1.3 ERM and GARP Code of Conduct
Question 1
PE2018Q95 / PE2019Q95 / PE2020Q95 / PE2021Q95 / PE2022Q95
In characterizing various dimensions of a bank’s data, the Basel Committee has suggested several principles to promote strong and effective risk data aggregation capabilities. Which statement correctly describes a recommendation that a bank should follow in accordance with the Basel Committee’s principles for effective risk data aggregation and risk reporting?
A. The integrity principle recommends that data aggregation should be completely automated without any manual intervention.
B. The completeness principle recommends that a financial institution should capture data on its entire universe of material risk exposures.
C. The adaptability principle recommends that a bank should frequently update its risk reporting systems to incorporate changes in best practices.
D. The accuracy principle recommends that the risk data be reconciled with management’s estimates of risk exposure prior to aggregation.
Answer: B
Learning Objective: Describe key governance principles related to risk data aggregation and risk reporting practices.
The completeness principle recommends that a bank be able to capture and aggregate all data on the material risks to which it is exposed across the organization. This will allow it to identify and report risk exposures, concentrations, and set exposure limits.
Question 2
A board of directors is evaluating the implementation of a new ERM program at an asset management company. Which statement below is consistent across the various current definitions of an ERM program and most appropriate to be included in the company’s ERM definition and goals?
A. The ERM program should reduce costs by transferring or insuring most of the company’s major risk exposures.
B. The major goal of the new ERM program should be to reduce earnings volatility.
C. The ERM program should be managed separately from the operational side of the company.
D. The ERM program should provide an integrated strategy to manage risk across the company as a whole.
Answer: D
An effective ERM program should be integrated at several levels, across the company as a whole and integrated with the operational side of the company.
Question 3
PE2018Q49 / PE2019Q49 / PE2020Q49 / PE2021Q49 / PE2022Q49
The board of directors of a growing insurance company has recommended the firm establish an enterprise risk management (ERM) framework. Which of the following represents key benefit for the firm that it will likely attain after establishing an ERM framework?
A. Increasing the organization’s risk appetite and its expected return on new projects
B. Improving the firm’s risk reporting practices
C. Allowing the board of directors to validate risk models to ensure their accuracy
D. Increasing the expected correlation between risk factors where there is exposure across the enterprise
Answer: B
Learning objective: Describe the motivations for a firm to adopt an ERM initiative.
Implementation of ERM requires integration. Establishing a centralized risk management unit, infusion of a wholistic risk management approach into business processes and applying coordinated risk transfer strategies bring increased efficiency and better performance in various bank practices including risk reporting.
Question 4
The board of directors of a growing asset management company has recommended that the firm establish an ERM framework. Which of the following represents a key benefit that the firm will likely attain after establishing an ERM framework?
A. Allowing the company to determine and make use of a higher risk appetite
B. Finding the optimal reporting methodology for each risk function
C. Improving the top-down communication and coordination in the company
D. Taking advantage of the new opportunities that create value on a standalone basis
Answer: C
Implementation of ERM requires integration. Appointing a CRO and establishing a centralized, integrated risk management team can better address the interdependencies among individual risks faced by the company and thus increase efficiency.
A is incorrect because ERM does not necessarily allow the company to determine and make use of a higher risk appetite.
B is incorrect because ERM suggests the opposite of a fragmented approach in risk management.
D is incorrect because ERM improves business performance by taking a portfolio view of all risks rather than on a standalone basis.
Question 5
PE2018Q20 / PE2019Q20 / PE2020Q20 / PE2021Q20
Which of the following is a potential consequence of violating the GARP Code of Conduct once a formal determination is made that such a violation has occurred?
A. Formal notification to the GARP Member’s employer of such a violation
B. Suspension of the GARP Member’s right to work in the risk management profession
C. Removal of the GARP Member’s right to use the FRM designation
D. Required participation in ethical training
Answer: C
Learning Objective: Describe the potential consequences of violating the GARP Code of Conduct.
According to the GARP Code of Conduct, violation(s) of this Code may result in, among other things, the temporary suspension or permanent removal of the GARP Member from GARP’s Membership roles, and may also include temporarily or permanently removing from the violator the right to use or refer to having earned the FRM designation or any other GARP granted designation, following a formal determination that such a violation has occurred.
