2017 Erp Part II Practice Exam

ERP Part II
2017
Practice Exam
Energy Risk Professional (ERP) Part II Practice Exam

Introduction
The ERP Exam is a practice-oriented examination. Its questions are derived from a combination of theory, as
set forth in the core readings, and real-world work experience. Candidates are expected to understand
energy risk management concepts and approaches and how they would apply to an energy risk managers
day-to-day activities.

The ERP Exam is also a comprehensive examination, testing an energy risk professional on a number of
risk management concepts and approaches. It is very rare that an energy risk manager will be faced with
an issue that can immediately be slotted into just one category. In the real world, an energy risk manager
must be able to identify any number of risk-related issues across the physical and financial energy markets
and be able to deal with them effectively.

The 2017 ERP Part I and Part II Practice Exams have been developed to aid candidates in their preparation for
the ERP Exam in May and November 2017. These practice exams are based on a sample of actual questions
from past ERP Exams and is suggestive of the questions that will be in the 2017 ERP Exam.

The 2017 ERP Part I Practice Exam contains 80 multiple choice questions and the 2017 ERP Part II Practice
Exam contains 60 multiple-choice questions, the same number of questions that the actual 2017 ERP Exam
Part I and 2017 ERP Exam Part II will contain. As such, the Practice Exams were designed to allow candidates
to calibrate their preparedness both in terms of material and time.
The 2017 ERP Practice Exams do not necessarily cover all topics to be tested in the 2017 ERP Exam as any test
samples from the universe of testable possible knowledge points. However, the questions selected for
inclusion in the Practice Exams were chosen to be broadly reflective of the material assigned for 2017 as well
as to represent the style of question that the Energy Oversight Committee considers appropriate based on
assigned material.
For a complete list of current topics, core readings, and key learning objectives candidates should refer to the
2017 ERP Exam Study Guide and 2017 ERP Learning Objectives.
Core readings were selected in conjunction with the Energy Oversight Committee to assist candidates in their
review of the subjects covered by the Exam. Questions for the ERP Exam are derived from the core readings.
It is strongly suggested that candidates study these readings in depth prior to sitting for the Exam.

2017 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

To maximize the effectiveness of the practice exams, candidates are encouraged to follow these
recommendations:

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

Set dates appropriately to give sufficient study/review time for the practice exam prior to the actual exam.

2. Simulate the test environment as closely as possible.
Take the practice exam in a quiet place.

Have only the practice exam, candidate answer sheet, calculator, and writing instruments (pencils,
erasers) available.
Minimize possible distractions from other people, cell phones, televisions, etc.; put away any study
material before beginning the practice exam.
Allocate 4 hours to complete ERP Part I Practice Exam and 4 hours to complete ERP Part II Practice
Exam and keep track of your time. The actual ERP Exam Part I and ERP Exam Part II are 4 hours each.
Follow the ERP calculator policy. Candidates are only allowed to bring certain types of calculators
into the exam room. The only calculators authorized for use on the ERP Exam in 2017 are listed
below, there will be no exceptions to this policy. You will not be allowed into the exam room with a
personal calculator other than the following: Texas Instruments BA II Plus (including the BA II Plus
Professional), Hewlett Packard 12C (including the HP 12C Platinum and the Anniversary Edition),
Hewlett Packard 10B II, Hewlett Packard 10B II+ and Hewlett Packard 20B.

3. After completing the ERP Practice Exams

Calculate your score by comparing your answer sheet with the practice exam answer key.
Use the practice exam Answers and Explanations to better understand the correct and incorrect
answers and to identify topics that require additional review. Consult referenced core readings to
prepare for the exam.
Remember: pass/fail status for the actual exam is based on the distribution of scores from all
candidates, so use your scores only to gauge your own progress and level of preparedness.



Common Abbreviations and Acronyms
The following is a list of common abbreviations and acronyms that may appear on the ERP Examination:
Bbl = Barrel of _________ Gal = Gallon of _____ NGL = Natural gas liquids
Bcf = Billion cubic feet HDD = Heating degree days NOC = National oil company
Btu = British Thermal Unit IOC = Independent oil company NOK = Norwegian Krone
CAD = Canadian Dollar IRR = Internal rate of return NPV = Net present value
CCP = Central counterparty ISDA = International Swaps and NYMEX = New York Mercantile
Derivatives Association Exchange
CDD Cooling degree days
ISO = Independent system OTC = Over-the-counter
CFD = Contract for differences operator
PJM = Pennsylvania/New
CIF = Cargo, insurance, freight KPI = Key performance indicator Jersey/Maryland
Interconnection (electricity
COSO = Committee of KRI = Key risk indicator market)
Sponsoring Organizations of the
Treadway Commission kW = Kilowatt PSC = Production sharing
contract
CSA = Credit support annex kWh = Kilowatt hour
RBOB = Reformulated
CVA = Credit valuation LIBOR = London Interbank blendstock for oxygenate
adjustment Offered Rates blending (gasoline)

DAT = Delivered at terminal LMP = Locational marginal price RTO = Regional Transmission
DWT = Deadweight tonnage Organization
LNG = Liquefied natural gas
SGD = Singaporean Dollar
ERM = Enterprise Risk LPG = Liquefied petroleum
Management gases SMA = Simple moving average
/t = Per ton of _______
EUR = Euro (currency) MMBtu = One million British
Thermal Units ULSD = Ultra-low sulfur diesel
EWMA = Exponentially
weighted moving average MT = Metric tons USD = United States dollar
FOB = Free on board MtM = Mark-to-market VaR = Value-at-Risk
FTR = Financial transmission MW = Megawatt WTI = West Texas intermediate
right
MWh = Megawatt hour



2017 ERP Part II Practice Exam Candidate Answer Sheet

1. 16. 31. 46.
2. 17. 32. 47.
3. 18. 33. 48.
4. 19. 34. 49.
5. 20. 35. 50.
6. 21. 36. 51.
7. 22. 37. 52.
8. 23. 38. 53.
9. 24. 39. 54.
10. 25. 40. 55.
11. 26. 41. 56.
12. 27. 42. 57.
13. 28. 43. 58.
14. 29. 44. 59.
15. 30. 45. 60.



1. A commodity trader holds a long position in October WTI futures contracts. Details of the position are
summarized below:
Trade date: June 25

Number of contracts: 500
Purchase price: USD 53.60/bbl
Initial margin requirement: USD 4,020,000
Required maintenance threshold: USD 3,500,000

The exchange requires all futures account to be topped-up to meet initial margin requirements. Below which
of the following prices (in USD) will a margin call be triggered on the traders position?

A. 51.52
B. 52.56
C. 53.60
D. 54.64

2. A Simple Moving Average can be used to estimate the standard deviation of historical price returns for a VaR
model. Which of the following statements best describes the primary weakness in applying a SMA to energy
commodity price return data?

A. The SMA weights all historical price return data equally.
B. The SMA over weights the most recent price return data.
C. The SMA ignores the impact of jumps in the price return data.
D. The SMA ignores the impact of autocorrelation on price return data.

