ERP Part 2 Final Exam 2019 PDF

ENERGY RISK PROFESSIONAL
2019
ERP ®
Practice Exam Part II
Updated 06/03/19
ERP® Practice Exam Part II
The ERP Exam is a practice-oriented examination. Exam questions reflect recommended core readings and
“real-world” scenarios. The successful candidate demonstrates an understanding of inherent risks across
varied energy markets, as well as tools and best business practices used to manage these risks.
A comprehensive examination, the ERP Exam tests an energy risk professional on a number of risk
management concepts and approaches. The breadth of topics covered reflect a truly dynamic and
evolving energy industry. An effective risk manager in the energy sector identifies physical and financial
risks, along with appropriate mitigation options.
The 2019 ERP Part I and Part II Practice Exams aid candidates in their preparation for the May 2019 Exam
and November 2019 Exam. These Practice Exams are based on a sample of questions from past ERP Exams
and are suggestive of questions on the 2019 ERP Exam.
The Practice Exams are a useful study tool. Completing the Practice Exams results in an assessment of the
candidate’s exam readiness. By design, the practice exams align with the ERP exam length and curriculum:
Part I Part II
Length
ERP Exam ERP Practice Exam ERP Exam ERP Practice Exam
80 questions 60 questions
Physical Energy Commodity and Electricity Markets Financial Energy Products and Risk Management
Curriculum
Crude Oil Markets & Refined Products Measure & Model Market Risk
Natural Gas & Coal Markets Measure & Model Credit/Liquidity Risk
LNG Market Fundamentals Apply Finance Energy Products to Manage Risk
Electricity Markets (includes renewables Generation) Risk Governance, ERM, and Capital Planning
The 2019 ERP Practice Exams may not cover all topics included in the 2019 ERP Exam, as any test samples
from the universe of testable possible knowledge points. Questions selected for the practice exams reflect
core reading material assigned for 2019. In addition, practice questions represent the style of question
preferred by the ERP Energy Oversight Committee (EOC).
For a complete list of current topics, core readings, and key learning objectives, candidates must refer to
the 2019 ERP Exam Study Guide and 2019 ERP Learning Objectives. Both are available at www.garp.org.
The EOC endorses core readings to assist candidates in their review of the subjects covered by the exam.
Questions for the ERP Exam are derived from the core readings. Candidates who include these readings in
their study plan enjoy a higher rate of success on the ERP Exam.
© 2019 Global Association of Risk Professionals. All rights reserved. It is illegal to reproduce this material
in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc. 1
Suggested Use of Practice Exams
1. Plan a date and time to take the practice exam
• Set dates appropriately, consider your target exam day date

• Allow yourself sufficient study and review time before taking the practice exam
2. Simulate the exam day environment as closely as possible
• Take the practice exam(s) in a quiet place, free from interruption

• Limit yourself to the practice exam, candidate answer sheet, calculator, and pencils available
• Minimize possible distractions from other people, cell phones, televisions, etc.
• Put away any study materials before beginning the practice exam
• Keep track of your time while taking the exam. The actual ERP Exam Part I and ERP Exam Part II are
four (4) hours each. Allocate four (4) hours to complete the ERP Part I Practice Exam and four (4)
hours to complete the ERP Part II Practice Exam
• Follow the ERP calculator policy. The only calculators authorized for use on the ERP Exam in 2019
are listed below:
o Texas Instruments BA II Plus (including the BA II Plus Professional)
o Hewlett Packard 12C (including the HP 12C Platinum and the Anniversary Edition)
o Hewlett Packard 10B II
o Hewlett Packard 10B II+
o Hewlett Packard 20B
There are no exceptions to this policy. You will not be allowed into the exam room with a personal
calculator other than those listed above
3. Calculate your score(s) and adjust your study plan accordingly
• After completing the practice exam, calculate your score. Check your answer sheet against the
practice exam answer key included in this document
• Use the practice exam answers and explanations to better understand your correct and incorrect
answers
• Identify topics where you require additional review. Consult the core readings referenced with
each question to prepare for the exam
• Remember, the pass/fail status for the actual exam is based on the distribution of scores from all
candidates. Only use your practice exam scores to gauge your own progress and level of
preparedness
Common Abbreviations and Acronyms

• Bbl: Barrel of _________ • JCC: Japan customs cleared (oil price)
• BOE: Barrel of oil equivalent • KPI: Key performance indicators
• BTU: British Thermal Unit • KRI: Key risk indicators
• CCP: Central counterparty • kW: Kilowatt
• CDD: Cooling degree days • kWh: kilowatt-hour
• Cf: Cubic feet • LMP: Locational marginal pricing
• CFD: Contract for Differences • LNG: Liquefied natural gas
• CFR: Cost and freight • LSE: Load serving entity
• CIF: Cargo, insurance, and freight • Mcf: Million cubic feet
• CIP: Cargo and insurance paid • MMBtu: Million British thermal units
• CPT: Carriage paid to all transport • MT: Metric ton
• CRO: Chief Risk Officer • MtM: Mark-to-market
• CSA: Credit Support Annex • MW: Megawatt
• CVA: Credit value adjustment • MWh: Megawatt-hour
• DA: Day-ahead • NGL: Natural gas liquid
• DAP: Delivered at place • NOC: National oil company
• DAT: Delivered at terminal • NPV: Net present value
• DDP: Delivered duty paid • NYMEX: New York Mercantile Exchange
• DES: Delivered ex ship • OPEC: Organization of the Petroleum
• EFP: Exchange for physicals Exporting Countries
• EIA: (US) Energy Information Agency • OTC: Over-the-counter
• ERM: Enterprise risk management • PFE: Potential future exposure
• ETS: Emissions trading system • PPA: Power purchase agreement
• EWMA: Exponentially weighted moving • PSA: Production sharing agreement
average • PTR: Physical transmission right
• EXW: Ex-works • PV: Photovoltaic installation (solar)
• FAS: Free alongside ship • PSC: Production services contract
• FOB: Free on board • RAROC: Risk-adjusted return on capital
• FTR: Financial transmission right • RBOB: Reformulated gasoline blendstock
• GARCH: Generalized auto-regressive for oxygen blending
conditional heteroskedasticity • RCSA: Risk control self-assessment
• HDD: Heating degree days • RTO: Regional Transmission
• ICE: Intercontinental Exchange Organization
• IEA: International Energy Agency • SMP: System marginal price
• IOC: Independent oil company • ULSD: Ultra-low sulfur diesel
• IRR: Internal rate of return • VaR: Value-at-risk
• ISDA: International Swaps and • VOLL: Value of lost load
Derivatives Association • VPP: Volumetric production payment
• ISO: Independent System Operator • WACC: Weighted average cost of capital
• WTI: West Texas intermediate crude oil
•
2019 ERP Practice Exam, Part II – Candidate Answer Sheet

1. ___________ 31. __________

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30. __________ 60. __________
1. An investment analyst compiles a due diligence report on an exchange traded fund (ETF). The ETF
returns are largely derived from rolling investments in front-month Henry Hub natural gas and WTI
crude oil futures contracts. The following statistics on the fund’s monthly returns between 2015 and
2018 are included in the analyst’s report:
Standard
Year Mean (µ) Skewness Kurtosis
Deviation (σ)
2015 -0.02 0.02 -0.42 3.81
2016 0.01 0.01 0.13 1.61
2017 -0.01 0.01 -0.11 2.45
2018 0.00 0.02 0.31 4.76
The following table summarizes the number of monthly occurrences when the return varied more
than three standard deviations from the mean between 2015 and 2018.
Year Monthly return < µ – 3σ Monthly return > µ + 3σ

A 0 1
B 1 2
C 1 1
D 0 0
Which year (A, B, C or D) most likely corresponds to the statistical data on the fund’s monthly returns
for 2018, as cited in the analyst’s due diligence report?
a. Year A
b. Year B
c. Year C
d. Year D
2. An energy trader forecasts significant near-term volatility in the Brent crude market. The trader
creates a straddle position in options on Brent crude futures contracts with the following terms:
● Three-month ICE call option on Brent crude futures, with a strike price of USD 65.00/bbl at a
premium of USD 1.51/bbl
● Three-month ICE put option on Brent crude futures, with a strike price of USD 65.00/bbl at a
Shortly before the expiration of both contracts, the closing Brent crude futures price is USD
59.28/bbl. Calculate the current net MtM value (in USD) per contract of the straddle position.
a. -24,500
b. -2,450
c. 2,450
d. 24,500
3. A bank holds a portfolio of derivative transactions with a single counterparty that declares default.
The mark-to-market value and pledged collateral for each transaction at the time of default is
summarized below:
MtM value Collateral value

(in SGD) (in SGD)
Trade A 2,500,000 1,500,000
Trade B -7,000,000 0
Trade C 10,000,000 2,500,000
Trade D 3,000,000 1,000,000
The transactions are covered by an ISDA CSA with a closeout netting agreement. Assuming a zero
recovery rate, calculate the bank’s total net exposure (in SGD) to the counterparty.
a. 3,500,000
b. 5,000,000
c. 8,500,000
d. 10,500,000
4. Seismic surveys are used to test the future viability of crude oil production at 100 potential
deepwater drilling sites. A survey produces a positive test result for 95% of sites that are
commercially viable and produces a negative result 80% of the time if the site is not viable. If 5 out
of 100 drilling sites are commercially viable, calculate the probability that best approximates the
viability of a site, given a positive test result.
a. 5%
b. 10%
c. 20%
d. 25%
5. A risk manager at a refinery wants to reduce the volatility of its input costs and hedge against
potential adverse price movements at a minimal cost. To help achieve this objective, the risk
management team plans to structure a collar using the following options on NYMEX WTI futures
contracts:
Strike Price Call Premium Put Premium

(USD/bbl) (USD) (USD)
50.00 3.67 0.84
55.00 0.87 3.59
If the prompt-month NYMEX WTI futures price is currently USD 52.50/bbl, which of the following
sets of transactions will most effectively achieve the refiner’s economic objectives?
a. Buy USD 55.00 put options; sell USD 50.00 call options
b. Buy USD 50.00 put options; sell USD 55.00 call options
c. Sell USD 50.00 put options; buy USD 55.00 call options
d. Sell USD 55.00 put options; buy USD 50.00 call options
6. An energy commodity trader observes the volatility of daily futures price returns typically increases
as futures contracts approach maturity. Which of the following choices best explains this price
behavior?
a. Seasonality of supply and demand of energy futures contracts

b. Market contango creating an incentive to roll expiring prompt-month futures contracts
c. Increased hedging demand for deep OTM options on futures contracts
d. Increased trading volumes in response to new market information
7. A purchasing manager for a gas-powered plant assesses the volatility of NYMEX Henry Hub prices
over a period of 250 trading days. The analyst notes the variance of historical daily price returns over
this period was 0.000269.
Assume a month includes 22 trading days. Which of the following volatilities represent the monthly
volatility on the NYMEX Henry Hub contract, based on the daily price return data for this 250-day
period?
a. 0.6%
b. 1.6%
c. 7.7%
d. 36.1%
8. A Canadian refinery pays USD 6.20 per contract to buy 1,000 European-style call options on the
prompt-month Brent crude futures contract. The call options have a strike price of USD 54.25/bbl
and expire in six months. The prompt-month Brent futures contract trades at USD 58.75/bbl, and
the current 1-year risk-free rate is 1.50%.
Which of the following amounts (in USD) will the refinery expect to pay for 1,000 European-style put
options with the same maturity and strike price?
a. 1,634
b. 1,700
c. 1,734
d. 1,767
9. A US-based E and P is building an LNG terminal in Australia, scheduled for completion in five years.
To help reduce exposure to foreign currency fluctuations, the company structured a seven-year,
fixed-for-floating swap on the Australian dollar (AUD) with a BBB-rated counterparty. If the company
is concerned about a potential deterioration in the credit quality of the counterparty during the later
years of the swap, and has no other transactions with the counterparty, which of the following
provisions should it incorporate in the counterparty arrangement?
a. Reset agreement
b. Netting agreement
c. Threshold amount
d. Take-or-pay provision
10. Three months ago, a shipping company entered into a 1-year forward contract to purchase 100,000
MT of bunker fuel from a counterparty at a price of USD 410/MT.
Current market pricing for bunker fuel is summarized below:
● Spot price: USD 395/MT

● 6-month forward price: USD 415/MT
● 1-year forward price: USD 430/MT
Assume no impact from discounting. Calculate the shipping company’s credit exposure (in USD) if
the counterparty defaults today.
a. 0
b. 500,000
c. 1,500,000
d. 2,000,000
11. A credit analyst assesses the default profile for a portfolio of debt exposures to sovereign
counterparties. The following chart illustrates the estimated annual default probability for a specific
counterparty over the next 7 years (i.e. the probability the exposure will default in that year alone):
20.0%
Annual Probability of Default
18.0%
16.0%
14.0%
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
1 2 3 4 5 6 7
Year
Using the Moody’s rating standards as a guideline, what is the most likely rating for this counterparty
exposure?
a. Aa
b. Baa
c. B
d. Caa
12. A commercial natural gas end-user in the US state of Virginia hedges 100% of its expected February
2020 gas consumption, totaling 100,000 MMBtu. To best-minimize basis risk in its operation, which
of the following sets of transactions should the end-user execute?
a. Buy 10 February 2020 NYMEX Henry Hub natural gas futures contracts and buy a Transco Zone 5
natural gas basis swap for February 2020, covering 100,000 MMBtu.
b. Buy 10 February 2020 NYMEX Henry Hub natural gas futures contracts and sell a Transco Zone 5
c. Sell 10 February 2020 NYMEX Henry Hub natural gas futures contracts and buy a Transco Zone 5
d. Sell 10 February 2020 NYMEX Henry Hub natural gas futures contracts and sell a Transco Zone 5
13. A credit analyst assesses a USD 5,200,000 credit exposure related to a 10-year, fixed rate bond,
issued by a Ba/BB-rated midstream oil and gas company. The bond has a par value of USD 6,000,000
and an estimated recovery rate of 40%, while the exposure has an expected loss of USD 190,000.
What is the correct implied default probability on this exposure?
a. 3.7%
b. 5.3%
c. 6.1%
d. 9.1%
14. A renewable investor uses the RAROC approach to evaluate the terms of a PPA offered by a utility for
a proposed 100 MW wind farm. The investor makes the following estimates for the first year of
operation under the terms of the PPA:
• Pre-tax net income from operations: EUR 18 million