Question 6
Junaid Manzoor has been hired as head of risk management by KDB Asset Management, a small investment firm in Pakistan. Manzoor implements a risk measurement framework to gauge portfolio risk for the firm. Unfortunately, the methodology he implements for risk measurement has changed considerably in recent years and is no longer used internationally. Neither Manzoor nor anyone else at the firm is aware of the changes to risk measurement approaches. As a GARP member, has Junaid violated the GARP Code of Conduct?
A. No, this is not a violation of the GARP Code of Conduct because neither Manzoor nor the firm is aware of the changes to risk measurement approaches.
B. No, this is not a violation as the methodology worked when Manzoor took his FRM exams.
C. This is only a violation of the GARP Code of Conduct if investment decisions are made based on Manzoor’s risk reports.
D. Yes, this is a violation of the GARP Code of Conduct.
Answer: D
The GARP Code of Conduct states that GARP members should be familiar with current generally accepted risk management practices.
Question 7
Which of the following are potential consequences of violating the GARP Code of Conduct once a formal determination that such a violation has occurred is made?
I. Suspension of the GARP Member from GARP’s Membership roles.
II. Suspension of the GARP Member’s right to work in the risk management profession.
III. Removal of the GARP Member’s right to use the FRM designation or any other GARP granted designation.
IV. Required participation in ethical training.
A. I and Il only
B. I and lIl only
C. Il and IV only
D. Ill and IV only
Question 8
Isabelle Burns, FRM, is an investment advisor for a firm whose client base is composed of high net worth individuals, in her personal portfolio, Burns has an investment in Torex, a company that has developed software to speed up Internet browsing. Burns has thoroughly researched Torex and believes the company is financially strong yet currently significantly undervalued. According to the GARP Code of Conduct, Burns may:
A. Not recommend Torex as long as she has a personal investment in the stock.
B. Not recommend Torex to a client unless her employer gives written consent to do so.
C. Recommend Torex to a client, but she must disclose her investment in Torex to the client.
D. Recommend Torex to a client without disclosure as long as it is a suitable investment for the client.
Answer: C
Standards 2.1 and 2.2 - Conflicts of Interest.
Members and candidates must act fairly in all situations and must fully disclose any actual or potential conflict to all affected parties. Sell-side members and candidates should disclose to their clients any ownership in a security that they are recommending.
Question 9
Beth Anderson, FRM, is a portfolio manager for several wealthy clients including Reuben Carlyle. Anderson managers Carlyle’s personal portfolio of stock and bond investments. Carlyle recently told Anderson that he is under investigation by the IRS for tax evasion related to his business, Carlyle Concrete (CC). After learning about the investigation, Anderson proceeds to inform a friend at a local investment bank so that they may withdraw their proposal to take CC public. Which of the following is most likely correct? Anderson:
A. Violated the Code by failing to immediately terminate the client relationship with Carlyle.
B. Violated the Code by failing to maintain the confidentiality of her client’s information.
C. Violated the Code by failing to detect and report the tax evasion to the proper authorities.
D. Did not violate the Code since the information she conveyed pertained to illegal activities on the part of her client.
Answer: B
Anderson must maintain the confidentiality of client information according to Standard 3.1.
Confidentiality may be broken in instances involving illegal activities on the part of the client, but the client’s information may only be relayed to proper authorities. Anderson did not have the right to inform the investment bank of her client’s investigation.
Question 10
Over the past two days, Lorraine Quigley, FRM, manager of a hedge fund, has been purchasing large quantities of Craeger Industrial Products’ common stock while at the same time shorting put options on the same stock. Quigley did not notify her clients of the trades although they are aware of the fund’s general strategy to generate returns. Which of the following statements is most likely correct? Quigley:
A. Did not violate the Code.
B. Violated the Code by manipulating the prices of publicly traded securities.
C. Violated the Code by failing to disclose the transactions to clients before they occurred.
D. Violated the Code by failing to establish a reasonable and adequate basis before making the trades.
Answer: A
A Quigley’s trades are most likely an attempt to take advantage of an arbitrage opportunity that exists between Craeger’s common stock and its put options. She is not manipulating the prices of securities in an attempt to mislead market participants. She is pursuing a legitimate investment strategy Participants in her hedge fund are aware of the fund’s investment strategy, and thus Quigley did not violate the Code by not disclosing this specific set of trades in advance of trading (Standards 2.1 and 5.1).