3. To protect against adverse price movements in the refined product markets, a petroleum company creates a
straddle position in NYMEX ULSD futures contracts with the following terms:
2-month NYMEX ULSD call option with a strike price of USD 1.69/gal at a premium of USD 0.04/gal
2-month NYMEX ULSD put option with a strike price of USD 1.69/gal at a premium of USD 0.07/gal

One week after establishing the position, the closing NYMEX ULSD prompt-month futures price is USD
1.82/gallon. Calculate the current net MtM value (in USD) of the straddle position.
A. -10,080
B. 20
C. 840
D. 5,460



4. A bank holds a portfolio of derivative transactions with a single counterparty that declares default. The MtM
value and pledged collateral for each transaction at the time of default is summarized below:
MtM value Collateral value

(in EUR) (in EUR)
Trade A +3,000,000 2,000,000
Trade B +10,000,000 2,000,000
Trade C -6,000,000 0
Trade D +4,000,000 1,000,000

The transactions are covered by an ISDA CSA with a closeout netting agreement. Calculate the banks total
net exposure (in EUR) to the counterparty, assuming the recovery rate for each trade is 30%.
A. 900,000
B. 2,700,000
C. 4,200,000
D. 5,900,000

5. The following market prices for NYMEX WTI crude oil futures are quoted at the close of trading on
February 1 and April 1, respectively:
WTI Futures Price WTI Futures Price

February 1 (USD/bbl) April 1 (USD/bbl)
May 48.93 51.31
June 49.29 51.76

On February 1, a crude oil trader expects the spread between the May and June WTI futures closing price to
widen over the next two months. How would the trader structure a calendar spread on February 1 to benefit
from this view and what is the realized net profit/loss per contract on the position based on the April 1
closing prices?
A. Long May and short June futures; USD -90

B. Long June and short May futures; USD -45
C. Long May and short June futures; USD 45
D. Long June and short May futures; USD 90



6. Seismic surveys are used to test the future viability of crude oil production at 100 potential deepwater drilling
sites. A survey will produce a positive test result for 100% of sites that are commercially viable, and a
negative test result for 85% of sites that are not viable. If 1 drilling site out of 100 is commercially viable, the
probability that a site is viable given a positive test result is approximately:

A. 0.1%.
B. 6.0%.
C. 15.0%.
D. 94.0%.

7. The primary economic objectives at a refinery are to manage price risk and maximize operating margins. To
help achieve these objectives, the risk management team plans to structure a collar using the following
options on NYMEX RBOB futures contracts:
RBOB Strike Price Call Premium Put Premium

(USD/bbl) (USD) (USD)
1.54 0.128 0.092
1.57 0.105 0.087

If the prompt-month NYMEX RBOB futures price is currently USD 1.558/gal, which of the following sets of
transactions will most effectively achieve the refiners economic objectives?
A. Buy USD 1.57 put options and sell USD 1.54 call options.
B. Buy USD 1.54 put options and sell USD 1.57 call options.
C. Sell USD 1.54 put options and buy USD 1.57 call options.
D. Sell USD 1.57 put options and buy USD 1.54 call options.

8. A natural gas trader has arranged a 6-month storage contract in June, based on the expectation that the
spread between summer and winter natural gas prices will increase. The trader plans to withdraw injected
natural gas at expiration of the storage contract. Which of the following structures has she most likely
arranged?

A. Park-and-loan
B. Cash-and-carry
C. Exchange-for-physical
D. Contract-for-differences



9. A USD 8,500,000 commodity portfolio has a 10-day, 95% VaR of USD 900,000. Which of the following
statements correctly describes the practical interpretation of the VaR amount?

A. The probability of portfolio losses exceeding USD 900,000 over the next 10 trading days is 5%.
B. The probability of portfolio losses exceeding USD 900,000 over the next 10 trading days is 95%.
C. Portfolio losses during a 10-day period are expected to exceed USD 900,000 once in every five
10-day period.
D. Portfolio losses during a 10-day period are expected to exceed USD 900,000 once in every twenty
10-day periods.

10. A factor-push model is applied to stress test the MtM value of several combinations of option positions on
the July NYMEX WTI futures contract. The modeling parameters assume a four standard deviation decline in
the price of the underlying futures contract. Each option has the same expiration date and the current
settlement price for the July WTI contract is USD 55.00/bbl.
Which of the following combinations of options would be least likely to generate an extreme loss under the
stress testing methodology described above?
A. A long 50 call and a long 60 call

B. A long 55 call and a long 55 put
C. A long 52.50 call and a short 47.50 call
D. A long 50 call and a short 50 put

11. The variance of historical monthly price returns on the SP-15 peak power futures contract is 0.0902 over a
3-year period. Which of the following volatilities represents the annual volatility on the SP-15 contract based
on the monthly price return data for the 3-year period?

A. 30.0%
B. 82.1%
C. 104.4%
D. 216.6%

12. A Japanese refinery pays USD 5.80/contract to buy 500, European style call options on the prompt Brent
Crude futures contract. The call options have a strike price of USD 53.25/bbl and expire in three months.
If the prompt Brent futures contract is trading at USD 54.75/bbl and the current 3-month risk-free rate is
2.50%, which of the following amounts (in USD) will the refinery need to pay for 500 European style put
options with the same maturity and strike price?

A. 2,131
B. 2,145
C. 2,155
D. 2,168



13. A US-based producer is building an LNG train in Australia which is scheduled to be completed in five years.
To help reduce exposure to foreign currency fluctuations, the producer has structured a 5-year, fixed-for-
floating swap on the Australian dollar (AUD) with an A-rated counterparty. If the producer is concerned about
a potential deterioration in the credit quality of the counterparty during the later years of the swap, which of
the following provisions should it incorporate in the counterparty arrangement?

A. CVA
B. Netting
C. Reset
D. Take-or-pay

14. Six months ago, a shipping company entered into a 1-year forward contract to purchase 50,000 MT of bunker
fuel from a counterparty at a price of USD 162/MT.
Current market pricing for bunker fuel is summarized below:
Spot price: USD 184/MT

6-month forward price: USD 194/MT
1-year forward price: USD 206/MT

Calculate the shipping companys credit exposure (in USD) if the counterparty defaults today (assume
discounting has no impact).
A. 1,100,000
B. 1,600,000
C. 2,300,000
D. 8,100,000

15. A natural gas market analyst applies a linear regression analysis on daily price data for a 1-year (365 day)
period to estimate the mean reversion rate of natural gas spot prices at Henry Hub. If estimates from the
regression imply a mean reversion rate of 14, which of the following number of days best approximates the
half-life for price shocks during the period?

A. 18
B. 20
C. 26
D. 28



16. A commercial natural gas end-user in the northeast United States hedges 100% of its expected February gas
consumption totaling 150,000 MMBtu. Which of the following sets of transactions should the end-user
execute in order to best minimize basis risk in its operation.

A. Buy 15 February NYMEX natural gas futures contracts and sell a Transco zone 6 natural gas basis
swap for February covering 150,000 MMBtu.
B. Sell 150 February NYMEX natural gas futures contracts and buy a Transco zone 6 natural gas basis
C. Buy 15 February NYMEX natural gas futures contracts and buy a Transco zone 6 natural gas basis
D. Sell 150 February NYMEX natural gas futures contracts and sell a Transco zone 6 natural gas basis

17. A separate estimate of correlation between risk factors is typically not required when applying which of the
following VaR methodologies?

A. Delta-gamma
B. Delta-normal
C. Historical Simulation
D. Monte Carlo Simulation

18. A credit analyst is assessing a USD 16,000,000 credit exposure related to a 10-year, fixed rate bond issued by
a Baa1/BBB+ rated midstream oil and gas company. The bond has a par value of USD 15,600,000, an
estimated recovery rate of 63%, and an expected loss of USD 720,000 in the event of default. Calculate the
implied default probability on the bond?

A. 9.20%
B. 10.86%
C. 12.16%
D. 16.90%

19. An electricity market analyst is using the following model to estimate the spot price S:
dS = ((t) log(S))Sdt + (t)Sdz + kSdq
Based on the parameters above, which of the following features of electricity markets does the model rely on
for estimating the spot price?
A. Convenience yield
B. Seasonality
C. Stochastic volatility
D. Storage Constraints



20. Under terms of a bilateral netting agreement, which of the following OTC derivative transactions would offer
the greatest benefit to the counterparty identified in the transaction?

A. A refinery long a straddle on gasoline futures.
B. A natural gas producer long a floor on natural gas.
C. A crude oil producer long a put option on WTI futures.
D. A gas-fired electric power generator long a natural gas swap.

