GARP Updated 2016-FRR Exam Questions and Answers by taylor

When hedging a portfolio of bonds against shifts in the yield curve, using only duration as a measure is effective for small parallel shifts. However, for larger shifts, convexity becomes significant. Convexity accounts for the curvature in the relationship between bond prices and yields, providing a more accurate measure of interest rate risk. To ensure the portfolio is hedged against larger parallel shifts, Sam should take positions that neutralize the portfolio's convexity. This involves adjusting the portfolio in a way that it is less sensitive to changes in interest rates, providing a second-order measure of risk beyond duration.

In the event of a bank liquidation, the order of repayment is as follows:

Depositors: They are given priority as they are often covered by deposit insurance schemes to maintain confidence in the banking system.

Debt Holders: After depositors, holders of the bank’s debt are repaid. This includes both secured and unsecured creditors, with secured creditors having a higher claim.

Shareholders: They are last in line to receive any remaining funds after all other obligations have been satisfied. Common shareholders are the last to be paid, after preferred shareholders.

This hierarchy ensures that the most senior and secured claims are addressed first, providing a structured approach to liquidation.References: How Finance Works, discussions on bank liquidation processes and the hierarchy of claims​​.

When evaluating a diversified equity portfolio, an endowment asset manager should consider:

Company-specific projected earnings and earnings risk to understand the performance potential and variability of individual assets.

Aggregate earnings expectations to gauge the overall market outlook and economic conditions affecting the portfolio.

Individual asset volatility to assess the risk and potential fluctuations in the value of specific investments within the portfolio.

Market liquidity, while important, is not typically a primary concern for long/short equity strategies focused on diversified portfolios.

The Capital Asset Pricing Model (CAPM) equation used to calculate the required return on a stock is:Required return = risk-free return + beta × (market risk premium).

This formula helps determine the return an investor should expect for taking on additional risk compared to a risk-free asset.