GARP Updated 2016-FRR Exam Questions and Answers by kira

The credit spread reflects the additional yield over the risk-free rate that investors demand to compensate for the risk of default. An increase in the probability of default of the issuer (I) would directly increase the credit spread as investors require more return for higher risk. Similarly, an increase in expected loss (IV) would increase the credit spread since the potential loss in the event of default is greater. On the other hand, a decrease in risk premium (II) or a decrease in loss given default (III) would typically lower the credit spread, not increase it.

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.

Credit risk refers to the risk that a borrower will default on any type of debt by failing to make required payments. It is typically a form of performance risk in a contractual relationship, where one party is at risk of loss due to another party's inability to fulfill financial obligations. This is distinguished from market risk (related to market prices), liquidity risk (related to the availability of funds), and other operational risks that companies might face.

The foreign exchange market (forex or FX) is widely believed to be the most liquid financial market in the world. This market operates 24 hours a day and involves the highest volume of trading compared to other financial markets. The high liquidity is due to the significant volume of transactions conducted by various participants, including governments, financial institutions, corporations, and individual traders. The vast number of buyers and sellers ensures that trades can be executed quickly and at stable prices.