21. A refined products trader has structured a 1-year fixed-for-floating swap on 150,000 barrels of gasoil with a
Ba1/BB+ rated counterparty. The trader applies the following information to price counterparty risk into
the transaction:

Expected exposure: 3.50%
Loss given default: 70%
Probability of default, 1-Year: 0.87%
Annual continuously compounded risk-free rate: 1.50%

The best approximation of the CVA for the swap (assuming annual settlements) is:

A. 0.009%
B. 0.021%
C. 0.599%
D. 2.414%

22. Which of the following pairs of statements correctly differentiates risk appetite and risk tolerance?

A. Risk appetite is a willingness to embrace risk; risk tolerance is an aversion to risk.
B. Risk appetite cannot be derived empirically; risk tolerance is a quantitative measure.
C. Risk appetite expresses a range of risk levels an organization is willing to take; risk tolerance is a
single definitive figure.
D. Risk appetite measures the amount of risk an organization is willing to take; risk tolerance is used
to communicate a level of acceptable risk.

23. When calibrating model parameters, which one of the following applications is most appropriate for
estimating the predictive power of the price return data used in an energy price forecasting model?

A. R2
B. Q-Q plot
C. Autocorrelation
D. Skew and kurtosis



24. The 1-day, 95% VaR for a Brent crude oil futures position is EUR 1,500,000, based on 5,000 simulated 1-day
returns. Which of the following statements best describes the 1-day, 95% expected shortfall?

A. The maximum 1-day simulated loss.
B. The average simulated 1-day loss that exceeds EUR 1,500,000.
C. The difference between the 1-day, 95% VaR and the 1-day, 99% VaR.
D. The difference between the 1-day, 95% VaR and the average simulated 1-day return for the position.

25. The following call and put option contracts are available on the prompt month Brent crude oil
futures contract:
Contract Option Strike (USD) Expiration

W Call 52 June 30, 2015
X Call 62 June 30, 2015
Y Put 62 June 30, 2015
Z Put 72 June 30, 2015

Assume the underlying futures contract is trading at USD 62. Which of the following combinations of the
option contracts is required to estimate implied volatility?
a. W and X
b. X and Y
c. W and Z
d. Y and Z



26. A market risk analyst at a diversified energy company has identified seven exceptions when backtesting a
1-day, 99% VaR model for the past year (250 trading days). Which of the following describes the proper
interpretation of these results in accordance with standards published by the Bank for International
Settlements (BIS) Basel Committee?

A. The VaR model is in the green zone and is acceptable to use with no further revision.
B. The VaR model is in the yellow zone and required further adjustment such as increasing the safety
multiplier assumption.
C. The VaR model is in the orange zone and must be substantially modified.
D. The VaR model is in the red zone and must be replaced.

27. Consider the following information related to bonds issued by two different IOCs:
Bond 1 Bond 2
Position size USD 100,000 USD 50,000
Probability of default 6% 5%
Expected recovery rate 20% 40%

Assuming bond defaults are independent, which of the following amounts (in USD) is closest to the 95%
Credit VaR for the combined position?
A. 0
B. 30,000
C. 80,000
D. 110,000

28. Which of the following best describes the relationship between risk-neutral default probabilities and
historical default probabilities?

A. Theoretical default probabilities are typically higher than historical default probabilities due to
liquidity risk premiums.
B. Historical default probabilities are typically higher than theoretical default probabilities due to
negative skew in bond returns.
C. Theoretical default probabilities are typically higher than historical default probabilities for investment
grade credits and lower than historical default probabilities for non-investment grade credits.
D. Historical default probabilities are typically higher than theoretical default probabilities for investment
grade credits and lower than theoretical default probabilities for non-investment grade credits.



29. As a crude oil forward contract approaches expiration, its price return volatility will typically increase, due
primarily to an increasingly higher:

A. sensitivity to seasonal market fundamentals.
B. rate of mean reversion toward an average long-term market price.
C. volume of trading activity as market participants react to new information.
D. number of market positions closed to avoid physical delivery obligations.

30. The following table summarizes daily price return data for Henry Hub natural gas and WTI crude oil over
a five-day period:

Rotterdam coal Brent

(USD/1,000 MT) (USD/bbl)
Day 1 2.78% 0.83%
Day 2 1.98% 3.01%
Day 3 -2.67% 1.14%
Day 4 1.76% 3.56%
Day 5 -2.77% 0.23%
Sample Mean Return 0.22% 1.75%
Standard Deviation 0.025 0.014

Which of the following values is the best estimate of the correlation between Rotterdam coal and Brent
crude oil price returns for the period?
A. -0.46
B. -0.39
C. 0.39
D. 0.46



31. A refinery buys a 3-month cap to manage price volatility on its crude oil supply requirements for the next
three months. The cap is written on 180,000 barrels of crude oil per month at a strike price of USD 63.50/bbl
and premium of USD 1.80/bbl. Settlement occurs on a monthly basis against the average daily prompt-month
NYMEX WTI contract closing prices summarized below:

Month 1: USD 65.10/bbl

Which of the following amounts (in USD) represents the cumulative net profit/loss earned by the refinery for
the 3-month period?

A. 450,000
B. 510,000
C. 720,000
D. 1,038,000

32. An airline executes an OTC jet fuel swap with a bank counterparty. The airline is classified as a qualified end
user and the bank is classified as a major swap participant. Which of the following describes the specific
requirements for reporting the swap to a swap data repository (SDR) under Dodd-Frank rules?

A. The bank and airline are both exempt from reporting the exposure to a SDR.
B. The bank is responsible for reporting the exposure to a SDR.
C. The airline is responsible for reporting the exposure to a SDR.
D. The airline and bank are both responsible for reporting their pro-rata portion of the exposure to a SDR.

33. An analyst has been asked to estimate the volatility for Brent crude oil using the EWMA model with a decay
factor () of 0.93. The estimated volatility yesterday was 2.75% per day. The market price of Brent crude oil
was USD 56.22 yesterday and USD 55.94 the day before yesterday. Which of the following volatilities is the
best estimate of Brent crude oil volatility today?

A. 0.66%
B. 0.87%
C. 2.59%
D. 2.66%



34. In early March 2017, the spot price of Brent crude oil is USD 47.90/bbl and estimated monthly storage costs
are USD 0.75/bbl. Traders use the following data to assess the economics of a storage arbitrage transaction:
Brent crude oil futures contract prices:
October 2017: USD 51.24/bbl


US Treasury zero-coupon bond yields:

March 2017 through September 2017: 2.50%
October 2018: 3.75%

Calculate the breakeven forward price (in USD) required for a 6-month storage arbitrage to be profitable
assuming storage costs are paid at the beginning of each month.
A. 47.09
B. 53.03
C. 55.73
D. 58.53

35. A power trader manages the following portfolio of power positions and natural gas hedges. The power and
gas positions have the following individual 1-day, 99% VaR amounts:

Power: 1.8 million
Natural gas: 2.0 million
If the correlation between power and natural gas price returns is 0.80, assuming a mean zero normal
distribution, which of the following amounts (in USD) best approximates the 1-day, 99% VaR of the portfolio?
A. 3.10 million
B. 3.20 million
C. 3.60 million
D. 3.80 million

36. When compared to pre-settlement risk, settlement risk exposures are typically:

A. Larger and occur more frequently.
B. Larger and occur less frequently.
C. Smaller and occur more frequently.
D. Smaller and occur less frequently.



37. Which of the following transactions will best reduce the gamma on a portfolio of options on NYMEX WTI
crude oil futures contracts?

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.