• Economic capital required to support the project: EUR 140 million
• Tax rate for the project: 25%
The estimated pre-tax net income includes an adjustment for expected losses the investor incurs if
the utility defaults. Additionally, the investor assumes it invests its economic capital risk-free at
2.0%. Given these factors, what is the expected RAROC for this project?
a. 11.1%
b. 12.7%
c. 12.9%
d. 14.9%
15. A refined products trader structured a 1-year fixed-for-floating swap on 50,000 bbls of gasoil with a
Ba1/BB+ rated counterparty. The trader applies the following information to price counterparty risk
into the transaction:
● Expected exposure as a percentage of notional value: 11.0%

● Loss given default: 80.0%
● 1-year probability of default: 3.21%
Assuming annual settlements and ignoring the impact of discounting, what is the best approximation
of the CVA (as a % of notional value) for the swap?
a. 0.07%
b. 0.28%
c. 0.77%
d. 2.20%
16. A refinery contracted to purchase 150,000 bbls of Brent crude from an upstream producer for
delivery on March 15. On March 3, a risk manager instructs a trader to hedge price risk on this
upcoming delivery.
Which of the following market-on-close orders will the trader submit to establish the hedge?
a. Sell 15 lots of March Brent futures.

b. Sell 150 lots of March Brent futures.
c. Sell 15 lots of April Brent futures.
d. Sell 150 lots of April Brent futures.
17. The market risk team at a retail power distributor investigates why off-peak real-time electricity
prices spiked in the PJM market the previous day. Assuming no market coupling exists between PJM
and other ISOs, which of the following market factors most likely explains the off-peak price spike?
a. The unplanned outage of a 1 GW nuclear generator occurred in the PJM market.

b. The planned retirement of a 1 GW coal-fired generator in PJM was announced.
c. The average hourly cooling degree days were two standard deviations below the 5-year
historical average for that date.
d. The neighboring MISO market experienced price spikes due to unexpected demand.
18. A risk manager at an energy trading firm supplemented the firm’s 1-day, 99% VaR model with a 1-
day, 99% expected shortfall measure. The manager considers a position in NYMEX WTI crude futures
with a 1-day 99% VaR of USD 750,000, based on 5,000 simulated 1-day returns.
Which of the following statements best describes the 1-day, 99% expected shortfall for this position?
a. The average simulated 1-day loss that exceeds USD 750,000

b. The maximum simulated loss out of the 5,000 simulated observations
c. The 50th largest simulated loss out of the 5,000 simulated observations
d. The difference between the 1-day, 99% VaR and the average simulated 1-day return for
the position
19. Consider the following information related to bonds issued by two different large regional energy
producers:
Bond A Bond B
Position size (MXN) 8,000,000 4,000,000
Probability of default 3.0% 4.0%
Expected recovery rate 30% 40%
Assuming bond defaults are independent, which of the following amounts (in MXN) is closest to the
99% Credit VaR for the combined position?
a. 0
b. 2,400,000
c. 5,600,000
d. 8,000,000
20. A trader holds a 1,000,000 MMBtu position in Platts Waha natural gas futures. Due to an unexpected
slump in demand, the position decreases in value by 15%, which exceeds the trader’s allowable loss
for the position. The CRO instructs the trader to liquidate the position when the current bid and
offer prices are USD 2.87/MMBtu and 2.91/MMBtu respectively.
Assuming normal market conditions, the expected cost (in USD) of liquidation is:
a. 20,000
b. 40,000
c. 60,000
d. 80,000
21. An energy trader sells a 3-month floor to manage price volatility requirements for the next three
months. The floor is written on 100,000 bbls of crude per month at a strike price of USD 60.00/bbl
and a monthly premium of USD 2.15/bbl. Settlement occurs on a monthly basis against the average
daily prompt-month NYMEX WTI contract closing prices summarized below:
● Month 1: USD 58.75/bbl

Which of the following amounts (in USD) represents the cumulative net cash inflow/outflow earned
by the trader on this contract over the 3-month period?
a. -465,000
b. -215,000
c. 180,000
d. 395,000
22. A risk consultant researches the concept of convenience yield to include in a presentation about
investment and hedging strategies for energy companies. In which of the following situations would
convenience yield most likely impact the economics of the given energy commodity?
a. Baseload electricity supply during on-peak hours

b. Natural gas prices during winter months
c. Renewable energy capacity in energy-only markets
d. LNG sold through a fixed-price contract to a Korean buyer
23. An analyst has been asked to estimate the volatility for Brent crude using the EWMA model with a
decay factor (λ) of 0.95. The estimated volatility yesterday was 1.73% per day. The market price of
Brent crude was USD 60.99/bbl yesterday and USD 60.45/bbl the day before yesterday.
Which of the following volatilities is the best estimate of Brent crude volatility today?
a. 1.63%
b. 1.70%
c. 1.73%
d. 1.78%
24. A risk analyst at a refinery examines the feasibility of potential storage strategies for Brent crude.
The spot price of Brent crude on the ICE exchange is USD 63.50/bbl. The continuously compounded
annual risk-free interest rate is 3.5%, and the monthly storage cost is USD 0.40/bbl.
If the crude can be stored for three months but cannot be sold out of storage before the three-
month storage term ends, what is the breakeven forward price supporting a storage strategy (in
USD/bbl)?
a. 64.05
b. 64.71
c. 65.27
d. 67.00
25. A commodity trader manages portfolios of energy futures positions. One portfolio currently contains
only two futures positions with the following individual 1-day, 95% VaR amounts:
● Long October 2019 RBOB futures contracts: USD 2.10 million

● Short October 2019 WTI futures contracts: USD 1.95 million
If the return correlation of the two positions is equal to -0.88, assuming returns of both positions are
normally distributed with a mean of zero, which of the following amounts best approximates the 1-
day, 95% VaR (in USD millions) of the portfolio?
a. 0.15
b. 1.00
c. 2.15
d. 2.87
26. A credit risk manager at an IOC describes the difference between counterparty settlement risk and
pre-settlement risk to a team of newly hired analysts. The manager explains that compared to
settlement risk, losses due to pre-settlement risk are typically:
a. Larger and occur more frequently

b. Larger but occur less frequently
c. Smaller but occur more frequently
d. Smaller and occur less frequently
27. A commodity trader holds a portfolio of long call options on NYMEX WTI crude futures contracts. A
risk limit is reached, and the trader is instructed to reduce the gamma of the long option portfolio.
Which of the following transactions is most effective in reducing the gamma in this portfolio?
a. Buy at-the-money options

b. Buy out-of-the-money options
c. Sell at-the-money options
d. Sell out-of-the money options
28. A global transport and logistics provider entered into a contract to purchase gasoline at the
wholesale price. To hedge the exposure, it purchases RBOB gasoline futures based on the following
historical return data:
• Standard deviation of wholesale gasoline price returns: 16.49%

• Standard deviation of RBOB gasoline futures: 20.90%
• Correlation between wholesale gasoline and RBOB gasoline futures: 0.95
The minimum variance hedge ratio required to properly size the futures position is closest to which
of the following?
a. 0.75
b. 0.79
c. 1.20
d. 1.27
29. A shipping company entered into an OTC swap contract to purchase 15,000 MT of IFO 380 bunker
fuel to be delivered in 1 month at a fixed price of USD 450/MT. Terms of the ISDA credit agreement
are as follows:
• Margining period: Weekly

• Threshold amount: USD 200,000
• Minimum transfer amount: USD 50,000
• Reference price: Platts Singapore ISO 380 front-month futures price
End-of-week Platts Singapore ISO 380 bunker futures pricing for the first two weeks of the swap
were as follows:
• Week 1: USD 435/MT
How much collateral (in USD) did the shipping company have to post in each of the first two weeks of
the swap?
a. 0 in week 1; 0 in week 2
b. 0 in week 1; 160,000 in week 2
c. 200,000 in week 1; 0 in week 2
d. 225,000 in week 1; 135,000 in week 2
30. A Japanese power company owns a network of five gas-fired generating plants fueled with imported
LNG, purchased at an oil-linked price. As part of its contingency funding plan, risk managers at the
company prepare a list of Early Warning Indicators (EWI’s) the company can use to trigger its
liquidity exception reporting.
Which of the following market observations most likely triggers a liquidity exception report at the
company?
a. A reduction in the collateral haircuts applied to bonds of several competitors

b. A significant appreciation in the Japanese yen against the US dollar and euro
c. An increase in credit spreads for investment-grade Japanese utility bonds
d. A decrease in global crude oil and natural gas market volatility
31. An energy company purchased an option contract to hedge the risk of unexpectedly low monthly
natural gas and power demand in February. The company purchases a put option with a strike of 28
referenced to the local monthly HDD index, and a payoff based on a notional amount of
USD 100,000 per HDD.
The average daily temperatures (°F) observed during the month are summarized below:
Week Mon Tues Wed Thurs Fri Sat Sun

1 65 66 66 65 65 65 64
2 64 62 60 60 63 64 65
3 65 65 65 66 66 67 69
4 70 66 65 65 64 64 65
Ignoring interest rate effects, calculate the payoff (in USD) realized on the put option.
a. 800,000
b. 1,200,000
c. 1,900,000
d. 2,400,000
32. A bank sold an OTC fixed-for-floating RBOB swap to a BB-rated refiner. The swap is subject to a
close-out agreement and the bank currently reports a positive MtM on the position.
Assume this is the bank’s only exposure to the counterparty. Which of the following steps will the
bank most likely take if the refiner defaults on the exposure?
a. Reassign the defaulted position to a solvent counterparty.

b. Auction off the exposure to other potential counterparties.
c. Terminate the position and become a creditor to the refiner’s estate.
d. File a claim with the central counterparty equivalent to the MtM value of the defaulted position.
33. A risk manager at an energy trading firm builds a model to forecast the number of operational loss
events occurring at the firm during each 1-week period. The model assumes the probability of an
operational loss event is constant over time and independent of all other operational loss events.
Which type of distribution will the manager use to model the number of operational loss events in a
1-week period?
a. Bernoulli
b. Chi-squared
c. Lognormal
d. Poisson
34. A consultant begins a new engagement with an energy company. The energy company seeks advice
implementing an ERM program. In preparation for the engagement, the consultant reviews several
case studies on successful ERM implementation at energy companies. Among these cases is Statoil,
which applies a concept called “total risk optimization”. Which of the following statements describes
the process Statoil used to achieve its objective?
a. Centralize the core risk function to prevent some value-destroying decisions made by individual
business units
b. Build a firm-wide distribution of risk exposures by summing together all risk exposures faced by
the individual units
c. Place the CRO in charge of all risk management decisions which impact operations at the
business unit level
d. Encourage business units to hedge their own risk exposures aggressively in order to reduce firm-
wide risk exposure
35. An IOC assesses macroeconomic risk associated with its producing asset in a small, oil-rich host
country. A recent decline in global crude oil prices weakened the local economy of the small nation,
so the IOC considers the risk of government default on its sovereign debt. Which of the following
describes the most likely outcome of a sudden default on its sovereign debt by the host country?
a. A deep economic recession that produces multiple years of negative year-over-year GDP growth
b. Dramatic increases in inflation and interest rates resulting in hyperinflation
c. A complete loss of their investments for holders of the sovereign debt
d. Short-term political unrest followed by a longer-term period of increased financing costs
36. A refinery in Pennsylvania processes 4,500,000 bbls of crude oil per month. The refinery creates a
financial position, replicating a 3:2:1 refining spread, to hedge its monthly production of gasoline and
ULSD. To hedge the ULSD portion of the 3:2:1 spread, the refinery will:
a. Buy 1,500 CME NY Harbor ULSD futures contracts.

b. Buy 3,000 CME NY Harbor ULSD futures contracts.
c. Sell 1,500 CME NY Harbor ULSD futures contracts.
d. Sell 3,000 CME NY Harbor ULSD futures contracts.
37. Two 120 MW generators supply power to the grid in an energy-only market. The marginal costs of
the generators are USD 35.00/MWh and USD 55.00/MWh, respectively. Peak hourly consumption is
uniformly distributed, within a range of 90 and 160 MWh.
Assume these two generators are the only ones supplying power to the grid. Calculate the
probability the market clearing price during a peak hour is less than USD 40.00/MWh.
a. 33.3%
b. 42.9%
c. 57.1%
d. 66.7%
38. An energy trading firm holds a long position in 1,000 put options on Brent crude futures at a strike
price of USD 65.00/bbl. Each option in the position has a current delta of -0.571, a gamma of 0.0402
and a vega of 0.0265. The firm wants to fully hedge the delta and gamma of this position. It
considers an option contract with the following metrics to implement the hedge:
• Delta: -0.416
• Gamma: 0.0342
The firm structures the transaction so gamma is first neutralized, before trading futures to neutralize
delta. How many futures does it buy or sell?
a. Buys 82 futures
b. Sells 82 futures
c. Buys 1,175 futures
d. Sells 1,175 futures
39. A GARCH (1,1) model applies the following expression to estimate volatility:
σt2 = ω + ασ2(t-1) + βrt2
Where: rt = εtσt and εt ~ N(0,1).
Assuming factors α and β are both greater than zero, what assumption is required to ensure volatility
estimates remain balanced and plausible?
a. α+β<1
b. α+β≥1
c. α < 1 and β < 1
d. α ≥ 1 and β ≥ 1
40. On July 1, a natural gas-fired power plant operator considers the risk of a possible cold winter. The
operator structures a calendar spread using 100 November and January Henry Hub futures contracts.
The following table shows the NYMEX Henry Hub futures prices on July 1 and on October 1:
Futures Expiration Futures Price July 1 Futures Price October 1

Month (USD/MMBtu) (USD/MMBtu)
November 2.571 3.155

January 3.884 4.937
Based on October 1 closing prices, which of the following describes the position established by the
operator and the current profit or loss on the position (in USD)?
a. Long January and short November futures; 469,000

b. Long January and short November futures; 1,782,000
c. Long November and short January futures; - 469,000
d. Long January and short November futures; -1,782,000
41. A risk analyst at an energy trading firm calculates the 10-day, 99% VaR on a natural gas futures
position currently valued at USD 3,250,000. Using daily returns for natural gas prices over the past
12 months, the firm applies an EWMA model with a lambda of 0.98 to estimate the VaR. Over the
latest month, natural gas prices fell substantially and volatility increased significantly. The analyst
expects increased volatility to persist for the foreseeable future. As a result, the analyst changes the
model’s lambda to 0.9 to recalibrate the volatility factor used in the VaR model.
Applying the new volatility estimate will most likely cause the new VaR amount to do which of the
following?
a. Increase slightly relative to the original VaR.

