GARP 2016-FRR Exam With Confidence Using Practice Dumps

When the dollar strengthens against the pound, the value of an option that allows the purchase of dollars at a predetermined exchange rate increases. This is because the option provides the right to buy the appreciating dollar at a rate that becomes more favorable as the market rate moves higher.

Economic capital is a risk measure used by banks to determine the amount of capital they need to hold to remain solvent and cover potential losses:

Internal Risk Estimates: Unlike regulatory capital, which is determined by external regulatory requirements, economic capital is based on the bank's own risk assessment models and internal estimates of potential losses.

Risk Types: It considers a range of risks including credit risk, market risk, operational risk, and other financial risks that the bank might face.

Purpose: The goal is to ensure the bank has enough capital to absorb unexpected losses and to maintain confidence among depositors and investors.

Therefore, economic capital is a measure of the potential losses based on the bank's internal risk estimates.

Adverse selection occurs when one party in a transaction has more or better information than the other party, often leading to the more informed party exploiting the situation. In this case, the bank customer chooses a mortgage with low initial payments, knowing she will have trouble making early payments. The bank, using standard default assumptions for ordinary mortgages, underestimates the risk of default, thus exposing itself to adverse selection, where the higher-risk borrowers are more likely to select this type of mortgage.