38. A global shipping company is short bunker fuel. To hedge the exposure, it purchases fuel oil futures based on
the following historical return data:
Standard deviation of bunker fuel price returns: 8.43%

Standard deviation of fuel oil price returns: 9.98%
Correlation between bunker fuel and fuel oil price returns: 0.863

The minimum variance hedge ratio required to properly size the futures position is closest to:
A. 0.616.
B. 0.729.
C. 1.022.
D. 1.210.

39. A petroleum producer is assessing macroeconomic risk associated with its production activity in a small,
oil-rich host country. A recent decline in global crude oil prices has weakened the local economy and
increased the probability that the government will default on its sovereign debt. Which of the following
describes the most likely outcome of a sovereign debt default by the host country?

A. Short-term political unrest that triggers a longer-term increase in financing costs.
B. Sharp increases in inflation and interest rates that create hyperinflation.
C. A deep economic recession that produces multiple years of negative year-over-year GDP growth.
D. Cancellation of outstanding sovereign debt obligations that results in a total loss of investor capital.

40. A netting set includes five equal counterparty exposures totaling EUR 4,750,000 with an average correlation
between the positions of 0.28. Assuming the future value of the exposures are normally distributed, which of
the following amounts (in EUR) represents the best estimate of the expected net exposure?

A. 794,000
B. 1,273,000
C. 1,944,000
D. 3,092,000



41. The 4-year implied default probability associated with several midsize oil exploration and production
companies is summarized below:
Company Year 1 Year 2 Year 3 Year 4
W 0.04% 0.17% 0.37% 0.53%
X 0.42% 1.05% 1.61% 2.32%
Y 4.68% 8.41% 11.6% 13.8%
Z 26.5% 33.1% 39.0% 44.2%

Based on implied default probabilities, a Moodys/Standard & Poors rating of B1/B+ will most likely be
assigned to which of the following companies?

A. W
B. X
C. Y
D. Z

42. Which of the following market factors will most likely be undetected by an LNG exporter that applies a KPI
analysis to its operations?

A. Fuel lost due to leakages in the LNG train.
B. Delays caused by operational inefficiencies in the LNG tanker loading process.
C. A decline in global gas prices due to a current economic downturn in Asia.
D. Anticipated natural gas shortages due to more stringent fracking regulations in the US.

43. A risk analyst has performed a regression analysis on ICE National Balancing Point (NBP) natural gas spot
price returns over the past 500 days in order to estimate the parameters for a simple mean reversion model.
Results from the regression analysis include the following coefficients for a linear relationship where:
y = 0.0285 x (Log of daily NBP Spot Prices) + 0.0188
Using the coefficients in the linear relationship, which of the following amounts (in days) is the best estimate
of the mean reversion rate for NBP natural gas spot prices?
A. 2
B. 9
C. 14
D. 21



44. Consider an electric utility company that serves a large region in the southeastern United States. The
company purchases exchange traded CDD contracts to help manage the economic risk associated with a
significant deviation from average temperatures during the summer. The chart below summarizes regional
average temperature data for one week during the peak summer cooling season:
High Low Average

Temperature Temperature Temperature
Sunday 86F 69F 78F
Monday 89F 71F 80F
Tuesday 91F 76F 84F
Wednesday 95F 80F 88F
Thursday 101F 81F 91F
Friday 93F 71F 82F
Saturday 82F 64F 73F

Calculate the number of Cooling Degree Days (CDD) for the week.
A. 7
B. 65
C. 91
D. 121

45. A natural gas fired generation plant has a daily fuel requirement of 10,000 MMBtu. The risk management
team is using the following NYMEX gas forward curve to price a swap:
Henry Hub WaHa Location Day

USD/MMBtu USD/MMBtu Count
November 4.20 4.07 30
December 4.41 4.28 31
January 4.63 4.77 31

Ignoring the impact of discounting, which of the following amounts (in USD) most closely approximates the
fixed price on a November to January NYMEX Henry Hub strip?
A. 4.36
B. 4.38
C. 4.40
D. 4.42



46. A bank has 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. Which of the following steps will
the bank most likely take if the refiner declares default 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 refiners estate.
D. File a claim with the central counterparty equivalent to the MtM value of the defaulted position.

47. Which of the following statements best describes the primary objective for structuring a
stack-and-roll position?

A. Hedge cross-commodity basis risk
B. Lock in a positive spread when there is an expectation that the forward curve will steepen.
C. Realize the spread on a series of call and put options on the same underlying prompt contract.
D. Manage commodity price risk when the market is perceived to lack liquidity in longer dated
futures contracts.

48. A crude oil refiner structures a cross-hedge to protect the value of its asphalt production. The refiner
consumes 1.5 barrels of crude oil to produce 1 gallon of asphalt. If the hedge ratio is 0.1875, which of the
following number of crude oil futures contracts is required to hedge 42,000 gallons of asphalt production?

A. 1
B. 5
C. 8
D. 12

49. A risk analyst is developing a probability density function to model price returns associated with a portfolio of
electricity futures contracts. The analyst might choose to use a t-distribution as an alternative to a normal
distribution because the t-distribution can display:

A. Excess kurtosis.
B. Higher variance.
C. Mean reversion.
D. Negative skewness.



50. Which of the following statements is a correct assumption to make when estimating the recovery rate for an
individual counterparty exposure?

A. The recovery rate is negatively correlated with default rates.
B. The recovery rate is positively correlated with counterparty credit spreads.
C. The recovery rate associated with subordinated debt is higher than senior unsecured debt.
D. The recovery rate associate with OTC derivative transactions is lower than subordinated debt.

51. An energy futures portfolio consists of contracts covering 40,000 gallons of RBOB and 60,000 gallons of ULSD.
The current pricing for each prompt month contract is summarized below:
Bid (USD/gal) Offer (USD/gal)

RBOB 1.235 1.257
ULSD 1.108 1.129

Calculate the expected cost of liquidating the portfolio (in USD) under normal market conditions with
sufficient market liquidity.
A. 1,070
B. 1,250
C. 2,140
D. 2,510

52. A refinery processes 6,000,000 barrels of crude oil per month. It creates a financial position that replicates a
3:2:1 refining spread to hedge its monthly production of gasoline and heating oil. To hedge the gasoline
portion of the 3:2:1 spread, the refinery will:

A. Buy 2,000 NYMEX RBOB futures contracts.
B. Buy 4,000 NYMEX RBOB futures contracts.
C. Sell 2,000 NYMEX RBOB futures contracts.
D. Sell 4,000 NYMEX RBOB futures contracts.



53. Management at a refinery strategically shifts production away from gasoline to increase its production of
distillates. Which of the following spread positions will best hedge production if distillates account for 50% of
the refiners new product mix?

A. 2:1:1 crack spread hedge
B. 4:3:1 crack spread hedge
C. 5:3:2 crack spread hedge
D. 6:2:1 crack spread hedge

54. Assume two 100 MW generators supply power to the grid at a cost of USD 45.00/MWh and USD 5.00/MWh,
respectively. Peak hourly demand is assumed to be uniformly distributed between 65 MWh and 185 MWh.
Calculate the probability that the market clearing price during a peak hour is less than USD 55.00/MWh.

A. 25.0%
B. 29.2%
C. 32.2%
D. 35.0%

55. A crude oil producer maintains a long put option position consisting of 500 contracts on crude oil futures with
a strike price of USD 35/bbl. The position is currently delta neutral with a gamma of 0.038 and a vega of 5.7.
The producer is required to neutralize gamma while keeping the position delta neutral.

An option with the following delta and gamma has been identified:

Delta: 0.52
Gamma: 0.048

Which of the following sets of transactions will the producer execute to neutralize the option positions
gamma and delta, respectively?
A. Sell 206 options; buy 396 futures.