b. Increase sharply relative to the original VaR.
c. Decrease slightly relative to the original VaR.
d. Decrease sharply relative to the original VaR.
42. The risk committee of a global exploration and production company evaluates an opportunity to
expand its production business into the Canadian oil sands market. The project requires a large
capital investment for bidding on several concessions and establishing local operations. When
assessing strategic risk related to this expansion from an ERM perspective, which of the following
actions is most appropriate?
a. Estimating the most likely outcome and deciding to expand if the return on investment in this
case exceeds the firm’s cost of capital
b. Comparing the probability weighted distribution of potential returns from the new project to the
firm’s hurdle rate
c. Adding the VaR of the proposed expansion to the VaR of the company’s existing operations to
project the overall firm-wide VaR
d. Deciding to expand if the RAROC for the proposed expansion is greater than the project’s
economic capital requirement
43. A portfolio manager analyzes the risk of a large energy portfolio with a 1-day standard deviation of
USD 2,575,000. Assume portfolio returns are normally distributed.
What is the best estimate of the 10-day, 99% Value-at-Risk (VaR) for the portfolio?
a. USD 8,060,000
b. USD 18,940,000
c. USD 25,490,000
d. USD 59,900,000
44. A crude oil trader considers the impact of an expected sharp increase in crude oil market volatility on
a portfolio of long European call options on NYMEX WTI futures. Which of the following risk
measures can the trader use to quantify the potential change in MTM value of the portfolio due to
the expected volatility increase?
a. Beta
b. Gamma
c. Theta
d. Vega
45. A crude oil trader purchased spot crude for USD 60.00/bbl in a margin account.
• The current 1-month forward price for crude oil is USD 62.00/bbl
• The 2-month forward price is USD 63.00/bbl
Assume the trader’s monthly borrowing cost is USD 0.25/bbl and monthly storage cost is
USD 1.00/bbl. No other transportation, maintenance or storage costs apply.
What is the best way for the trader to maximize their risk-return profile?
a. Sell the crude today at the prevailing 1-month forward price.

b. Sell the crude today at the prevailing 2-month forward price.
c. Sell the crude today at the prevailing 3-month forward price.
d. Hold the crude in storage for 3 months and then sell it at the prevailing spot price.
46. A credit analyst compares the use of expected exposure (EE) and potential future exposure (PFE) to
quantify counterparty risk in contracts with risky counterparties. Which of the following is the
primary difference between expected exposure and potential future exposure?
a. Unlike PFE, EE accounts for positive mark-to-market values only.

b. EE will typically be greater than PFE at the initiation of a credit exposure.
c. PFE may underestimate the exposure for short-dated transactions.
d. PFE measures the worst-case exposure scenario at a given confidence level.
47. A risk modeler uses a single-factor lognormal model to value a portfolio of European-style energy
options. Which of the following volatility inputs is most appropriate to use in this model to ensure
the most accurate MtM valuation of the option portfolio?
a. A string of volatilities implied from at-the-money options that correspond to the portfolio’s
option expiration dates.
b. A matrix of volatilities implied from all the available options that correspond to the portfolio’s
option expiration dates and strike prices.
c. A single volatility that corresponds to spot price volatility estimated using historical price data
over the past 30 days, consistent with the single-factor model.
d. A single volatility that corresponds to spot price volatility estimated using historical price data
over one year or more, consistent with the single-factor model.
48. A credit analyst at a bank specializing in energy transactions considers the potential for wrong-way
risk in the bank’s derivative exposures. Assuming a stable economic environment, which of the
following long option positions, executed with the referenced counterparties, contains the greatest
potential for wrong-way risk?
a. At-the-money call option on an oil future with a BBB-rated oil producer

b. Out-of-the-money put option on an oil future with a BBB-rated shipping company
c. At-the-money put option on an oil future with an AA-rated shipping company
d. Out-of-the-money put option on an oil future with an AA-rated oil producer
49. An analyst built an ordinary least squares (OLS) linear regression model to forecast the natural gas
price, as a function of the average daily temperature and the spot coal price. In performing due
diligence on the model, the analyst evaluates the residuals (error term) generated by the model to
determine if it is correctly calibrated.
If the OLS model is calibrated correctly, which of the following observations will the analyst observe?
a. The residual term has a zero mean and a constant variance.

b. The residual term has a zero mean and a variance that increases with the natural gas price.
c. The residual term has a non-zero mean and a constant variance.
d. The residual term has a non-zero mean and a variance that increases with the natural gas price.
50. A power generator designs an AR (autoregressive) model to forecast natural gas consumption (G). An
analyst at the generator builds four potential AR models of different orders. The specification of
each model, as well as its Akaike information criterion (AIC) and Bayesian information criterion (BIC),
is presented in the following table:
Model Model specification AIC BIC

1
A 𝐴𝑅 (2): 𝐺) = 𝑐 + - 𝛼/ 𝐺)0/ + 𝜀) 1264.2 1165.3

/23
6
B 𝐴𝑅 (3): 𝐺) = - 𝛼/ 𝐺)0/ + 𝜀) 1154.3 976.8

/23
C 𝐴𝑅 (5): 𝐺) = 𝑐 + - 𝛼/ 𝐺)0/ + 𝜀) 1164.7 1006.9

/23
:
D 𝐴𝑅 (7): 𝐺) = - 𝛼/ 𝐺)0/ + 𝜀) 1213.6 1312.3

/23
Which of the following models will the generator choose?
a. Model A
b. Model B
c. Model C
d. Model D
51. A diversified energy company conducts a stress test of its liquidity profile. As part of the process, a
treasury analyst considers the availability and transferability of different classes of liquidity on the
firm’s balance sheet during periods of stress. Which of the following assumptions, insights, or
conclusions should an analyst rely on when developing a liquidity stress test?
a. The restricted liquidity balance can be quickly used to meet stress liquidity needs if certain
adverse financial market conditions are met.
b. The firm can reassign strategic liquidity as contingent liquidity if the strategic liquidity balance is
composed of high-quality liquid assets.
c. Operational liquidity can contribute to the stressed liquid asset buffer that the firm calculates
during its liquidity stress test.
d. Corporate bonds and common stock should be included in the firm’s liquid asset buffer.
52. The senior management of a globally diversified exploration and production company mandated the
firm adopt an ERM framework. What action should the firm take to ensure the implementation of
the ERM framework reflects best practices?
a. The framework should only address the risk categories that the firm believes it is most exposed
to, including market and operational risk.
b. Each global division of the firm should develop a separate ERM framework to manage the unique
operating characteristics of that division.
c. Each section of the framework should be communicated with a high level of detail so that
stakeholders can validate the assumptions used to quantify each risk.
d. The framework should capture offsetting risk exposures in different business divisions to
incorporate diversification benefits.
53. The board of directors of an energy conglomerate approved a recommendation by senior

management to pursue new business opportunities to fuel potential growth. As part of the new
strategic approach, the firm will sell a business unit with a 5% expected rate of return and 7%
earnings volatility. It will invest the entire proceeds of the sale in a new business unit with a
projected 8% rate of return and 20% earnings volatility.
How will the firm’s capital profile most likely change, assuming the business unit is sold, the new
investment is made, and no gains or losses are recorded on the transactions?
a. The firm’s economic capital requirement will increase and its book capital will increase.
b. The firm’s economic capital requirement will decrease and its book capital will decrease.
c. The firm’s economic capital requirement will increase but its book capital will not change until
the firm reports profits or losses.
d. The firm’s economic capital requirement will decrease but its book capital will not change until
54. A NOC evaluates E&P bids received during a licensing round to develop various domestic
hydrocarbon reservoirs. After receiving numerous bids, the NOC narrows its selection to four
potential E&P partners. The NOC received the following 1-year operating data, to assess the relative
operating efficiency of each company:
Company W Company X Company Y Company Z

(in thousands BOE)
Production 20,000 35,000 14,000 60,000
Discoveries 11,000 18,000 8,000 41,000
Extensions 5,000 2,000 7,000 29,000
Total reserves 170,000 230,000 90,000 275,000
(in thousands USD)
Revenues 1,100,000 1,925,000 770,000 3,300,000
Depreciation &
125,000 40,000 25,000 102,000
Amortization
Exploration costs 98,000 108,000 67,000 550,000
Capital
100,000 385,000 154,000 660,000
expenditures
Net income 88,000 215,000 89,000 467,000
Using the finding cost ratio as a guideline, which company was most efficient in adding new reserves
over the past year?
a. W
b. X
c. Y
d. Z
55. When calibrating model parameters, which one of the following statistics is most appropriate for
estimating the explanatory power of the input variables used in an energy pricing model?
a. Autocorrelation
b. Kurtosis
c. Degrees of freedom
d. R2
56. A NOC granted concessions to an E&P company to explore a natural gas field. The E&P company
drafts a report to propose a new well, highlighting a 10% chance of a major structural failure as a key
risk to the completion of the project. During a subsequent discussion with the E&P company, the
NOC management suggested the probability be much lower. The E&P indicated it recently suffered a
similar incident, leading to a conservative assessment of the risk.
The NOC is most likely concerned which of the following biases occurred in the E&P’s decision-
making process?
a. Anchoring bias
b. Confirmation bias
c. Availability bias
d. Motivational bias
57. The risk committee of a multinational oil company considers the company’s exposure to emerging
risk factors. A risk manager evaluates best practices to identify, prioritize and manage these
emerging risk exposures. Which of the following actions should the manager suggest?
a. Develop scenarios that explore potential interactions among different emerging risks.
b. Purchase insurance to cover a wide range of potential emerging risk exposures.
c. Increase the IOC’s risk tolerance limits to incorporate potential losses from emerging risks.
d. Build a model to quantify the expected size of the loss from each emerging risk exposure.
58. An oil drilling firm implements a risk appetite framework incorporating a “three lines of defense”
model for governance. The risk committee proposes roles and responsibilities for different
organizational units. Which of the following statements describes the most appropriate role for a
given business unit in accordance with a three lines of defense model?
a. Business unit managers should manage the risk of their business units as part of the first line of
defense.
b. Risk and compliance functions should manage firm-wide risks as part of the first line of defense.
c. Senior management and the ERM function should develop analytical tools to manage risks as
part of the third line of defense.
d. Business line managers should challenge the risk appetite framework developed by senior
management as part of the third line of defense.
59. An energy trading firm performs a validation exercise on several VaR models for its portfolio of
natural gas derivatives. Which of the following actions reflects best practices in validating the
models?
a. The model development team should take a leading role in performing technical aspects of the
validation.
b. A model should be implemented in a widespread manner before validation begins, so that
enough data points can be generated to validate the model.
c. The validation team should ensure that the model incorporates a stable correlation between
portfolio holdings to standardize the long-term model output.
d. The validators should subject any third-party vendor models it selects to the same validation
process used for the firm’s internal models.
60. A risk manager at an IOC stress tests the liquidity profile of its investment portfolio to simulate a
period of broad systemic financial market stress. In developing the modeling process for the liquidity
stress test, which of the following assumptions should the manager make?
a. Market interest rates will increase significantly.

b. Bid-ask spreads for corporate bonds will widen.
c. Haircuts on pledged collateral will decrease.
d. Return correlations between different risky asset classes will decrease.
•
2019 ERP Practice Exam, Part II – Candidate Answer Sheet

1. ______b____ 31. _____a____

2. ______c____ 32. _____c____
3. ______a____ 33. _____d____
4. ______c____ 34. _____a____
5. ______c____ 35. _____d____
6. ______d____ 36. _____c____
7. ______c____ 37. _____b____
8. ______c____ 38. _____a____
9. ______a____ 39. _____a____
10. _____c____ 40. _____a____
11. _____d____ 41. _____b____
12. _____a____ 42. _____b____
13. _____c____ 43. _____b____
14. _____a____ 44. _____d____
15. _____b____ 45. _____a____
16. _____d____ 46. _____d____
17. _____a____ 47. _____b____
18. _____a____ 48. _____d____
19. _____c____ 49. _____a____
20. _____a____ 50. _____b____
21. _____c____ 51. _____b____
22. _____b____ 52. _____d____
23. _____b____ 53. _____c____
24. _____c____ 54. _____c____
25. _____b____ 55. _____d____
26. _____c____ 56. _____c____
27. _____c____ 57. _____a____
28. _____a____ 58. _____a____
29. _____b____ 59. _____d____
30. _____c____ 60. _____b____
1. An investment analyst compiles a due diligence report on an exchange traded fund (ETF). The ETF
returns are largely derived from rolling investments in front-month Henry Hub natural gas and WTI
crude oil futures contracts. The following statistics on the fund’s monthly returns between 2015 and
2018 are included in the analyst’s report:
Standard
Year Mean (µ) Skewness Kurtosis
Deviation (σ)
2015 -0.02 0.02 -0.42 3.81
2016 0.01 0.01 0.13 1.61
2017 -0.01 0.01 -0.11 2.45
2018 0.00 0.02 0.31 4.76
The following table summarizes the number of monthly occurrences when the return varied more
than three standard deviations from the mean between 2015 and 2018.
Year Monthly return < µ – 3σ Monthly return > µ + 3σ

A 0 1
B 1 2
C 1 1
D 0 0
Which year (A, B, C or D) most likely corresponds to the statistical data on the fund’s monthly returns
for 2018, as cited in the analyst’s due diligence report?
a. Year A
b. Year B
c. Year C
d. Year D
Answer: b
Explanation:
Both 2015 and 2018 have relatively large kurtosis, implying a relatively larger number of extreme
return observations, making B and C potential candidates. The positive skew of 2018 would imply
that the extreme monthly returns on the upside should outnumber the extreme monthly returns on
the downside, making B the correct choice.
Reference: Michael Miller. Mathematics and Statistics for Financial Risk Management, 2nd Edition,
Chapter 3.
2. An energy trader forecasts significant near-term volatility in the Brent crude market. The trader
creates a straddle position in options on Brent crude futures contracts with the following terms:
● Three-month ICE call option on Brent crude futures, with a strike price of USD 65.00/bbl at a
● Three-month ICE put option on Brent crude futures, with a strike price of USD 65.00/bbl at a
Shortly before the expiration of both contracts, the closing Brent crude futures price is USD
59.28/bbl. Calculate the current net MtM value (in USD) per contract of the straddle position.
a. -24,500
b. -2,450
c. 2,450
d. 24,500
Answer: c
Explanation:
To enter into the straddle position, the trader goes long both the call and the put option and pays a
combined premium of USD 3.27/bbl. With the Brent crude futures price (Fo) at 59.28, the current
MtM of the call option is max (Fo- 65.00, 0) or 0; while the current MtM of the put option is max
(65.00 - Fo, 0) or 5.72/bbl. Since one option references 1,000 bbls the trader’s current net MtM is
(5.72-3.27) * 1,000 or 2,450.
Reference: S. Mohamed Dafir and Vishnun N. Gajjala. Fuel Hedging and Risk Management,
Chapter 4.
3. A bank holds a portfolio of derivative transactions with a single counterparty that declares default.
The mark-to-market value and pledged collateral for each transaction at the time of default is
summarized below:
MtM value Collateral value