Question 11
Jack Scbleifer, FRM, is an analyst for Brown Investment Managers (BIM). Schleifer has recently accepted an invitation to visit the facilities of ChemCo, a producer of chemical compounds used in a variety of industries. ChemCo offers to pay for Schlelfer’s accommodations in a penthouse suite at a luxury hotel and allow Schleifer to use the firm’s private jet to travel to its three facilities located in New York, Hong Kong, and London. In addition, ChemCo offers two tickets to a formal high-society dinner in New York. Schleifer declines to use ChemCo’s corporate jet or to allow the firm to pay for his accommodations but accepts the tickets to the dinner (which he discloses to his employer) since he will be able to market his firm’s mutual hinds to other guests at the dinner. Has Schieifer violated the CARP Code of Conduct?
A. Yes.
B. No, since he is using the gifts accepted to benefit his employer’s interests.
C. No, since the gifts he accepted were fully disclosed in writing to his employer.
D. No, since the gift he accepted is of nominal value and he declined to accept the hotel accommodations and the use of ChemCo’s jet.
Answer: A
GARP Members must not offer, solicit, or accept any gift, benefit, compensation, or consideration that could be reasonably expected to compromise their own or another’s independence and objectivity Schleifer has appropriately rejected the offer of the hotel accommodations and the use of ChemCo’s jet. However, Schleifer cannot accept the tickets to the dinner. Since it is a formal high-society dinner, the tickets are most likely expensive or hard to come by. Even though he has disclosed the gift to his employer and he plans to use the dinner as a marketing opportunity for his firm, the gift itself may influence Schliekr’s future research in favor of ChemCo. Allowing such potential influence is a violation of Professional Integrity and Ethical Conduct (Standard 1.2).
Question 12
Beth Bixby, FRM, oversees a mid-cap fund that is required to invest in a minimum of 40 and a maximum of 60 different issues. Bixby uses a quantitative approach to actively manage the assets. In promotional materials, she states that “through our complex quantitative approach, securities are selected that have similar exposures to a number of risk factors that are found in the S&P 500 Index. Thus the fund is designed to track the performance of the S&P 500 Index but will receive a return premium of between 2% and 4% according to our model’s risk-returnmeasures.” This statement is:
A. Permissible since the assertion is supported by modern portfolio theory and estimates from the firms’ model.
B. Not permissible since Bixby is misrepresenting the services that she and/or her firm are capable of performing.
C. Not permissible since Bixby is misrepresenting the investment performance she and/or her firm can reasonably expect to achieve.
D. Permissible since the statement describes the basic characteristics of the fund’s risk and return objectives.
Answer: C
It is not reasonable for Bixby to expect a 40-to-60 stock mid-cap portfolio to track the entire S&P 500 Index, which is a large-cap index. She should know that there will be periods of wide variance between the performance of the portfolio and the S&P 500 index. There is no assurance that a premium of 2% to 4% will consistently be obtained. Biaby is in violation of Standard 1.4: “GARP Members shall not knowingly misrepresent details relating to analysis, recommendations, actions, or other professional activities,” since she has made an implicit guarantee of the fund’s expected performance.
Question 13
Credit risk analysts at an investment bank are preparing a report on a company. After concluding their research, they estimate a 60% probability that the company will have its credit rating downgraded within one year by a major agency. If including in the report, which of the following would be a violation of the GARP code of Conduct?
A. A discussion of a possible trade in the debt of two competing firms that could potentially be acquired by the company.
B. An analysis of trading in the company’s debt by its major bondholders.
C. A statement that the company’s debt is almost certain to be downgraded.
D. A valuation matrix projecting several potential valuations for the company’s debt based on potential credit ratings at the end of one year.
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