B. Sell 328 options; buy 632 futures.
C. Sell 396 options; buy 206 futures.
D. Sell 632 options; buy 328 futures



56. A GARCH (1,1) model applies the following expression to estimate volatility:
t2 = + 2(t-1) + rt2
Where: rt = tt and t ~ N(0,1).
Assuming that factors and are both greater than zero, what assumption is required to ensure that
volatility estimates remain balanced and plausible?
A. + 1
B. + 1
C. 1 and 1
D. 1 and 1

57. The following natural gas pricing data is available for the month of February:
Published AECO hub price: USD 2.03/MMBtu

Henry Hub settlement price: USD 1.96/MMBtu

The current pipeline capacity charge for gas shipments between Henry Hub and AECO is USD 0.08/MMBtu.
Calculate the realized AECO basis (in USD/MMBtu) for the month.
A. -0.15
B. -0.07
C. 0.01
D. 0.07

58. A crude oil producer typically sells forward contracts to hedge price risk on its expected future production.
As an alternative to selling a forward contract at USD 35.00/bbl, the producer buys a 2-year put option on
crude oil futures. The put option has a USD 35.00/bbl strike and a premium of USD 3.25/bbl. If the
annualized risk-free rate is 1.50%, the economic return on the put option will outperform the economic
return on the forward contract when the price (in USD/bbl) of crude oil at option expiration is:

A. Below 31.65.
B. Above 31.65.
C. Below 38.35.
D. Above 38.35.



59. Which of the following corporate stakeholders will typically serve as the first line of defense within an
effective ERM framework?
A. Chief Risk Officer

B. Chief Compliance Officer
C. Individual business line managers
D. Functionally independent corporate risk department

60. A risk analyst at a refinery is calculating the 10-day, 95% VaR on a 100,000 barrel Brent crude oil position
currently valued at USD 3,250,000. Using a daily returns for Brent crude oil prices over the past 12 months,
the analyst applies a simple moving average to estimate the volatility factor used in the VaR model. Noticing
higher crude oil price volatility over the past month, the analyst applies an EWMA with a lambda of 0.99 to
adjust the volatility factor used in the VaR model. Applying the new volatility estimate will most likely cause
the new VaR amount to:

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.



2017 ERP Part II Practice Exam Candidate Answer Sheet

1. B 16. C 31. A 46. C
2. A 17. C 32. B 47. D
3. C 18. C 33. D 48. D
4. A 19. B 34. B 49. A
5. D 20. D 35. C 50. A
6. B 21. B 36. B 51. A
7. B 22. D 37. C 52. D
8. A 23. A 38. B 53. A
9. D 24. B 39. A 54. B
10. B 25. B 40. D 55. C
11. C 26. B 41. C 56. A
12. C 27. C 42. D 57. D
13. C 28. A 43. C 58. A
14. B 29. C 44. D 59. C
15. A 30. D 45. D 60. A



2017 ERP Part II Practice Exam Answers & Explanations
1. A commodity trader holds a long position in October WTI futures contracts. Details of the position are
summarized below:

Trade date: June 25
Number of contracts: 500
Purchase price: USD 53.60/bbl
Initial margin requirement: USD 4,020,000
Required maintenance threshold: USD 3,500,000

The exchange requires all futures accounts to be topped-up to meet initial margin requirements. Below
which of the following prices (in USD) will a margin call be triggered on the traders position?
A. 51.52
B. 52.56
C. 53.60
D. 54.64

Correct answer: B
Explanation: The trader can lose no more than (4,020,000 3,500,000), or 520,000, on this trade without
receiving a call. In order to find the correct price, we must first find the gain or loss on the trade per dollar
change in the WTI futures contracts, which is 500 contracts * 1,000 barrels per contract, or USD 500,000.
Therefore, the contract can trade no lower than 53.60 - (520,000 / 500,000), or USD 52.56/bbl, before the
trader gets a call.
Reading reference: Jon Gregory. Central Counterparties, Chapter 3.



2. A Simple Moving Average can be used to estimate the standard deviation of historical price returns for a VaR
model. Which of the following statements best describes the primary weakness in applying a SMA to energy
commodity price return data?

1. The SMA weights all historical price return data equally.
2. The SMA over weights the most recent price return data.
3. The SMA ignores the impact of jumps in the price return data.
4. The SMA ignores the impact of autocorrelation on price return data.

Correct answer: A

Explanation: A potential flaw with SMA is that all returns are given equal weight, even though price returns
from a few months ago may have little relevance to current market conditions. A way of addressing this
concern is through the Exponentially Weighted Moving Average, which gives more weight to more recent
data returns.

Reading reference: Les Clewlow and Chris Strickland. Energy Derivatives: Pricing and Risk Management,
Chapter 10



3. To protect against adverse price movements in the refined product markets, a petroleum company creates a
straddle position in NYMEX ULSD futures contracts with the following terms:
2-month NYMEX ULSD call option with a strike price of USD 1.69/gal at a premium of USD 0.04/gal
2-month NYMEX ULSD put option with a strike price of USD 1.69/gal at a premium of USD 0.07/gal

One week after establishing the position, the closing NYMEX ULSD prompt-month futures price is
USD 1.82/gallon. Calculate the current net MtM value (in USD) of the straddle position.
A. -10,080
B. 20
C. 840
D. 5,460

Correct answer: C
Explanation: Based on the closing NYMEX ULSD prompt-month futures price of USD 1.74/gal, the current net
MtM value of the straddle is calculated as follows: 1.82 - 1.69 - 0.04 - 0.07 = 0.02 multiplied by 42,000 gallons
per contract resulting in a net MtM value of USD 840. In this scenario, the call option generates a profit
which is offset by the premium paid for each option.
Reading reference: S. Mohamed Dafir and Vishnun N. Gajjala. Fuel Hedging and Risk Management,
Chapter 4.



4. A bank holds a portfolio of derivative transactions with a single counterparty that declares default. The MtM
value and pledged collateral for each transaction at the time of default is summarized below:
MtM value Collateral value

(in EUR) (in EUR)
Trade A +3,000,000 2,000,000
Trade B +10,000,000 2,000,000
Trade C -6,000,000 0
Trade D +4,000,000 1,000,000

The transactions are covered by an ISDA CSA with a closeout netting agreement. Calculate the banks total
net exposure (in EUR) to the counterparty, assuming the recovery rate for each trade is 30%.
A. 900,000
B. 2,700,000
C. 4,200,000
D. 5,900,000

Correct answer: A
Explanation: Exposure is reduced by both the netting agreement and the collateral.
The bank has 17,000,000 of net exposures at the time of default. Since 30% of this amount is immediately
recovered, that leaves it with 11,900,000 of exposures outstanding. During the closeout, this is netted
against the negative exposure leaving it with a balance of 5,900,000. Since EUR 5,000,000 in pledged
collateral is available, that leaves a total net exposure of EUR 900,000.
B is incorrect as it assumes 30% is recovered from the netted amount of 11,000,000 instead of the gross
amount of 17,000,000, with the collateral being collected afterward for a net remaining exposure of
2,700,000. The bank did not default (the counterparty did) so this is impossible.
C is incorrect as it applies the recovery rate after all netting and collateral adjustments. E.g., 0.7*6,000,000 =
4,200,000.
D is incorrect as it doesnt factor in the netted trade for which the bank has negative exposure
Reading reference: Jon Gregory, Counterparty Credit Risk and Credit Value Adjustment: A Continuing
Challenge for Global Financial Markets, 2nd Edition, Chapter 4.