(in SGD) (in SGD)
Trade A 2,500,000 1,500,000
Trade B -7,000,000 0
Trade C 10,000,000 2,500,000
Trade D 3,000,000 1,000,000
The transactions are covered by an ISDA CSA with a closeout netting agreement. Assuming a zero
recovery rate, calculate the bank’s total net exposure (in SGD) to the counterparty.
a. 3,500,000
b. 5,000,000
c. 8,500,000
d. 10,500,000
Answer: a
Explanation:
Exposure is reduced by both the netting agreement and the collateral. At the time of default, the
bank has SGD 15,500,000 in positive exposures and 7,000,000 in negative exposures. Because of the
netting agreement, these two exposures can be netted against each other for a total exposure of
SGD 8,500,000 before collateral is considered. The bank will then take ownership of the SGD
5,000,000 in collateral leaving it with SGD 3,500,000 of net exposure to the counterparty.
Reference: Jon Gregory. The xVA Challenge: Counterparty Credit Risk, Funding, Collateral and Capital,
3rd Edition, Chapter 5.
4. Seismic surveys are used to test the future viability of crude oil production at 100 potential
deepwater drilling sites. A survey produces a positive test result for 95% of sites that are
commercially viable and produces a negative result 80% of the time if the site is not viable. If 5 out
of 100 drilling sites are commercially viable, calculate the probability that best approximates the
viability of a site, given a positive test result.
a. 5%
b. 10%
c. 20%
d. 25%
Answer: c
Explanation:
Assume P(V) is the probability that a reservoir is commercially viable and P(T) the probability that the
test is positive. P(NV) and P(NT) are the probabilities of the opposite events. We are asked to find
P(V|T), the probability that a site is commercially viable given a positive test result.
Using this notation, P(T|V)=95%. Since the probability of a negative test given that the site is not
viable, P(NT|NV), is equal to 80%, we can conclude that a positive test result is given on the
remaining 20% of non-viable sites, i.e. P(T|NV)=20%. Furthermore P(V)=5/100.
First, derive the probability for a positive test result:
P(T) = P(T|V) * P(V) + P(T|NV) * P(NV)

=95%*5/100 + 20%*95/100=23.75%
Then, using conditional probability theory, we can calculate P(V|T) as follows:

P(V|T) = P (V and T) / P (T)
=P (T|V) * P(V) / P(T)
= (95%*5/100) / 23.75% = 20.00%
Chapter 2.
5. A risk manager at a refinery wants to reduce the volatility of its input costs and hedge against
potential adverse price movements at a minimal cost. To help achieve this objective, the risk
management team plans to structure a collar using the following options on NYMEX WTI futures
contracts:
Strike Price Call Premium Put Premium

(USD/bbl) (USD) (USD)
50.00 3.67 0.84
55.00 0.87 3.59
If the prompt-month NYMEX WTI futures price is currently USD 52.50/bbl, which of the following
sets of transactions will most effectively achieve the refiner’s economic objectives?
a. Buy USD 55.00 put options; sell USD 50.00 call options
b. Buy USD 50.00 put options; sell USD 55.00 call options
c. Sell USD 50.00 put options; buy USD 55.00 call options
d. Sell USD 55.00 put options; buy USD 50.00 call options
Answer: c
Explanation:
The collar will help the refiner hedge price risk and, by extension, margins on its refining operation.
In this case, the refiner will lock in a range of buying prices between USD 50.00 and 55.00 per barrel
(less any cost of implementing the trade). If the WTI price rallies over 55.00, the refiner can use the
long call to lock in a price of 55.00 for its oil. However, if the WTI price falls below 50.00 then the
short put would be put to the refiner, resulting in an effective purchase price of 50.00 for WTI in that
case. Therefore, this low-cost collar strategy would allow the refiner to fix its price within that range.
Reference: Vincent Kaminski. Energy Markets, Chapter 18.
6. An energy commodity trader observes the volatility of daily futures price returns typically increases
as futures contracts approach maturity. Which of the following choices best explains this price
behavior?
a. Seasonality of supply and demand of energy futures contracts

b. Market contango creating an incentive to roll expiring prompt-month futures contracts
c. Increased hedging demand for deep OTM options on futures contracts
d. Increased trading volumes in response to new market information
Answer: d
Explanation:
As the time remaining to the physical delivery (settlement) date of an energy forward contract
approaches zero, the price volatility tends to increase. This is attributed to several interconnected
factors, such as traders having more information about the contract as it draws closer to maturity,
which causes a rise in trades of that forward contract that, in turn, increases price volatility.
Reference: S. Mohamed Dafir and Vishnun N. Gajjala. Fuel Hedging and Risk Management, Chapter
4.
7. A purchasing manager for a gas-powered plant assesses the volatility of NYMEX Henry Hub prices
over a period of 250 trading days. The analyst notes the variance of historical daily price returns over
this period was 0.000269.
Assume a month includes 22 trading days. Which of the following volatilities represent the monthly
volatility on the NYMEX Henry Hub contract, based on the daily price return data for this 250-day
period?
a. 0.6%
b. 1.6%
c. 7.7%
d. 36.1%
Answer: c
Explanation:
Historical volatility is derived by multiplying the standard deviation (square root of variance) of daily
price changes by the square root of time (22), the factor required to provide a monthly volatility
from the daily prices observed in the sample:
(sqrt 0. 000269)*(sqrt 22) = 0.0164 * 4.690 = 7.7%
Reference: Les Clewlow and Chris Strickland. Energy Derivatives: Pricing and Risk Management,
Chapter 3.
8. A Canadian refinery pays USD 6.20 per contract to buy 1,000 European-style call options on the
prompt-month Brent crude futures contract. The call options have a strike price of USD 54.25/bbl
and expire in six months. The prompt-month Brent futures contract trades at USD 58.75/bbl, and
the current 1-year risk-free rate is 1.50%.
Which of the following amounts (in USD) will the refinery expect to pay for 1,000 European-style put
options with the same maturity and strike price?
a. 1,634
b. 1,700
c. 1,734
d. 1,767
Answer: c
Explanation:
The prices of put and call options are related via an algebraic equation, which states that holding a
stock and a put option on the stock is equivalent to purchasing a call option and investing in a bond
that pays out the strike price at maturity. This relationship is known as “put–call” parity.
In the case of commodities, options are generally written on futures contracts and not spot prices.
Investors hold forward or futures positions and not spot positions and, therefore, the put–call parity
relationship is written as: F0e−rT + P = C + K e−rT or C − P = (F0 − K) e−rT , where:
F0e−rT is equal to the discounted value of the Futures price

K e−rT is equal to the discounted value of the Option Strike price
C is equal to the Option Call Premium
P is equal to the Option Call Premium
By valuing only one of either a call or a put option, we can calculate the value of the other option
using this parity relationship. Rearranging and applying the market data from the question stem:
C = 6.20
K = 54.25
F = 58.75
T= 0.50
r = 1.50%
𝑃 = 6.20 − 𝑒 (0.A38 ∙ .8A) (58.75 − 54.25)
P = 1.734
The amount the refinery pays for 1,000 put options is: USD 1,734 (USD 1,000* USD 1.734).
Chapter 4.
9. A US-based E and P is building an LNG terminal in Australia, scheduled for completion in five years.
To help reduce exposure to foreign currency fluctuations, the company structured a seven-year,
fixed-for-floating swap on the Australian dollar (AUD) with a BBB-rated counterparty. If the company
is concerned about a potential deterioration in the credit quality of the counterparty during the later
years of the swap, and has no other transactions with the counterparty, which of the following
provisions should it incorporate in the counterparty arrangement?
a. Reset agreement
b. Netting agreement
c. Threshold amount
d. Take-or-pay provision
Answer: a
Explanation:
A reset agreement stipulates that the mark-to-market be settled at certain designated points in time.
At these points, a cash payment is made that reflects the current mark-to-market and the terms of
the swap are reset at the prevailing rate so that exposure becomes 0 after every reset is made. This
allows exposure to be “paid out” more frequently and reduces the amount of exposure which could
potentially be outstanding in later years of the agreement when the health of the counterparty is
much less certain.
A is incorrect. A threshold amount would set an exposure level under which collateral would not
have to be posted by the counterparty. This would introduce counterparty risk on the
uncollateralized amount.
B is incorrect. A netting agreement would only help if the producer had multiple transactions with
the counterparty as it would allow the producer to net out negative exposures against positive ones.
D is incorrect. A take or pay provision is used on commodity contracts and not credit agreements. It
could be used by the producer in structuring a contract to sell LNG but would not be relevant to
manage the counterparty risk of this swap.
10. Three months ago, a shipping company entered into a 1-year forward contract to purchase 100,000
MT of bunker fuel from a counterparty at a price of USD 410/MT.
Current market pricing for bunker fuel is summarized below:
● Spot price: USD 395/MT

● 1-year forward price: USD 430/MT
Assume no impact from discounting. Calculate the shipping company’s credit exposure (in USD) if
the counterparty defaults today.
a. 0
b. 500,000
c. 1,500,000
d. 2,000,000
Answer: c
Explanation:
Credit exposure defines the loss in the case the counterparty defaults. It is equal to the replacement
risk of entering into a new contract (i.e. the incremental cost) plus the settlement risk (if any). In this
case, since there are now nine months to maturity, the shipper is essentially holding a nine-month
forward contract. The replacement risk is therefore: (425-410) * 100,000 = 1,500,000. Since the
shipping company has not paid the counterparty yet, there is zero settlement risk.
Reference: Markus Burger, Bernhard Graeber, and Gero Schindlmayr. Managing Energy Risk: An
Integrated View on Power and Other Energy Markets, 2nd Edition, Chapter 3 (Section 3.4).
11. A credit analyst assesses the default profile for a portfolio of debt exposures to sovereign
counterparties. The following chart illustrates the estimated annual default probability for a specific
counterparty over the next 7 years (i.e. the probability the exposure will default in that year alone):
20.0%
Annual Probability of Default
18.0%
16.0%
14.0%
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
1 2 3 4 5 6 7
Year
Using the Moody’s rating standards as a guideline, what is the most likely rating for this counterparty
exposure?
a. Aa
b. Baa
c. B
d. Caa
Answer: D
Explanation:
This default probability profile would most closely correspond to a Caa Moody’s rating, equivalent to
an S&P rating of CCC. This can be implied by the charts of cumulative default probabilities presented
in the text. A Caa rating implies that the counterparty is in “poor standing, subject to very high credit
risk”. For a lower speculative grade rating such as Caa, the probability of default is highest in the first
couple of years. The reasoning is that low-graded exposures are most likely to suffer a default event
early on; if they survive the near term, they have likely improved their financial standing to escape
their near-term credit pressure and the marginal likelihood of default decreases in future years.
Integrated View on Power and Other Energy Markets, 2nd Edition, Chapter 3 (Section 3.4).
12. A commercial natural gas end-user in the US state of Virginia hedges 100% of its expected February
2020 gas consumption, totaling 100,000 MMBtu. To best-minimize basis risk in its operation, which
of the following sets of transactions should the end-user execute?
a. Buy 10 February 2020 NYMEX Henry Hub natural gas futures contracts and buy a Transco Zone 5
b. Buy 10 February 2020 NYMEX Henry Hub natural gas futures contracts and sell a Transco Zone 5
c. Sell 10 February 2020 NYMEX Henry Hub natural gas futures contracts and buy a Transco Zone 5
d. Sell 10 February 2020 NYMEX Henry Hub natural gas futures contracts and sell a Transco Zone 5
Answer: a
Explanation:
Basis refers to the difference in price between a forward (futures) market and a cash (spot) market.
The end–user is seeking to eliminate the basis price risk associated with the gas price in February
2020 compared to today’s spot price. Therefore, the company should buy February 2020 Henry Hub
futures contracts. Since 1 futures contract represents 10,000 MMBtu, the company should buy 10
futures contracts.
However, since the company purchased Henry Hub futures, the company is still exposed to locational
basis risk. The company can purchase a locational basis swap in order mitigate the risk exposure
between the natural gas price at Virginia’s Transco zone 5, where it expects to consume the gas, and
Henry Hub. By purchasing the basis swap, the company will pay a fixed basis (spread) and receive the
floating spread in February 2020. The company would not sell the swap as then it would pay the
floating and receive the fixed price, which would increase its basis risk.
13. A credit analyst assesses a USD 5,200,000 credit exposure related to a 10-year, fixed rate bond,
issued by a Ba/BB-rated midstream oil and gas company. The bond has a par value of USD 6,000,000
and an estimated recovery rate of 40%, while the exposure has an expected loss of USD 190,000.
What is the correct implied default probability on this exposure?
a. 3.7%
b. 5.3%
c. 6.1%
d. 9.1%
Answer: c
Explanation:
The implied default probability can be derived using the following relationship: Expected loss (EL) =
Loss Given Default (LGD) x probability of default.
In this example LGD is derived by multiplying the Credit Exposure by (1-Recovery Rate) = USD
3,120,000.
The implied default probability is then the EL of USD 190,000 divided by the LGD USD 3,120,000 or
6.1%.
Note: The par value of the bonds is not used in the calculation.
Integrated View on Power and Other Energy Markets, 2nd Edition, Chapter 3 (Section 3.4 Credit Risk
only).
14. A renewable investor uses the RAROC approach to evaluate the terms of a PPA offered by a utility for
a proposed 100 MW wind farm. The investor makes the following estimates for the first year of
operation under the terms of the PPA:
• Pre-tax net income from operations: EUR 18 million

• Economic capital required to support the project: EUR 140 million
• Tax rate for the project: 25%
The estimated pre-tax net income includes an adjustment for expected losses the investor incurs if
the utility defaults. Additionally, the investor assumes it invests its economic capital risk-free at
2.0%. Given these factors, what is the expected RAROC for this project?
a. 11.1%
b. 12.7%
c. 12.9%
d. 14.9%
Answer: a
Explanation:
RAROC is equal to: After-tax risk-adjusted net income / Economic capital. This can also be expressed
as: (Revenues – costs – expected losses + return on risk capital) / Economic capital. Because the
pre-tax net income from operations already includes the adjustments for costs and expected losses,
the RAROC is:
[(18 million + (140 million * 2.0%)) * (1-0.25)] / 140 million = 11.1%.
Reference: Michel Crouhy, Dan Galai, and Robert Mark. The Essentials of Risk Management, 2nd
Edition, Chapter 17.
15. A refined products trader structured a 1-year fixed-for-floating swap on 50,000 bbls of gasoil with a
Ba1/BB+ rated counterparty. The trader applies the following information to price counterparty risk
into the transaction:
● Expected exposure as a percentage of notional value: 11.0%

