include independence, importance, and relevance. Security is not typically considered a critical feature of the upward reporting governance structure. The focus is on ensuring that the governance structure is independent, important, and relevant to the organization's operational risk management.References:Upward reporting governance structure guidelines.

An asset-sensitive bank has more rate-sensitive assets than rate-sensitive liabilities. This results in a positive cumulative gap, meaning the bank will benefit from rising interest rates. As interest rates increase, the income from rate-sensitive assets will increase more than the expense on rate-sensitive liabilities, improving the bank's net interest income.