5. The following market prices for NYMEX WTI crude oil futures are quoted at the close of trading on February 1
and April 1, respectively:
WTI Futures Price WTI Futures Price

February 1 (USD/bbl) April 1 (USD/bbl)
May 48.93 51.31
June 49.29 51.76

On February 1, a crude oil trader expects the spread between the May and June WTI futures closing price to
widen over the next two months. How would the trader structure a calendar spread on February 1 to benefit
from this view and what is the realized net profit/loss per contract on the position based on the April 1
closing prices?
A. Long May and short June futures; USD -90

B. Long June and short May futures; USD -45
C. Long May and short June futures; USD 45
D. Long June and short May futures; USD 90

Correct answer: D
Explanation: A futures position taken with the expectation that the spread will widen assumes the the higher
priced June contract is purchased at USD 49.29/bbl and the lower priced May contract is sold at USD
48.93/bbl. By April 1, the spread between the two contracts had widened by USD 0.09/bbl (0.36 spread in
February vs. 0.45 spread in April), thus creating a gain of USD 90 per contract (0.09*1,000 bbls).
Reading reference: Robert McDonald. Derivatives Markets, 3rd Edition, Chapter 6.



6. Seismic surveys are used to test the future viability of crude oil production at 100 potential deepwater drilling
sites. A survey will produce a positive test result for 100% of sites that are commercially viable, and a
negative test result for 85% of sites that are not viable. If 1 drilling site out of 100 is commercially viable, the
probability that a site is viable given a positive test result is approximately:

A. 0.1%.
B. 6.0%.
C. 15.0%.
D. 94.0%.

Correct answer: B
Explanation: Assume P(F) is the probability that a reservoir is commercially viable and P(T) probability that
the test is positive. P(NF) and P(NT) are the probabilities of the opposite events.

From the text we understand that: P(T|F)=100%, P(T|NF)=15%,P(F)=1/100.
We can therefore derive: P(T)=P(T|F)*P(F)+P(T|NF)*P(NF)=100%*1/100+15%*99/100=15.85% P(F|T)=P(F
and T)/P(T) =P(T|F)*P(F)/P(T)=(100%*1/100)/15.85% = 6.30%

More simply: For every 100 reservoirs the seismic survey will produce 1 positive test result for a reservoir
that is viable and for 15% of the other 99 reservoirs (approximately 15) the survey will produce a positive
result for reservoirs that are not viable. Therefore, there will be approximately 16 positive test results for
every 100 observations; for any positive report there is only (1/16) or approximately a 6.30% chance that a
reservoir is actually viable.

Reading reference: Michael Miller, Mathematics and Statistics for Financial Risk Management, 2nd Edition,
Chapter 2.



7. The primary economic objectives at a refinery are to manage price risk and maximize operating margins.
To help achieve these objectives, the risk management team plans to structure a collar using the following
options on NYMEX RBOB futures contracts:
RBOB Strike Price Call Premium Put Premium

(USD/bbl) (USD) (USD)
1.54 0.128 0.092
1.57 0.105 0.087

If the prompt-month NYMEX RBOB futures price is currently USD 1.558/gal, which of the following sets of
transactions will most effectively achieve the refiners economic objectives?
A. Buy USD 1.57 put options and sell USD 1.54 call options.
B. Buy USD 1.54 put options and sell USD 1.57 call options.
C. Sell USD 1.54 put options and buy USD 1.57 call options.
D. Sell USD 1.57 put options and buy USD 1.54 call options.

Correct answer: B
Explanation: The collar will help the refiner to hedge price risk and, by extension, margins on its refining
operation for the month of October. In this case, the refiner will lock in a range of selling prices between 1.54
and 1.57 (less any cost of implementing the trade). If the RBOB price rallies over 1.57, the short call will be
assigned to the refiner so the refiner will realize an effective price of 1.57. If the price falls below 1.54, the
refiner can exercise the put option to lock in the price at that level.
Reading reference: Vincent Kaminski, Energy Markets, Chapter 18.



8. A natural gas trader has arranged a 6-month storage contract in June, based on the expectation that the
spread between summer and winter natural gas prices will increase. The trader plans to withdraw injected
natural gas at expiration of the storage contract. Which of the following structures has she most likely
arranged?

A. Park-and-loan
B. Cash-and-carry
C. Exchange-for-physical
D. Contract-for-differences
Correct answer: A
Explanation: A park-and-loan structure involves buying a commodity in the cheaper months (when demand
is lower) and storing to the expensive months (when demand is higher). As such, participants in the natural
gas markets know that if the spread between winter and summer months rises the profit can increase by
injecting in the summer and selling in the winter.
Reading reference: Glen Swindle. Valuation and Risk Management in Energy Markets, Chapter 2.



9. A USD 8,500,000 commodity portfolio has a 10-day, 95% VaR of USD 900,000. Which of the following
statements correctly describes the practical interpretation of the VaR amount?

A. The probability of portfolio losses exceeding USD 900,000 over the next 10 trading days is 5%.
B. The probability of portfolio losses exceeding USD 900,000 over the next 10 trading days is 95%.
C. Portfolio losses during a 10-day period are expected to exceed USD 900,000 once in every five
10-day period.
D. Portfolio losses during a 10-day period are expected to exceed USD 900,000 once in every twenty
10-day periods.

Correct answer: D
Explanation: A 95% confidence level means that there is a one-in-20, or a 5% chance, that a loss should
exceed the portfolio VaR over the time period that the VaR specifies. In this case, the 10-day VaR of 2 million
indicates that the portfolio should be expected to lose more than USD 2 million once in every twenty,
10-day periods.
Reading reference: John C. Hull. Risk Management and Financial Institutions, 4th Edition. Chapter 12.



10. A factor-push model is applied to stress test the MtM value of several combinations of option positions on
the July NYMEX WTI futures contract. The modeling parameters assume a four standard deviation decline in
the price of the underlying futures contract. Each option has the same expiration date and the current
settlement price for the July WTI contract is USD 55.00/bbl.
Which of the following combinations of options would be least likely to generate an extreme loss under the
stress testing methodology described above?
A. A long 50 call and a long 60 call

B. A long 55 call and a long 55 put
C. A long 52.50 call and a short 47.50 call
D. A long 50 call and a short 50 put

Correct answer: B
Explanation: A factor-push model is only useful when the maximum loss on the position occurs when the risk
factor has been pushed or stressed the hardest. Therefore, the return profile of the underlying position
with respect to the risk factor needs to be monotonic (i.e. steadily increasing or decreasing for every value of
the risk factor.) In cases where a position has non-monotonicity, or the maximum loss occurs when the value
of the risk factor is not at an extreme, a factor-push model will not predict the maximum loss. In this case,
the combination of a long 55 call and a long 55 put would create the greatest loss if the underlying remained
at USD 55.00/bbl. The position would actually increase in value if the factor was pushed in either direction.
Reading reference: Dowd, Managing Market Risk, Chapter 13.



11. The variance of historical monthly price returns on the SP-15 peak power futures contract is 0.0902 over a 3-
year period. Which of the following volatilities represents the annual volatility on the SP-15 contract based
on the monthly price return data for the 3-year period?

1. 30.0%
2. 82.1%
3. 104.4%
4. 216.6%

Correct answer: C
Explanation: Historical volatility is derived by multiplying the standard deviation (square root of variance) of
price changes by the square root of time (12), the factor required to annualize the monthly prices observed in
the sample: (sqrt 0.0902)*(sqrt 12) = 0.30033 * 3.46410 = 104.4%
Reading reference: Les Clewlow and Chris Strickland, Energy Derivatives: Pricing and Risk Management,
Chapter 3.



12. A Japanese refinery pays USD 5.80/contract to buy 500, European style call options on the prompt Brent
Crude futures contract. The call options have a strike price of USD 53.25/bbl and expire in three months.
If the prompt Brent futures contract is trading at USD 54.75/bbl and the current 3-month risk-free rate is
2.50%,, which of the following amounts (in USD) will the refinery need to pay for 500 European style put
options with the same maturity and strike price?
A. 2,131
B. 2,145
C. 2,155
D. 2,168

Correct answer: C

Explanation: Using the Put-Call Parity relationship:

= + '( )'*

= 500 [5.80 '.456 7 .56) 54.75 53.25 = USD 2,155

Reading reference: S. Mohamed Dafir and Vishnun N. Gajjala. Fuel Hedging and Risk Management,
Chapter 4.