● Loss given default: 80.0%
● 1-year probability of default: 3.21%
Assuming annual settlements and ignoring the impact of discounting, what is the best approximation
of the CVA (as a % of notional value) for the swap?
a. 0.07%
b. 0.28%
c. 0.77%
d. 2.20%
Answer: b
Explanation:
CVA can be estimated as follows: CVA ≈ [EE * (1-RR) * PD]
Where EE is the Expected Exposure as a percentage of the notional value of the swap, (1-RR) is the
Loss Given Default, and PD is the probability of default.
CVA ≈ 11.00% * 80% * 3.21% = 0.002825 or approximately 0.28%.
16. A refinery contracted to purchase 150,000 bbls of Brent crude from an upstream producer for
delivery on March 15. On March 3, a risk manager instructs a trader to hedge price risk on this
upcoming delivery.
Which of the following market-on-close orders will the trader submit to establish the hedge?
a. Sell 15 lots of March Brent futures.

b. Sell 150 lots of March Brent futures.
c. Sell 15 lots of April Brent futures.
d. Sell 150 lots of April Brent futures.
Answer: d
Explanation:
Most energy commodities have a standard notional quantity for one contract, referred to as a “lot”.
For WTI crude oil, one lot references 1,000 bbls. Therefore, the refinery will sell 150 lots to reference
150,000 bbls (150 x 1,000).
As with all futures, trading for a given contract month ceases at a defined futures expiration date
prior to the contract month. In the case of the Brent contract, this is roughly two-thirds (2/3) of the
way through the previous contract month. Therefore, only April futures would be available for
trading.
Reference: Glen Swindle. Valuation and Risk Management in Energy Markets, Chapter 2.
17. The market risk team at a retail power distributor investigates why off-peak real-time electricity
prices spiked in the PJM market the previous day. Assuming no market coupling exists between PJM
and other ISOs, which of the following market factors most likely explains the off-peak price spike?
a. The unplanned outage of a 1 GW nuclear generator occurred in the PJM market.

b. The planned retirement of a 1 GW coal-fired generator in PJM was announced.
c. The average hourly cooling degree days were two standard deviations below the 5-year
historical average for that date.
d. The neighboring MISO market experienced price spikes due to unexpected demand.
Answer: a
Explanation:
Price spikes may appear in a stable demand environment when a considerable amount of base load
is removed from the market.
B is incorrect: The removal of future capacity on the grid is unlikely to affect real time prices;
however, it may increase the price level of the forward curve.
C is incorrect: An average hourly cooling degree day (CDD) below the 5-year historical average will
most likely create a load requirement that is lower than forecasted.
D is incorrect: Electricity market prices tend to have regional characteristics. One market has little to
no impact on other markets. If market coupling did exist, the PJM market could have experienced
some relief from a price spike by importing lower-cost power from neighboring markets if it was
available, but without coupling, a price spike in neighboring markets would have very little impact on
PJM prices and almost certainly would not increase them.
Reference: Rafal Weron. Modeling and Forecasting Electricity Loads and Prices, Chapter 2.
18. A risk manager at an energy trading firm supplemented the firm’s 1-day, 99% VaR model with a 1-
day, 99% expected shortfall measure. The manager considers a position in NYMEX WTI crude futures
with a 1-day 99% VaR of USD 750,000, based on 5,000 simulated 1-day returns.
Which of the following statements best describes the 1-day, 99% expected shortfall for this position?
a. The average simulated 1-day loss that exceeds USD 750,000

b. The maximum simulated loss out of the 5,000 simulated observations
c. The 50th largest simulated loss out of the 5,000 simulated observations
d. The difference between the 1-day, 99% VaR and the average simulated 1-day return for
the position
Answer: a
Explanation:
Expected shortfall is a measure of loss expectations above the VaR threshold. It represents the
average loss for a given confidence interval (X), and time period (T), conditional on the loss being
greater than the Xth percentile of the loss distribution. In this case X is equal to 99; therefore, since
the 99% VaR is equal to USD 750,000, the expected shortfall would be the average of all simulated 1-
day losses which exceed this amount.
Reference: John C. Hull. Risk Management and Financial Institutions, 4th Edition, Chapter 12.
19. Consider the following information related to bonds issued by two different large regional energy
producers:
Bond A Bond B
Position size (MXN) 8,000,000 4,000,000
Probability of default 3.0% 4.0%
Expected recovery rate 30% 40%
Assuming bond defaults are independent, which of the following amounts (in MXN) is closest to the
99% Credit VaR for the combined position?
a. 0
b. 2,400,000
c. 5,600,000
d. 8,000,000
Answer: c
Explanation:
The credit VaR is equal to the highest potential loss with a probability higher than or equal to the
confidence level. In this case, since we are asking for a 99% Credit VaR, the confidence level is 1%.
Given the recovery rate estimates, if bond A defaults the loss is MXN 5,600,000, and if bond B
defaults the loss is USD 2,400,000. We can then construct a table with the four possible outcomes:
Outcome Probability Loss (MXN)

Both bonds default 0.12% 8,000,000
Only Bond A defaults 2.88% 5,600,000
Only Bond B defaults 3.88% 2,400,000
Neither bond defaults 93.12% 0
In this case, a default of Bond A which would incur a loss of MXN 5,600,000 is the highest potential
loss with a probability over 1%. The probability of both bonds defaulting is 0.12% (3% * 4%), which is
below the confidence level, so 8,000,000 is not the 99% credit VaR.
Integrated View on Power and Other Energy Markets, 2nd Edition, Chapter 3 (Section 3.4 Credit Risk
only).
20. A trader holds a 1,000,000 MMBtu position in Platts Waha natural gas futures. Due to an unexpected
slump in demand, the position decreases in value by 15%, which exceeds the trader’s allowable loss
for the position. The CRO instructs the trader to liquidate the position when the current bid and
offer prices are USD 2.87/MMBtu and 2.91/MMBtu respectively.
Assuming normal market conditions, the expected cost (in USD) of liquidation is:
a. 20,000
b. 40,000
c. 60,000
d. 80,000
Answer: a
Explanation:
In order to determine the liquidation cost in a normal market condition, the firm should use the
formula:
Liquidation cost = (s * α) / 2
Where s is the spread expressed as a percentage of midpoint: (2.91-2.87)/2.89 = 0.0138

and α is the current portfolio value calculated at the midpoint, 1,000,000 * 2.89 = 2,890,000.
Hence the liquidation cost is equal to (2,890,000 * .00138)/2 = 20,000.
More simply, half the bid-offer spread is 0.02, so 1,000,000 units * 0.02 = 20,000
Answer B Incorrectly assumes the liquidation cost is equal to midpoint of the market value of the
position after the 15% drop in value (1,360,000 * 0.0625) = 85,000
Answer C incorrectly assumes the bid-ask spread times the position (0.20 * 500,000)
Answer D incorrectly assumes the market value of the position. (3.20 * 500,000)
Reference: John C. Hull. Risk Management and Financial Institutions, Chapter 24.
21. An energy trader sells a 3-month floor to manage price volatility requirements for the next three
months. The floor is written on 100,000 bbls of crude per month at a strike price of USD 60.00/bbl
and a monthly premium of USD 2.15/bbl. Settlement occurs on a monthly basis against the average
daily prompt-month NYMEX WTI contract closing prices summarized below:

Which of the following amounts (in USD) represents the cumulative net cash inflow/outflow earned
by the trader on this contract over the 3-month period?
a. -465,000
b. -215,000
c. 180,000
d. 395,000
Answer: c
Explanation:
By selling the floor, the trader receives a total of USD 645,000 in premiums (2.15 per month *
100,000 barrels/month * 3 months.)
However, if the settlement price of crude oil is below the strike price in a given month, the difference
between the prices must be paid by the trader. In this case, the first and second months are below
the strike price; the difference for month 1 is USD 1.25 and the difference for month 2 is USD 3.40.
Therefore, the trader must pay out USD 125,000 at the end of month 1 and USD 340,000 at the end
of month 2. Therefore, the total net profit for the trader over this period is 645,000 – 125,000 –
340,000 or 180,000.
22. A risk consultant researches the concept of convenience yield to include in a presentation about
investment and hedging strategies for energy companies. In which of the following situations would
convenience yield most likely impact the economics of the given energy commodity?
a. Baseload electricity supply during on-peak hours

b. Natural gas prices during winter months
c. Renewable energy capacity in energy-only markets
d. LNG sold through a fixed-price contract to a Korean buyer
Answer: b
Explanation:
Convenience yield is a theoretical framework often used to explain backwardation in forward energy
commodity prices. While many practitioners argue that convenience yield is irrelevant, storable
commodities that exhibit seasonal demand patterns do have a positive economic benefit that
accrues to the owner of the underlying physical energy commodity. One example is natural gas
which exhibits seasonally higher prices during winter months and extreme short-term volatility in
both demand and prices due to the weather. Since natural gas is storable, convenience yield can help
explain the benefits of storing gas during this time period as users store additional gas to protect
themselves from short-term price spikes or demand increases.
Choices A and C are incorrect as electricity can not be readily stored in large amounts. Choice D is
incorrect as the fixed-price contract has fixed the economics of the LNG deal removing the potential
impact of convenience yield.
References: S. Mohamed Dafir and Vishnun N. Gajjala. Fuel Hedging and Risk Management,
Chapter 4.
Glen Swindle. Valuation and Risk Management in Energy Markets, Chapter 2.
23. An analyst has been asked to estimate the volatility for Brent crude using the EWMA model with a
decay factor (λ) of 0.95. The estimated volatility yesterday was 1.73% per day. The market price of
Brent crude was USD 60.99/bbl yesterday and USD 60.45/bbl the day before yesterday.
Which of the following volatilities is the best estimate of Brent crude volatility today?
a. 1.63%
b. 1.70%
c. 1.73%
d. 1.78%
Answer: b
Explanation:
The correct application of the EWMA formula is:
Daily return = 60.99 / 60.45 -1= 0.00893.

Volatility = sqrt(0.95*0.01732+(1-0.95)*0.008932) or 1.70%.
By increasing the decay factor (lambda) in the EWMA model, current price returns will be weighted
less heavily in the daily volatility estimate. The model will be less responsive to sharp swings in
current market prices that are expected over the next month.
24. A risk analyst at a refinery examines the feasibility of potential storage strategies for Brent crude.
The spot price of Brent crude on the ICE exchange is USD 63.50/bbl. The continuously compounded
annual risk-free interest rate is 3.5%, and the monthly storage cost is USD 0.40/bbl.
If the crude can be stored for three months but cannot be sold out of storage before the three-
month storage term ends, what is the breakeven forward price supporting a storage strategy (in
USD/bbl)?
a. 64.05
b. 64.71
c. 65.27
d. 67.00
Answer: c
Explanation:
The breakeven forward price is the sum of the future value of the commodity and the future value of
3 months storage. The future value of the commodity is equal to 63.50 * exp (0.035 * 0.25) or 64.06,
while the future value of the 3 months of storage is 1.21. Therefore, the breakeven forward price is
64.06 + 1.21 or 65.27.
Reference: Robert McDonald. Derivatives Markets, 3rd Edition. Chapter 4.
25. A commodity trader manages portfolios of energy futures positions. One portfolio currently contains
only two futures positions with the following individual 1-day, 95% VaR amounts:
● Long October 2019 RBOB futures contracts: USD 2.10 million

● Short October 2019 WTI futures contracts: USD 1.95 million
If the return correlation of the two positions is equal to -0.88, assuming returns of both positions are
normally distributed with a mean of zero, which of the following amounts best approximates the 1-
day, 95% VaR (in USD millions) of the portfolio?
a. 0.15
b. 1.00
c. 2.15
d. 2.87
Answer: b
Explanation:
Multi-asset VaR can be generalized:
However, two asset VaR can be reduced to:
𝑉𝑎𝑅G,I = J𝑉𝑎𝑅G 1 + 𝑉𝑎𝑅I 1 + 2 ∗ 𝑉𝑎𝑅G ∗ 𝑉𝑎𝑅I ∗ 𝜌G,I
Using the portfolio information above, the 1-day, 95% portfolio VaR for this two-asset portfolio is:
1.0026 = N2.101 + 1.951 + (2 ∗ 2.10 ∗ 1.95 ∗ −0.88)
Note that the strong negative correlation between the positions results in a much lower portfolio
VaR than either of the individual VaRs of the positions.
26. A credit risk manager at an IOC describes the difference between counterparty settlement risk and
pre-settlement risk to a team of newly hired analysts. The manager explains that compared to
settlement risk, losses due to pre-settlement risk are typically:
a. Larger and occur more frequently

b. Larger but occur less frequently
c. Smaller but occur more frequently
d. Smaller and occur less frequently
Answer: c
Explanation:
Pre-settlement risk occurs prior to the maturity and/or settlement of a counterparty exposure, while
settlement risk is the risk of counterparty default during the settlement of the transaction.
The magnitude of pre-settlement risk is the mark-to-market (i.e. profit/loss) of the position which
reflects the difference in price of assuming an identical position with a different counterparty in the
case that the counterparty defaults. However, settlement risk is much larger as it can potentially
represent the full notional value of the transaction.
Settlement risk is limited to an extremely short period of time (in most cases) relative to the length
of the contract and thus events occur infrequently. Conversely, pre-settlement risk events occur
much more often since pre-settlement risk exists for the entire duration of the transaction.
27. A commodity trader holds a portfolio of long call options on NYMEX WTI crude futures contracts. A
risk limit is reached, and the trader is instructed to reduce the gamma of the long option portfolio.
Which of the following transactions is most effective in reducing the gamma in this portfolio?
a. Buy at-the-money options

b. Buy out-of-the-money options
c. Sell at-the-money options
d. Sell out-of-the money options
Answer: c
Explanation:
Gamma is defined as the rate of change in an option’s delta per a 1 unit move in the value of the
underlying asset, in this case the NYMEX WTI futures. Furthermore, delta is defined as the rate of
change in an option’s price per 1 unit move in the underlying. Deep out-of-the-money options have a
delta near 0, while deep in-the-money options have a delta near 1, as 1-unit changes in the
underlying asset price in both cases will have a very small impact on the option price. Therefore,
delta changes the fastest when options are at-the-money, so gamma is also the highest with at-the-
money options. The following chart shows the relationship between the strike price and gamma:
In addition, long call options have positive gamma, while long put options have negative gamma.
Since the original position is long call options, the manager should sell at-the-money options to
reduce gamma the fastest.
28. A global transport and logistics provider entered into a contract to purchase gasoline at the
wholesale price. To hedge the exposure, it purchases RBOB gasoline futures based on the following
historical return data:
• Standard deviation of wholesale gasoline price returns: 16.49%

