GARP Updated 2016-FRR Exam Questions and Answers by mina

Tier 3 capital under Basel II refers specifically to subordinated debt that is intended to cover market risk in the trading book. It is not as widely recognized or used as Tier 1 and Tier 2 capital and has more restrictive requirements. This capital can only be used to support market risk, not credit risk. Its purpose is to provide an additional layer of capital to absorb losses specifically arising from market risks.

DeltaBank should consider counterparty risk on both long and short OTC option positions. OTC options do not go through a centralized exchange, making them subject to counterparty risk. Exchange-traded options have significantly lower counterparty risk because the exchange acts as the counterparty to all trades.

Comprehensive and Detailed In-Depth Explanation:

Crowded trades occur when many market participants adopt the same trading strategy, leading to concentrated positions in a specific asset (e.g., selling physical gold). This increases systemic risk, as a sudden reversal or liquidity crunch can amplify losses. GARP’s FRR materials discuss crowded trades in the context of market risk and systemic vulnerabilities, noting their potential to destabilize markets. Basis trades involve exploiting price differences between related instruments, disappearance trades and break trades are not standard terms in this context, making "crowded trades" the correct answer.

Regulatory standards impose formulaic capital calculations for all of the bank's activities to ensure:

Comparability Across Banks: Different models used by banks would make it difficult for regulators to compare results across banks.

Comprehensive Risk Assessment: Standardized calculations help ensure that banks are not missing key risks in their calculations.

Avoiding Gaming of the System: Standardized calculations prevent banks from using capital calculations to game the banking regulation system, ensuring consistency and fairness.

References

Source: How Finance Works​