13. A US-based producer is building an LNG train in Australia which is scheduled to be completed in five years. To
help reduce exposure to foreign currency fluctuations, the producer has structured a 5-year, fixed-for-floating
swap on the Australian dollar (AUD) with an A-rated counterparty. If the producer is concerned about a
potential deterioration in the credit quality of the counterparty during the later years of the swap, which of
the following provisions should it incorporate in the counterparty arrangement?

A. CVA
B. Netting
C. Reset
D. Take-or-pay

Correct answer: C

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.

Reading reference: Jon Gregory. Counterparty Credit Risk and Credit Value Adjustment: A Continuing



14. Six months ago, a shipping company entered into a 1-year forward contract to purchase 50,000 MT of bunker
fuel from a counterparty at a price of USD 162/MT.
Current market pricing for bunker fuel is summarized below:
Spot price: USD 184/MT

6-month forward price: USD 194/MT
1-year forward price: USD 206/MT

Calculate the shipping companys credit exposure (in USD) if the counterparty defaults today (assume
discounting has no impact).

A. 1,100,000
B. 1,600,000
C. 2,300,000
D. 8,100,000
Correct answer: B
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 six months to maturity, the shipper is essentially holding a 6-month forward
contract. The replacement risk is therefore: (194-162) * 50,000 = 1,600,000. Since the shipping company has
not paid the counterparty yet, there is zero settlement risk.
Reading 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).



15. A natural gas market analyst applies a linear regression analysis on daily price data for a 1-year (365 day)
period to estimate the mean reversion rate of natural gas spot prices at Henry Hub. If estimates from the
regression imply a mean reversion rate of 14, which of the following number of days best approximates the
half-life for price shocks during the period?
A. 18
B. 20
C. 26
D. 28

Correct answer: A

Explanation: Using the half-life estimate provided in the text as follows:
T1/2= ln(2)/, where is mean reversion rate
= ln(2)/14 = 0.049511
= 0.049511*365 = 18.07 days

B is incorrect: 14/ln(2) = 20.2
C is incorrect: 365/14 = 26.1
D is incorrect: 14*0.5 = 28

Chapter 2.



16. A commercial natural gas end-user in the northeast United States hedges 100% of its expected February gas
consumption totaling 150,000 MMBtu. Which of the following sets of transactions should the end-user
execute in order to best minimize basis risk in its operation.

A. Buy 15 February NYMEX natural gas futures contracts and sell a Transco zone 6 natural gas basis
B. Sell 150 February NYMEX natural gas futures contracts and buy a Transco zone 6 natural gas basis
C. Buy 15 February NYMEX natural gas futures contracts and buy a Transco zone 6 natural gas basis
D. Sell 150 February NYMEX natural gas futures contracts and sell a Transco zone 6 natural gas basis

Correct answer: C
Explanation: Basis refers to the difference in price between a forward (futures) market and a cash (spot)
market. In the natural gas markets, the primary type of basis risk is locational basis risk. A basis swap is
contract that can help mitigate basis risk exposure. Note: In sizing the transaction keep in mind that one
natural gas future contract represents 10,000 MMBtu.
Reading reference: Vincent Kaminski. Energy Markets, Chapter 11



17. A separate estimate of correlation between risk factors is typically not required when applying which of the
following VaR methodologies?

A. Delta-gamma
B. Delta-normal
C. Historical Simulation
D. Monte Carlo Simulation

Correct answer: C
Explanation: An historical simulation based VaR methodology relies on historical data that typically
incorporates the underlying correlation between risk factors. The Delta-gamma, Delta-normal, and Monte
Carlo methodologies require a separate estimate of volatilities and correlation between risk factors.
Chapter 10.



18. A credit analyst is assessing a USD 16,000,000 credit exposure related to a 10-year, fixed rate bond issued by
a Baa1/BBB+ rated midstream oil and gas company. The bond has a par value of USD 15,600,000, an
estimated recovery rate of 63%, and an expected loss of USD 720,000 in the event of default. Calculate the
implied default probability on the bond?

A. 9.20%
B. 10.86%
C. 12.16%
D. 16.90%

Correct 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 5,920,000.

The implied default probability is then the EL of USD 720,000 divided by the LGD USD 5,920,000 or 12.16%.

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).



19. An electricity market analyst is using the following model to estimate the spot price S:
dS = ((t) log(S))Sdt + (t)Sdz + kSdq
Based on the parameters above, which of the following features of electricity markets does the model rely on
for estimating the spot price?
A. Convenience yield
B. Seasonality
C. Stochastic volatility
D. Storage Constraints

Correct answer: B

Explanation: The volatility term is simply (t)S, implying seasonal patterns in volatility can be captured (by a
periodic function of time) but not stochastic (random) volatility changes. Convenience yield and storage
constraints are not relevant to power price formation.

Chapter 2.



20. Under terms of a bilateral netting agreement, which of the following OTC derivative transactions would offer
the greatest benefit to the counterparty identified in the transaction?

A. A refinery long a straddle on gasoline futures.
B. A natural gas producer long a floor on natural gas.
C. A crude oil producer long a put option on WTI futures.
D. A gas-fired electric power generator long a natural gas swap.

Correct answer: D
Explanation: To provide economic benefit in a netting arrangement a derivative position must have the
potential to have a negative mark-to-market. Long option positions in which the premium is paid upfront
would be the least beneficial to a netting arrangement making a, b, and c incorrect. The long (fixed-rate
payer) position in a natural gas swap would have the greatest likelihood of creating a negative MtM and
therefore the greatest economic benefit in a netting arrangement.
Reading reference Jon Gregory. Counterparty Credit Risk and Credit Value Adjustment: A Continuing



21. A refined products trader has structured a 1-year fixed-for-floating swap on 150,000 barrels of gasoil with a
Ba1/BB+ rated counterparty. The trader applies the following information to price counterparty risk into
the transaction:

Expected exposure: 3.50%
Loss given default: 70%
Probability of default, 1-Year: 0.87%

The best approximation of the CVA (as a %) for the swap (assuming annual settlements) is:

A. 0.009%
B. 0.021%
C. 0.610%
D. 2.45%

Correct answer: B

Explanation: CVA can be estimated as follows: CVA [EE * (1-RR) * PD]
Where EE is the Expected Exposure, (1-RR) is the Loss Given Default, and PD is the Probability of Default or

CVA 3.50% * 70% * 0.87% = 0.00021315 or 0.021%

Explanations for the distracters:
Answer a applies the recovery rate instead of by the loss given default in the calculation.

Answer c omits the expected exposure in the calculation.

Answer d omits the probability of default in the calculation.




22. Which of the following pairs of statements correctly differentiates risk appetite and risk tolerance?

A. Risk appetite is a willingness to embrace risk; risk tolerance is an aversion to risk.
B. Risk appetite cannot be derived empirically; risk tolerance is a quantitative measure.
C. Risk appetite expresses a range of risk levels an organization is willing to take; risk tolerance is a
single definitive figure.
D. Risk appetite measures the amount of risk an organization is willing to take; risk tolerance is used
to communicate a level of acceptable risk.

Correct answer: D

Explanation: Applies the correct definition of risk appetite and risk tolerance.
Reading reference: James Lam, Implementing and Effective Risk Appetite. (The Association of Accountants
and Financial Professionals in Business, August 2015).



23. When calibrating model parameters, which one of the following applications is most appropriate for
estimating the predictive power of the price return data used in an energy price forecasting model?