• Standard deviation of RBOB gasoline futures: 20.90%
• Correlation between wholesale gasoline and RBOB gasoline futures: 0.95
The minimum variance hedge ratio required to properly size the futures position is closest to which
of the following?
a. 0.75
b. 0.79
c. 1.20
d. 1.27
Answer: a
Explanation:
The minimum variance hedge ratio is calculated as:
H* = -ρ (a,b) * (σa / σb), where ρ is the correlation coefficient between returns of the two
commodities, a is the commodity being hedged (wholesale gasoline), and b is the commodity being
used as a hedge (RBOB gasoline futures). Hence H =-0.95* (0.1649/0.2090), or -0.75. The negative
sign indicates that you need to take the opposite position in the hedge as the original position.
Chapter 3.
29. A shipping company entered into an OTC swap contract to purchase 15,000 MT of IFO 380 bunker
fuel to be delivered in 1 month at a fixed price of USD 450/MT. Terms of the ISDA credit agreement
are as follows:
• Margining period: Weekly

• Threshold amount: USD 200,000
• Minimum transfer amount: USD 50,000
• Reference price: Platts Singapore ISO 380 front-month futures price
End-of-week Platts Singapore ISO 380 bunker futures pricing for the first two weeks of the swap
were as follows:
How much collateral (in USD) did the shipping company have to post in each of the first two weeks of
the swap?
a. 0 in week 1; 0 in week 2
b. 0 in week 1; 160,000 in week 2
c. 200,000 in week 1; 0 in week 2
d. 225,000 in week 1; 135,000 in week 2
Answer: b
Explanation:
The MtM of the shipping company’s swap contract over the first two weeks is as follows:
Price Total Value MtM

Inception of swap 450 6,750,000 0
Week 1 435 6,525,000 -225,000
Week 2 426 6,390,000 -360,000
The threshold of 200,000 represents an undercollateralized amount. MtM in the counterparty’s favor
would have to exceed the threshold before a collateral call is made. However, the minimum transfer
amount of 50,000 specifies the minimum collateral to be transferred at one time.
During week 1, the MtM of -225,000 exceeds the threshold by 25,000. However, since 25,000 is less
than the minimum transfer amount, no collateral is transferred.
During week 2, the MtM is now -360,000. The shipping company would have to transfer 360,000-
200,000 or 160,000 in collateral.
30. A Japanese power company owns a network of five gas-fired generating plants fueled with imported
LNG, purchased at an oil-linked price. As part of its contingency funding plan, risk managers at the
company prepare a list of Early Warning Indicators (EWI’s) the company can use to trigger its
liquidity exception reporting.
Which of the following market observations most likely triggers a liquidity exception report at the
company?
a. A reduction in the collateral haircuts applied to bonds of several competitors

b. A significant appreciation in the Japanese yen against the US dollar and euro
c. An increase in credit spreads for investment-grade Japanese utility bonds
d. A decrease in global crude oil and natural gas market volatility
Answer: c
Explanation:
An increase in credit spreads of investment-grade Japanese bonds would serve as an Early Warning
Indicator since this would indicate that the credit outlook for firms in its industry could be
deteriorating. This may make it more difficult or expensive for the firm to receive funding in the
future.
A is incorrect as a reduction in collateral haircuts is an indicator of better credit quality.

B is incorrect as appreciating Yen would put the utility at an advantage in purchasing LNG and would
often be an indicator of a stronger Japanese economy.
D is incorrect as decreasing volatility is a sign of stability in the financial markets or its peer group.
Reference: Shyam Venkat and Robert Baird. Liquidity Risk Management: A Practitioner’s Perspective,
Chapter 7.
31. An energy company purchased an option contract to hedge the risk of unexpectedly low monthly
natural gas and power demand in February. The company purchases a put option with a strike of 28
referenced to the local monthly HDD index, and a payoff based on a notional amount of
USD 100,000 per HDD.
The average daily temperatures (°F) observed during the month are summarized below:
Week Mon Tues Wed Thurs Fri Sat Sun

1 65 66 66 65 65 65 64
2 64 62 60 60 63 64 65
3 65 65 65 66 66 67 69
4 70 66 65 65 64 64 65
Ignoring interest rate effects, calculate the payoff (in USD) realized on the put option.
a. 800,000
b. 1,200,000
c. 1,900,000
d. 2,400,000
Answer: a
Explanation:
The number of heating degree days (HDD) for each day is equal to 65 minus the daily average
temperature in degrees Fahrenheit. Therefore, to determine the payoff of this weather derivative,
we need to first calculate the HDD index for the month of February by summing all degrees less than
65 on individual days. This includes 9 days (64, 64, 62, 60, 60, 63, 64, 64, 64) and gives
1+1+3+5+5+2+1+1+1 = 20.
Since the company holds a put option with strike 28, the payoff is equal to (28-20) * USD 100,000 per
contract, or USD 800,000.
References: Robert McDonald. Derivatives Markets, 3rd Edition, Chapter 6.
Vincent Kaminski. Energy Markets, Chapter 11.
32. A bank sold an OTC fixed-for-floating RBOB swap to a BB-rated refiner. The swap is subject to a
close-out agreement and the bank currently reports a positive MtM on the position.
Assume this is the bank’s only exposure to the counterparty. Which of the following steps will the
bank most likely take if the refiner defaults on the exposure?
a. Reassign the defaulted position to a solvent counterparty.

b. Auction off the exposure to other potential counterparties.
c. Terminate the position and become a creditor to the refiner’s estate.
d. File a claim with the central counterparty equivalent to the MtM value of the defaulted position.
Answer: c
Explanation:
A close-out provision immediately terminates the defaulted positions and creates a claim in the
amount of the mark-to-market value of the netted positions (i.e. the replacement value of creating
identical positions with a solvent counterparty).
Reassigning or auctioning defaulted positions typically occur when trades are held within a CCP and a
large clearing member defaults. For a single OTC exposure to a counterparty, the bank would most
likely terminate the agreement and create a claim.
33. A risk manager at an energy trading firm builds a model to forecast the number of operational loss
events occurring at the firm during each 1-week period. The model assumes the probability of an
operational loss event is constant over time and independent of all other operational loss events.
Which type of distribution will the manager use to model the number of operational loss events in a
1-week period?
a. Bernoulli
b. Chi-squared
c. Lognormal
d. Poisson
Answer: d
Explanation:
A Poisson distribution would be appropriate to use here, as a Poisson process models the frequency
of specific events occurring over a given time horizon, when the number of potential events
occurring has no theoretical maximum. A Poisson process requires that the probability of an event
occurring is constant of time and independent of all other events. A binomial distribution would not
be appropriate to use in this case since a binomial distribution requires a discrete number of possible
events, such as the number of defaults in a portfolio of ten bonds.
Chapter 4.
34. A consultant begins a new engagement with an energy company. The energy company seeks advice
implementing an ERM program. In preparation for the engagement, the consultant reviews several
case studies on successful ERM implementation at energy companies. Among these cases is Statoil,
which applies a concept called “total risk optimization”. Which of the following statements describes
the process Statoil used to achieve its objective?
a. Centralize the core risk function to prevent some value-destroying decisions made by individual
business units
b. Build a firm-wide distribution of risk exposures by summing together all risk exposures faced by
the individual units
c. Place the CRO in charge of all risk management decisions which impact operations at the
business unit level
d. Encourage business units to hedge their own risk exposures aggressively in order to reduce firm-
wide risk exposure
Answer: a
Explanation:
As described in the Statoil case study, a key goal of the company’s risk management is to avoid
suboptimal decisions, which is also known as “optimizing total risk.” Statoil’s ERM program implies
that it is the perspective of the company as a whole that should prevail in practical situations where
different individuals and business units may have differing views on how to proceed. One example of
this firm-wide approach to risk management is making hedging decisions, where the central
management of core risk functions can prevent a situation in which two units with offsetting risk
exposures individually hedge their exposures and destroy value for the firm.
B is incorrect, this is bad practice as it ignores diversification benefits, which would be realized
through ERM.
C is incorrect, as the company does not centralize all risk management functions, most of which
continue to rest with the business units. Only “core” functions are coordinated centrally and owned
by the CEO.
D is incorrect, Statoil did the opposite by removing the ability of individual units to set FX derivative
policies. Rather, the firm centralized management of FX and other core hedging decisions rather
than letting these decisions be made on the unit level.
Reference: John Fraser, Betty Simkins, and Kristina Narvaez. Implementing Enterprise Risk
Management: Case Studies and Best Practices, Chapter 4.
35. An IOC assesses macroeconomic risk associated with its producing asset in a small, oil-rich host
country. A recent decline in global crude oil prices weakened the local economy of the small nation,
so the IOC considers the risk of government default on its sovereign debt. Which of the following
describes the most likely outcome of a sudden default on its sovereign debt by the host country?
a. A deep economic recession that produces multiple years of negative year-over-year GDP growth
b. Dramatic increases in inflation and interest rates resulting in hyperinflation
c. A complete loss of their investments for holders of the sovereign debt
d. Short-term political unrest followed by a longer-term period of increased financing costs
Answer: d
Explanation:
D is correct: Defaults have often resulted in political unrest including changes of government and
coups (often simultaneously), and defaulting countries will typically suffer increases in financing
costs lasting up to 10 or 15 years due to the reputational damage from the default.
A is incorrect: Default does typically result in a recession, but the impact has typically been short
lived, cf: p. 24, “Default has a negative impact on real GDP growth of between 0.5 and 2%, but the
bulk of the decline is in the first year after the default and seems to be short lived.”
B is incorrect: this would be a likelier outcome if the government chooses to print additional money
to avoid default (pp.22-23)
C is incorrect: Sovereign defaults typically do not result in a complete loss of the investment. Most of
the time the debt is swapped for new debt or other obligations which allow the investors to recoup a
substantial portion of the original investment.
Reference: Aswath Damodaran. Country Risk: Determinants, Measures and Implications, The 2017
Edition.
36. A refinery in Pennsylvania processes 4,500,000 bbls of crude oil per month. The refinery creates a
financial position, replicating a 3:2:1 refining spread, to hedge its monthly production of gasoline and
ULSD. To hedge the ULSD portion of the 3:2:1 spread, the refinery will:
a. Buy 1,500 CME NY Harbor ULSD futures contracts.

b. Buy 3,000 CME NY Harbor ULSD futures contracts.
c. Sell 1,500 CME NY Harbor ULSD futures contracts.
d. Sell 3,000 CME NY Harbor ULSD futures contracts.
Answer: c
Explanation:
The 3:2:1 crack spread represents the profit made per barrel of oil from selling refined products
such as gasoline and ULSD. The 3:2:1 indicates that 3 barrels of oil are used to produce 2 barrels
worth of gasoline and 1 barrel worth of ULSD. Therefore, if the refinery processes 4,500,000 barrels
per month, this implies that 3,000,000 barrels worth of gasoline and 1,500,000 barrels worth of
ULSD will be produced. There are 42 gallons in a barrel, and since ULSD is quoted as a price per
gallon, multiply 1,500,000 times 42 to get the number of gallons of ULSD the refinery expects to
produce and will need to hedge in that month, which is 63,000,000.
Since the refinery will be long ULSD, it will need to sell, not buy, the futures contracts in order to
hedge. Since one ULSD futures contract covers 42,000 gallons, the number of futures contracts to
sell will be 63,000,000 / 42,000, or 1,500.
37. Two 120 MW generators supply power to the grid in an energy-only market. The marginal costs of
the generators are USD 35.00/MWh and USD 55.00/MWh, respectively. Peak hourly consumption is
uniformly distributed, within a range of 90 and 160 MWh.
Assume these two generators are the only ones supplying power to the grid. Calculate the
probability the market clearing price during a peak hour is less than USD 40.00/MWh.
a. 33.3%
b. 42.9%
c. 57.1%
d. 66.7%
Answer: b
Explanation:
The electricity price is determined by the cost of power for the highest cost generator providing
electricity to the grid. Thus, the price can only be set below USD 40/MWh when electricity demand is
less than or equal to 120MW, i.e. when the generator with a cost of 35/MWh is the only one of the
two generators providing energy to meet demand. Since demand is uniformly distributed P (Price <
$40/MWh) = P(D <=120 MWh) = (120 MWh – 90 MWh) / (160 MW – 90 MWh) = 0.429.
Chapter 2.
38. An energy trading firm holds a long position in 1,000 put options on Brent crude futures at a strike
price of USD 65.00/bbl. Each option in the position has a current delta of -0.571, a gamma of 0.0402
and a vega of 0.0265. The firm wants to fully hedge the delta and gamma of this position. It
considers an option contract with the following metrics to implement the hedge:
• Delta: -0.416
• Gamma: 0.0342
The firm structures the transaction so gamma is first neutralized, before trading futures to neutralize
delta. How many futures does it buy or sell?
a. Buys 82 futures
b. Sells 82 futures
c. Buys 1,175 futures
d. Sells 1,175 futures
Answer: a
Explanation:
Since there are 1,000 options in the position, the position currently has a total delta exposure of
1000*-0.571 or -571, and a total gamma of 1,000 *0.0402 or 40.2.
To implement a delta-gamma hedge, the gamma first needs to be neutralized. Gamma is the rate of
change in delta with every 1 unit change in the value of the underlying futures. Since the original
position is a long option position resulting in a positive gamma, we would need to sell options to
neutralize the gamma. The proper number of options to sell is 40.2/0.0342 or 1,175 options.
However, selling these options also changes the delta. The sale also creates an incremental delta of
-1,175 * -0.416 or +489. Note that selling an option with negative delta actually increases the delta of
the combined position. The new delta is -571 + 489 or -82.
To neutralize delta, underlying futures would need to be traded, since they have a delta of 1 and no
gamma. Therefore 82 futures would need to be bought to complete the delta-gamma hedge.
39. A GARCH (1,1) model applies the following expression to estimate volatility:
σt2 = ω + ασ2(t-1) + βrt2
Where: rt = εtσt and εt ~ N(0,1).
Assuming factors α and β are both greater than zero, what assumption is required to ensure volatility
estimates remain balanced and plausible?
a. α+β<1
b. α+β≥1
c. α < 1 and β < 1
d. α ≥ 1 and β ≥ 1
Answer: a
Explanation:
In order to keep this a stationary process and assure that the volatility stays near the initial variable
ω, the combined factors α and β must be less than 1. Otherwise the volatility estimate could keep
increasing and eventually reach levels that are implausible.
Reference: John C. Hull. Risk Management and Financial Institutions, Chapter 10.
40. On July 1, a natural gas-fired power plant operator considers the risk of a possible cold winter. The
operator structures a calendar spread using 100 November and January Henry Hub futures contracts.
The following table shows the NYMEX Henry Hub futures prices on July 1 and on October 1:
Futures Expiration Futures Price July 1 Futures Price October 1

Month (USD/MMBtu) (USD/MMBtu)
November 2.571 3.155

January 3.884 4.937
Based on October 1 closing prices, which of the following describes the position established by the
operator and the current profit or loss on the position (in USD)?
a. Long January and short November futures; 469,000

b. Long January and short November futures; 1,782,000
c. Long November and short January futures; - 469,000
d. Long January and short November futures; -1,782,000
Answer: a
Explanation:
Correct answer is a. The power plant operator is expecting the calendar spread to widen, which
would be indicative of a cold winter. Therefore, this futures position taken with the expectation that
the spread will widen assumes a purchase of the higher priced January contract at USD 3.884 and the
sale of the lower priced November contract at USD 2.571, for a spread of 1.313. By October 1 the
spread between the two contracts has widened to (4.937-3.155) or 1.782, so the net profit on the
contract is equal to (1.782-1.313) * 100 contracts * 10,000 MMBtu/contract or USD 469,000.
Chapter 4.
41. A risk analyst at an energy trading firm calculates the 10-day, 99% VaR on a natural gas futures
position currently valued at USD 3,250,000. Using daily returns for natural gas prices over the past
12 months, the firm applies an EWMA model with a lambda of 0.98 to estimate the VaR. Over the
latest month, natural gas prices fell substantially and volatility increased significantly. The analyst
expects increased volatility to persist for the foreseeable future. As a result, the analyst changes the
model’s lambda to 0.9 to recalibrate the volatility factor used in the VaR model.
Applying the new volatility estimate will most likely cause the new VaR amount to do which of the
following?
a. Increase slightly relative to the original VaR.

b. Increase sharply relative to the original VaR.
c. Decrease slightly relative to the original VaR.
d. Decrease sharply relative to the original VaR.
Answer: b
Explanation:
Decreasing the decay factor from 0.98 to 0.90 will place a substantially greater weight on more
recent observations. Therefore, all else being equal, this will cause the standard deviation and VaR
to both increase.
42. The risk committee of a global exploration and production company evaluates an opportunity to
expand its production business into the Canadian oil sands market. The project requires a large
capital investment for bidding on several concessions and establishing local operations. When
assessing strategic risk related to this expansion from an ERM perspective, which of the following
actions is most appropriate?
a. Estimating the most likely outcome and deciding to expand if the return on investment in this
case exceeds the firm’s cost of capital
b. Comparing the probability weighted distribution of potential returns from the new project to the
firm’s hurdle rate
c. Adding the VaR of the proposed expansion to the VaR of the company’s existing operations to
project the overall firm-wide VaR
d. Deciding to expand if the RAROC for the proposed expansion is greater than the project’s
economic capital requirement
Answer: b
Explanation:
The most appropriate step in assessing strategic risk is to develop a distribution of the potential
outcomes of the expansion and assess the probability of each outcome occurring. That way the firm
will be able to assess the probability of “windfalls” (i.e. high profit outcomes) and extreme losses to
better assess whether the proposed expansion would add value to the firm. This can be done by
assessing whether the probability weighted outcome is greater than the firm’s hurdle rate. The firm
would then have to assess whether the proposed investment is also allowable given its risk appetite
and tolerance limits.
A is incorrect. This ignores the shape of the distribution of outcomes and the potential for extreme
losses or profits. Even if the most likely outcome adds value, if there is a significant potential for
extreme losses the project could still end up destroying value.
C is incorrect. This option does not account for any diversification benefits from the proposed
expansion. Since one of the main goals of ERM is to capture diversification benefits and assess risk
from a firm-wide perspective, this choice is not correct.
D is incorrect. RAROC is used to compare the expected return on the project to the company’s hurdle
rate. Since economic capital is the denominator of RAROC, this would imply that a return of at least
100% is needed to accept the project, which is far too high.
Reference: James Lam. Implementing Enterprise Risk Management: From Methods to Application,
Chapter 15.
43. A portfolio manager analyzes the risk of a large energy portfolio with a 1-day standard deviation of
USD 2,575,000. Assume portfolio returns are normally distributed.
What is the best estimate of the 10-day, 99% Value-at-Risk (VaR) for the portfolio?
a. USD 8,060,000
b. USD 18,940,000
c. USD 25,490,000
d. USD 59,900,000
Answer: b
Explanation:
To find the 10-day 99% VaR, there are two steps. First, multiply the daily standard deviation by the
99% confidence factor of 2.326 to get the 1-day VaR. Then, in order to scale the 1-day VaR to a 10-
day VaR, multiply that result by the square root of time, i.e. √10.
Answer “b” is correct: USD 2,575,000 x 2.326 x √10 = USD 18,943,136
44. A crude oil trader considers the impact of an expected sharp increase in crude oil market volatility on
a portfolio of long European call options on NYMEX WTI futures. Which of the following risk
measures can the trader use to quantify the potential change in MTM value of the portfolio due to
the expected volatility increase?
a. Beta
b. Gamma
c. Theta
d. Vega
Answer: d
Explanation:
Vega is defined as the change in the option’s value for every unit change in the volatility of the
underlying asset. Therefore, this risk measure will be used to quantify the potential change in the
portfolio value under this scenario.
45. A crude oil trader purchased spot crude for USD 60.00/bbl in a margin account.
• The current 1-month forward price for crude oil is USD 62.00/bbl
Assume the trader’s monthly borrowing cost is USD 0.25/bbl and monthly storage cost is
USD 1.00/bbl. No other transportation, maintenance or storage costs apply.
What is the best way for the trader to maximize their risk-return profile?
a. Sell the crude today at the prevailing 1-month forward price.

b. Sell the crude today at the prevailing 2-month forward price.
c. Sell the crude today at the prevailing 3-month forward price.
d. Hold the crude in storage for 3 months and then sell it at the prevailing spot price.
Answer: a
Explanation: The trader has USD 1.25 per month in storage borrowing costs. Given the set of
forward prices, the trader has three potential options:
a) Sell a 1-month forward for USD 62.00, pay storage and borrowing costs for 1 month. This would
lock in a profit of USD 0.75/bbl over the 1-month period.
b) Sell a 2-month forward for USD 63.00, pay storage and borrowing costs for 2 months. This would
c) Sell a 3-month forward for USD 64.25, pay storage and borrowing costs for 3 months. This would
Choice d is not optimal since the trader would bear the risk of potential downward moves in the
prevailing spot price over the 3-month period.
Therefore a is correct.
Reference: Robert McDonald. Derivatives Markets, 3rd Edition, Chapter 6.
46. A credit analyst compares the use of expected exposure (EE) and potential future exposure (PFE) to
quantify counterparty risk in contracts with risky counterparties. Which of the following is the
primary difference between expected exposure and potential future exposure?
a. Unlike PFE, EE accounts for positive mark-to-market values only.

b. EE will typically be greater than PFE at the initiation of a credit exposure.
c. PFE may underestimate the exposure for short-dated transactions.
d. PFE measures the worst-case exposure scenario at a given confidence level.
Answer: d
Explanation: The correct answer is d. PFE is roughly analogous to Value-at-Risk (VaR), it represents
the worst case scenario or loss at a given confidence level (PFE differs from VaR in that it calculates
gains, or exposure, rather than losses). The other answers are incorrect: while it is true that EE only
calculates positive MTM, this is also true of PFE; PFE returns a higher percentage than EE; and
underestimating short-term exposures is a condition associated with EE, not PFE.
47. A risk modeler uses a single-factor lognormal model to value a portfolio of European-style energy
options. Which of the following volatility inputs is most appropriate to use in this model to ensure
the most accurate MtM valuation of the option portfolio?
a. A string of volatilities implied from at-the-money options that correspond to the portfolio’s
option expiration dates.
b. A matrix of volatilities implied from all the available options that correspond to the portfolio’s
option expiration dates and strike prices.
c. A single volatility that corresponds to spot price volatility estimated using historical price data
over the past 30 days, consistent with the single-factor model.
d. A single volatility that corresponds to spot price volatility estimated using historical price data
over one year or more, consistent with the single-factor model.
Answer: b
Explanation: There is no model, even multi-factor models, that can perfectly model traded energy
market forwards and options. There are many reasons for this in energy markets, and some
important ones include the complexity of energy market environments and the impact of bid-ask
illiquidity on implied volatility calculations from available market quotes. The standard practice is to
therefore use a matrix of volatilities – both across time of expiration and across strikes – in order to
correctly capture the market view of the price distribution.
A is incorrect. Using only a string of volatilities across time does not correctly reflect the manner in
which the market price distribution differs from that assumed by the single-factor model in terms of
skew and kurtosis, and as captured by the volatility strike structure.
C and D are incorrect. Using historical volatilities is not appropriate and raises several potential
issues. A single historical volatility will not be able to provide marked-to-market valuation, and would
also not be able to include the divergence of the single factor model distribution from the implied
market distribution through time (i.e. volatility term structure) and across skew and kurtosis (i.e.
volatility strike structure). Hence, the correct answer is B.
Reference: Les Clewlow and Chris Strickland. Energy Derivatives: Pricing and Risk Management,
Chapter 3.
48. A credit analyst at a bank specializing in energy transactions considers the potential for wrong-way
risk in the bank’s derivative exposures. Assuming a stable economic environment, which of the
following long option positions, executed with the referenced counterparties, contains the greatest
potential for wrong-way risk?
a. At-the-money call option on an oil future with a BBB-rated oil producer

b. Out-of-the-money put option on an oil future with a BBB-rated shipping company
c. At-the-money put option on an oil future with an AA-rated shipping company
d. Out-of-the-money put option on an oil future with an AA-rated oil producer
Answer: d
Explanation:
Wrong-way risk arises in cases when the credit risk of the counterparty increases as the bank’s
exposure to that counterparty increases. In other words, there is a positive correlation between the
exposure to a counterparty and the credit risk (or default probability) of that counterparty. Choice D
has the most wrong-way risk: if the price of oil were to decrease, the mark-to-market of the option
price would decrease but the oil producer’s credit risk would be increasing at the same time.
The option in choice A exhibits right-way risk, since the oil producer will have decreasing credit risk
as the option exposure increases, given the higher price of oil.
Choices B and C are also generally right-way risk since a shipping company is a consumer of oil and is
therefore better off as oil prices fall. It could be argued that an economic downturn could cause a
drop in oil prices but also impair the business of the shipping company, so there could technically be
an element of wrong-way risk in that situation, but given a stable economic environment options C
and D mainly display right-way risk.
Reference: Jon Gregory. The xVA Challenge: Counterparty Credit Risk, Funding, Collateral and
Capital, 3rd Edition, Chapter 7.
49. An analyst built an ordinary least squares (OLS) linear regression model to forecast the natural gas
price, as a function of the average daily temperature and the spot coal price. In performing due
diligence on the model, the analyst evaluates the residuals (error term) generated by the model to
determine if it is correctly calibrated. If the OLS model is calibrated correctly, which of the following
observations will the analyst observe?
a. The residual term has a zero mean and a constant variance.

b. The residual term has a zero mean and a variance that increases with the natural gas price.
c. The residual term has a non-zero mean and a constant variance.
d. The residual term has a non-zero mean and a variance that increases with the natural gas price.
Answer: a
Explanation:
Two assumptions for a linear regression model to be correctly calibrated are as follows:
(𝜖|𝑋) = 0 𝑎𝑛𝑑 𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒 (𝜖|𝑋) = 𝜎 1 , where 𝜖 is the error term.
This mathematically states that the error term (or residuals) should have zero mean and constant
variance (i.e. the residuals are homoscedastic). All other choices violate one or both of the
assumptions.
Chapter 10.
50. A power generator designs an AR (autoregressive) model to forecast natural gas consumption (G). An
analyst at the generator builds four potential AR models of different orders. The specification of
each model, as well as its Akaike information criterion (AIC) and Bayesian information criterion (BIC),
is presented in the following table:
Model Model specification AIC BIC

1
A 𝐴𝑅 (2): 𝐺) = 𝑐 + - 𝛼/ 𝐺)0/ + 𝜀) 1264.2 1165.3

/23
6
B 𝐴𝑅 (3): 𝐺) = - 𝛼/ 𝐺)0/ + 𝜀) 1154.3 976.8

/23
C 𝐴𝑅 (5): 𝐺) = 𝑐 + - 𝛼/ 𝐺)0/ + 𝜀) 1164.7 1006.9

/23
:
D 𝐴𝑅 (7): 𝐺) = - 𝛼/ 𝐺)0/ + 𝜀) 1213.6 1312.3

/23
Which of the following models will the generator choose?
a. Model A
b. Model B
c. Model C
d. Model D
Answer: B
Explanation:
The most appropriate model has the lowest AIC and/or BIC value. In this case, the AR(3) model has
the lowest statistics in both categories so would be the appropriate model to choose. Note that the
BIC is also known as the Schwarz information criterion.
In cases where the two criteria give conflicting recommendations, the text generally says that the
more parsimonious model (i.e. the one with the fewer variables) should be chosen.
Reference: Rafal Weron. Modeling and Forecasting Electricity Loads and Prices, Chapter 3.
51. A diversified energy company conducts a stress test of its liquidity profile. As part of the process, a
treasury analyst considers the availability and transferability of different classes of liquidity on the
firm’s balance sheet during periods of stress. Which of the following assumptions, insights, or
conclusions should an analyst rely on when developing a liquidity stress test?
a. The restricted liquidity balance can be quickly used to meet stress liquidity needs if certain
adverse financial market conditions are met.
b. The firm can reassign strategic liquidity as contingent liquidity if the strategic liquidity balance is
composed of high-quality liquid assets.
c. Operational liquidity can contribute to the stressed liquid asset buffer that the firm calculates
during its liquidity stress test.
d. Corporate bonds and common stock should be included in the firm’s liquid asset buffer.
Answer: b
Explanation:
There are four key classes of liquidity: contingent, restricted, operational and strategic. Contingent
liquidity is the key measure of liquidity to be calculated in a liquidity stress test. Strategic liquidity
represents an amount of liquidity to be set aside to fund future strategic growth initiatives. In a
stress situation, strategic liquidity can be reassigned as contingent provided the assets are high
quality liquid assets.
A is incorrect. Restricted liquidity is tied to another obligation (i.e. collateral) and is not generally
available for contingent liquidity needs.
C is incorrect. Operational liquidity supports the firm’s operations and cannot contribute to the liquid
asset buffer in a stress test.
D is incorrect. Only high-quality liquid assets with low market and credit risk should be included in
the buffer.
Reference: Shyam Venkat and Stephen Baird. Liquidity Risk Management: A Practitioner’s
Perspective, Chapter 3.
52. The senior management of a globally diversified exploration and production company mandated the
firm adopt an ERM framework. What action should the firm take to ensure the implementation of
the ERM framework reflects best practices?
a. The framework should only address the risk categories that the firm believes it is most exposed
to, including market and operational risk.
b. Each global division of the firm should develop a separate ERM framework to manage the unique
operating characteristics of that division.
c. Each section of the framework should be communicated with a high level of detail so that
stakeholders can validate the assumptions used to quantify each risk.
d. The framework should capture offsetting risk exposures in different business divisions to
incorporate diversification benefits.
Answer: d
Explanation:
D is correct. A key goal of ERM is to view risk from a firm-wide perspective, which includes the
reflection of diversification benefits. If one division is long the euro and another division is short the
euro (for example), the ERM framework should net these two exposures against each other to show
a lower overall exposure.
A is incorrect. The framework needs to address all types of risk that the firm might be exposed to.
Emphasizing some classes of risks over others could result in the firm being inadequately prepared
for certain types of risk exposures.
B is incorrect. With an ERM framework, risk exposures are managed on a firm-wide level. A
company-wide ERM framework should be developed and then cascaded down to the business units.
C is incorrect. Simplicity is a key characteristic of an effective ERM framework. Developing a high
level of detail or making the ERM framework overly complicated could result in the framework failing
because it requires too much time or knowledge for stakeholders to grasp. Validation is done by
internal specialists and does not need to be taken on by stakeholders.
Reference: James Lam. Implementing Enterprise Risk Management: From Methods to Applications,
Chapter 7.
53. The board of directors of an energy conglomerate approved a recommendation by senior

management to pursue new business opportunities to fuel potential growth. As part of the new
strategic approach, the firm will sell a business unit with a 5% expected rate of return and 7%
earnings volatility. It will invest the entire proceeds of the sale in a new business unit with a
projected 8% rate of return and 20% earnings volatility.
How will the firm’s capital profile most likely change, assuming the business unit is sold, the new
investment is made, and no gains or losses are recorded on the transactions?
a. The firm’s economic capital requirement will increase and its book capital will increase.
b. The firm’s economic capital requirement will decrease and its book capital will decrease.
c. The firm’s economic capital requirement will increase but its book capital will not change until
d. The firm’s economic capital requirement will decrease but its book capital will not change until
Answer: c
Explanation:
The new business has higher volatility and hence will require a higher level of economic capital.
However, book capital did not change since the amount of capital for the new investment equaled
the capital from the divested venture. Book capital will only change when the unit reports profits or
losses which will then impact the capital balance.
Reference: Michel Crouhy, Dan Galai, and Robert Mark. The Essentials of Risk Management, 2nd
Edition, Chapter 17.
54. A NOC evaluates E&P bids received during a licensing round to develop various domestic
hydrocarbon reservoirs. After receiving numerous bids, the NOC narrows its selection to four
potential E&P partners. The NOC received the following 1-year operating data, to assess the relative
operating efficiency of each company:
Company W Company X Company Y Company Z

(in thousands BOE)
Production 20,000 35,000 14,000 60,000
Discoveries 11,000 18,000 8,000 41,000
Extensions 5,000 2,000 7,000 29,000
Total reserves 170,000 230,000 90,000 275,000
(in thousands USD)
Revenues 1,100,000 1,925,000 770,000 3,300,000
Depreciation &
125,000 40,000 25,000 102,000
Amortization
Exploration costs 98,000 108,000 67,000 550,000
Capital
100,000 385,000 154,000 660,000
expenditures
Net income 88,000 215,000 89,000 467,000
Using the finding cost ratio as a guideline, which company was most efficient in adding new reserves
over the past year?
a. W
b. X
c. Y
d. Z
Answer: c
Explanation: The correct answer is c. The finding cost ratio is defined as exploration costs divided by
extensions and recoveries. The finding cost (in USD per BOE) is therefore 6.13 for company A, 5.40
for company B, 4.47 for company C, and 7.86 for company D.
Reference: Betty Simkins and Russell Simkins, eds. Energy Finance and Economics, Chapter 9.
55. When calibrating model parameters, which one of the following statistics is most appropriate for
estimating the explanatory power of the input variables used in an energy pricing model?
a. Autocorrelation
b. Kurtosis
c. Degrees of freedom
d. R2
Answer: d
Explanation: Explanatory power is a measure of how well the input variables explain the dependent
variable which is being modeled, in this case the energy price. This is also known as the goodness of
fit of the model. The R-squared statistic is used to measure the goodness of fit and ranges from 0%
to 100%. An R-squared of 0% indicates that the input variables have no explanatory power at all,
while an R-squared of 100% would mean that the input variables explain the energy price perfectly.
A is incorrect because an autocorrelation relates to correlations between sequenced time-series
data. B is incorrect as kurtosis measures the size of the tails of the distribution of data.
C is incorrect as degrees of freedom measures the potential number of input variables that could be
introduced into the model and be allowed to vary.
Chapter 10.
56. A NOC granted concessions to an E&P company to explore a natural gas field. The E&P company
drafts a report to propose a new well, highlighting a 10% chance of a major structural failure as a key
risk to the completion of the project. During a subsequent discussion with the E&P company, the
NOC management suggested the probability be much lower. The E&P indicated it recently suffered a
similar incident, leading to a conservative assessment of the risk.
The NOC is most likely concerned which of the following biases occurred in the E&P’s decision-
making process?
a. Anchoring bias
b. Confirmation bias
c. Availability bias
d. Motivational bias
Answer: c
Explanation: This is an example of an availability bias. This bias occurs when the expected likelihood
of an event is increased based on the recent loss observations by the presenter.
Reference: SPE Technical Report. Guidance for Decision Quality for Multicompany Upstream Projects.
57. The risk committee of a multinational oil company considers the company’s exposure to emerging
risk factors. A risk manager evaluates best practices to identify, prioritize and manage these
emerging risk exposures. Which of the following actions should the manager suggest?
a. Develop scenarios that explore potential interactions among different emerging risks.
b. Purchase insurance to cover a wide range of potential emerging risk exposures.
c. Increase the IOC’s risk tolerance limits to incorporate potential losses from emerging risks.
d. Build a model to quantify the expected size of the loss from each emerging risk exposure.
Answer: a
Explanation:
A is correct. A leading way to manage emerging risk exposures is to assess potential interactions
between different types of emerging risks. One way to do this is to build explorative scenarios that
project various possible future states based on current knowledge and trends. That way the
company can assess which combinations of emerging risk drivers could potentially result in extreme
losses. Scenario analysis and capture/filtering of incremental information about these emerging risks
(often through newly published academic papers or international standards) are important in helping
determine the company’s potential vulnerability and impact to an emerging risk.
B is incorrect. Since emerging risks are relatively new and unknown, there is relatively little
information about these risks in the market. This also implies that insurance would not be widely
available, and if it is, may be vastly overpriced or underpriced as the insurance companies would
likely not have enough experience with that risk to price the insurance accurately. C is incorrect as
emerging risks should be considered within the firm’s existing risk appetite framework, and merely
increasing the limits to incorporate emerging risks would be poor risk management. D is incorrect as
emerging risks face a high level of uncertainty and relatively few historical observations so therefore
expected loss sizes cannot be accurately quantified.
Reference: IRGC Guidelines for Emerging Risk Governance.
58. An oil drilling firm implements a risk appetite framework incorporating a “three lines of defense”
model for governance. The risk committee proposes roles and responsibilities for different
organizational units. Which of the following statements describes the most appropriate role for a
given business unit in accordance with a three lines of defense model?
a. Business unit managers should manage the risk of their business units as part of the first line of
defense.
b. Risk and compliance functions should manage firm-wide risks as part of the first line of defense.
c. Senior management and the ERM function should develop analytical tools to manage risks as
part of the third line of defense.
d. Business line managers should challenge the risk appetite framework developed by senior
management as part of the third line of defense.
Answer: a
Explanation: In the first line of defense, business line managers manage the inherent the risks in
their business lines. The risk and compliance functions provide the second line of defense and
develop the firm’s overall risk appetite and tolerance framework; senior management and the ERM
team also develop analytical tools as part of the second line. The third line of defense is an
independent review and challenge of the risk appetite framework by the board of directors with the
support of internal audit.
Reference: James Lam. Implementing Enterprise Risk Management: From Methods to Applications,
Chapter 12.
59. An energy trading firm performs a validation exercise on several VaR models for its portfolio of
natural gas derivatives. Which of the following actions reflects best practices in validating the
models?
a. The model development team should take a leading role in performing technical aspects of the
validation.
b. A model should be implemented in a widespread manner before validation begins, so that
enough data points can be generated to validate the model.
c. The validation team should ensure that the model incorporates a stable correlation between
portfolio holdings to standardize the long-term model output.
d. The validators should subject any third-party vendor models it selects to the same validation
process used for the firm’s internal models.
Answer: d
Explanation: Third-party vendor models are often used by firms alongside internal models. If third
party vendor models are used, the firm should subject these models to the same rigorous validation
process as its internal models.
Choice A is incorrect as the validation should be performed independently from the development
team.
Choice B is incorrect. An initial validation should take place before the model is widely implemented
to ensure the model is effective. Sometimes this takes the form of a staged rollout where the model
is rolled out to a small group or used in a relatively minor way and then validated at each stage
before the decision is made to expand the use of the model.
Choice C is incorrect. Validation should ensure that the model remains effective and responsive to
potential or observed changes in market variables. Assuming stable correlations is a dangerous
practice and poor risk management since correlations often change dramatically in crisis situations.
60. A risk manager at an IOC stress tests the liquidity profile of its investment portfolio to simulate a
period of broad systemic financial market stress. In developing the modeling process for the liquidity
stress test, which of the following assumptions should the manager make?
a. Market interest rates will increase significantly.

b. Bid-ask spreads for corporate bonds will widen.
c. Haircuts on pledged collateral will decrease.
d. Return correlations between different risky asset classes will decrease.
Answer: b
Explanation:
A typical observation during a period of broad systemic financial market stress is reduced investment
portfolio liquidity. This results in widening bid-ask spreads for assets such as stocks, commodities and
corporate bonds.
A is incorrect. Interest rates typically decrease during a period of market stress.
C is incorrect. Collateral haircuts represent the discount assigned to securities (usually high-quality
investment grade debt) when used as collateral. The higher the haircut assigned to a security, the
greater the value of that security that will be required as collateral. During periods of market stress,
haircuts will increase as credit quality in the market is decreasing and firms are less willing to accept
securities as collateral.
D is incorrect. Return correlations between risky asset classes typically increase during market
downturns, as investors try to exit all asset classes in order to raise cash.
References: Shyam Venkat and Stephen Baird. Liquidity Risk Management: A Practitioner’s
Perspective, Chapter 3.
Jon Gregory. The xVA Challenge: Counterparty Credit Risk, Funding, Collateral and Capital, 3rd Edition,
Chapter 6.
Creating a culture of risk awareness ®
garp.org
About GARP | The Global Association of Risk Professionals (GARP) is a non-partisan,
not-for-profit membership organization serving the risk management industry.
Founded in 1996, GARP advances the profession through education, research and
promotion of best practices through the GARP Risk Institute, GARP Benchmarking
Initiative and an array of informational and certification programs. GARP has
200,000 members in more than 190 countries and territories, and has certified more
than 50,000 professionals.
New York London

111 Town Square Place 17 Devonshire Square
14th floor 4th floor
Jersey City, New Jersey London, EC2M 4SQ
07310 USA UK
+1 201.719.7210 +44 (0) 20.7397.9630
Washington D.C. Beijing

1001 19th Street North Unit 1010 Financial Street Centre
#1200 No 9A, Financial Street
Arlington, Virginia Xicheng District
22209 USA Beijing 100033 P.R. China © 2019 Global Association of Risk Professionals
+1 703.420.0920 +86 (010) 5737.9835 All rights reserved. (06.19)

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ENERGY RISK PROFESSIONAL

Practice Exam Part II

Suggested Use of Practice Exams

1. Plan a date and time to take the practice exam

• Set dates appropriately, consider your target exam day date

2. Simulate the exam day environment as closely as possible

• Take the practice exam(s) in a quiet place, free from interruption

3. Calculate your score(s) and adjust your study plan accordingly

Common Abbreviations and Acronyms

1. ___________ 31. __________

Year Monthly return < µ – 3σ Monthly return > µ + 3σ

MtM value Collateral value

Strike Price Call Premium Put Premium

55.00 0.87 3.59

a. Seasonality of supply and demand of energy futures contracts

Current market pricing for bunker fuel is summarized below:

● Spot price: USD 395/MT

What is the correct implied default probability on this exposure?

• Pre-tax net income from operations: EUR 18 million

● Expected exposure as a percentage of notional value: 11.0%

a. Sell 15 lots of March Brent futures.

a. The unplanned outage of a 1 GW nuclear generator occurred in the PJM market.

a. The average simulated 1-day loss that exceeds USD 750,000

● Month 1: USD 58.75/bbl

a. Baseload electricity supply during on-peak hours

● Long October 2019 RBOB futures contracts: USD 2.10 million

a. Larger and occur more frequently

a. Buy at-the-money options

• Standard deviation of wholesale gasoline price returns: 16.49%

• Margining period: Weekly

a. A reduction in the collateral haircuts applied to bonds of several competitors

Week Mon Tues Wed Thurs Fri Sat Sun

a. Reassign the defaulted position to a solvent counterparty.

a. Buy 1,500 CME NY Harbor ULSD futures contracts.

σt2 = ω + ασ2(t-1) + βrt2

Where: rt = εtσt and εt ~ N(0,1).

Futures Expiration Futures Price July 1 Futures Price October 1

November 2.571 3.155

a. Long January and short November futures; 469,000

a. Increase slightly relative to the original VaR.

a. Sell the crude today at the prevailing 1-month forward price.

a. Unlike PFE, EE accounts for positive mark-to-market values only.

a. At-the-money call option on an oil future with a BBB-rated oil producer

a. The residual term has a zero mean and a constant variance.

Model Model specification AIC BIC

A 𝐴𝑅 (2): 𝐺) = 𝑐 + - 𝛼/ 𝐺)0/ + 𝜀) 1264.2 1165.3

B 𝐴𝑅 (3): 𝐺) = - 𝛼/ 𝐺)0/ + 𝜀) 1154.3 976.8

C 𝐴𝑅 (5): 𝐺) = 𝑐 + - 𝛼/ 𝐺)0/ + 𝜀) 1164.7 1006.9

D 𝐴𝑅 (7): 𝐺) = - 𝛼/ 𝐺)0/ + 𝜀) 1213.6 1312.3

Which of the following models will the generator choose?

53. The board of directors of an energy conglomerate approved a recommendation by senior

Company W Company X Company Y Company Z

a. Market interest rates will increase significantly.

1. ______b____ 31. _____a____

Year Monthly return < µ – 3σ Monthly return > µ + 3σ

MtM value Collateral value

First, derive the probability for a positive test result:

P(T) = P(T|V) * P(V) + P(T|NV) * P(NV)

Then, using conditional probability theory, we can calculate P(V|T) as follows:

1. _ 31.

1. ____b 31. _a__