A. R2
B. Q-Q plot
C. Autocorrelation
D. Skew and kurtosis
Correct answer: A
Explanation: The R2 statistic measures the relative degree of fit for sets of historical data. The Q-Q plot
compares actual probabilities with expected probabilities, autocorrelation tests for the existence of
correlation between sequenced time-series data, and skew and kurtosis describe the statistical
characteristics (moments) of a normal distribution.

Reading reference: Rafal Weron, Modeling and Forecasting Electricity Loads and Prices, Chapter 3.



24. The 1-day, 95% VaR for a Brent crude oil futures position is EUR 1,500,000, based on 5,000 simulated 1-day
returns. Which of the following statements best describes the 1-day, 95% expected shortfall?

A. The maximum 1-day simulated loss.
B. The average simulated 1-day loss that exceeds EUR 1,500,000.
C. The difference between the 1-day, 95% VaR and the 1-day, 99% VaR.
D. The difference between the 1-day, 95% VaR and the average simulated 1-day return for the position.

Correct answer: B

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.
Reading reference: John C. Hull. Risk Management and Financial Institutions, 4th Edition, Chapter 12.

25. The following call and put option contracts are available on the prompt month Brent crude oil futures
contract:
Contract Option Strike (USD) Expiration

W Call 52 June 30, 2015
X Call 62 June 30, 2015
Y Put 62 June 30, 2015
Z Put 72 June 30, 2015

Assume the underlying futures contract is trading at USD 62. Which of the following combinations of the
option contracts is required to estimate implied volatility?
A. W and X
B. X and Y
C. W and Z
D. Y and Z

Correct answer: B

Explanation: As described in Clewlow and Strickland, Section 3.2.6, In practice, implied volatility is usually
quoted for at-the-money options and is often calculated based on the average of an at-the-money straddle (a
call and a put with the same strike price).
Chapter 3.



26. A market risk analyst at a diversified energy company has identified seven exceptions when backtesting a 1-
day, 99% VaR model for the past year (250 trading days). Which of the following describes the proper
interpretation of these results in accordance with standards published by the Bank for International
Settlements (BIS) Basel Committee?

A. The VaR model is in the green zone and is acceptable to use with no further revision.
B. The VaR model is in the yellow zone and required further adjustment such as increasing the safety
multiplier assumption.
C. The VaR model is in the orange zone and must be substantially modified.
D. The VaR model is in the red zone and must be replaced.

Correct answer: B

Explanation: Between 5 and 9 exceptions places the model in the yellow zone where further action must
be taken in order for the model to continue being used. One potential solution would be to raise the safety
multiplier, which is an adjustment made to the model result to account for model risk (or for a bank, an
adjustment to the VaR model result to dictate its economic capital requirement). Ten or more exceedances
puts the model into the red zone where it must be substantially revised before being considered usable.
Chapter 10.



27. Consider the following information related to bonds issued by two different IOCs:
Bond 1 Bond 2
Position size USD 100,000 USD 50,000
Probability of default 6% 5%
Expected recovery rate 20% 40%

Assuming bond defaults are independent, which of the following amounts (in USD) is closest to the 95%
Credit VaR for the combined position?
A. 0
B. 30,000
C. 80,000
D. 110,000

Correct 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 it would be a default of bond 1 which would incur a loss of 100,000-20,000,
or USD 80,000. The probability of both bonds defaulting is (6% * 5%) or 0.03% so this does not qualify for the
Credit VaR.
Integrated View on Power and Other Energy Markets, 2nd Edition, Chapter 3 (Section 3.4 Credit Risk only).



28. Which of the following best describes the relationship between risk-neutral default probabilities and
historical default probabilities?

A. Theoretical default probabilities are typically higher than historical default probabilities due to
liquidity risk premiums.
B. Historical default probabilities are typically higher than theoretical default probabilities due to
negative skew in bond returns.
C. Theoretical default probabilities are typically higher than historical default probabilities for investment
grade credits and lower than historical default probabilities for non-investment grade credits.
D. Historical default probabilities are typically higher than theoretical default probabilities for investment
grade credits and lower than theoretical default probabilities for non-investment grade credits.

Correct answer: A
Explanation: Spreadderived probability-of-defaults (PDs) include risk and liquidity premiums which typically
make then higher than historical PDs.




29. As a crude oil forward contract approaches expiration, its price return volatility will typically increase, due
primarily to an increasingly higher:

A. sensitivity to seasonal market fundamentals.
B. rate of mean reversion toward an average long-term market price.
C. volume of trading activity as market participants react to new information.
D. number of market positions closed to avoid physical delivery obligations.

Correct answer: C

Explanation: As energy forward contracts get closer to their maturity date, 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 which, in turn,
increases price volatility.

Chapter 3.



30. The following table summarizes daily price return data for Henry Hub natural gas and WTI crude oil over a
five-day period:

Rotterdam coal Brent

(USD/1,000 MT) (USD/bbl)
Day 1 2.78% 0.83%
Day 2 1.98% 3.01%
Day 3 -2.67% 1.14%
Day 4 1.76% 3.56%
Day 5 -2.77% 0.23%
Sample Mean Return 0.22% 1.75%
Standard Deviation 0.025 0.014

Which of the following values is the best estimate of the correlation between Rotterdam coal and Brent
crude oil price returns for the period?
A. -0.46
B. -0.39
C. 0.39
D. 0.46

Correct answer: D

Explanation: The correlation can be calculated as follows:
Covariance terms:
Commodity A Commodity B
( a) * (B b)
Day 1 2.78% 0.83% -0.00023691
Day 2 1.98% 3.01% 0.000221558
Day 3 -2.67% 1.14% 0.0001772
Day 4 1.76% 3.56% 0.000278846
Day 5 -2.77% 0.23% 0.000455066
Sample mean 0.22% 1.75%
Sample standard deviation 0.025 0.014
BCD EF FEC( GEHI(JIKGL *L(DB
Covariance: = 0.0001791516
K
Correlation ab/ab 0.45687

Reading reference: Michael Miller. Mathematics and Statistics for Financial Risk Management, 2nd Edition,
Chapter 3.



31. A refinery buys a 3-month cap to manage price volatility on its crude oil supply requirements for the next
three months. The cap is written on 180,000 barrels of crude oil per month at a strike price of USD 63.50/bbl
and premium of USD 1.80/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 profit/loss earned by the refinery for
the 3-month period?

A. 450,000
B. 510,000
C. 720,000
D. 1,038,000

Correct answer: A

Explanation: By selling a cap, if the settlement price of crude oil is above the strike price in a given month,
the difference between the prices must be paid to the refinery. In this case, the first and third months are
above the strike price; the difference for month 1 is USD 1.60, the difference for month 3 is USD 6.30.
Multiplied by the contract size of 180,000/bbl per month gives totals of USD 288,000 and USD 1,134,000,
respectively, for a total of USD 1,422,000. We then must subtract the premium paid for the cap (USD 1.80 x
180,000 bbl x 3 months = 972,000) from the cap total for a net settlement payment of USD 450,000.

Note: no payment is made in month 2 because the settlement price (USD 62.30) is below the strike price
(USD 63.50), though the cap premium is still paid for month 2.

Reading reference: Vince Kaminski, Energy Markets, Chapter 18



32. An airline executes an OTC jet fuel swap with a bank counterparty. The airline is classified as a qualified end-
user and the bank is classified as a major swap participant. Which of the following describes the specific
requirements for reporting the swap to a swap data repository (SDR) under Dodd-Frank rules?

A. The bank and airline are both exempt from reporting the exposure to a SDR.
B. The bank is responsible for reporting the exposure to a SDR.
C. The airline is responsible for reporting the exposure to a SDR.
D. The airline and bank are both responsible for reporting their pro-rata portion of the exposure to a SDR.

Correct answer: B

Explanation: When a Category 3 entity (end-user) enters into a swap agreement with a Category 1 entity
(swap dealer or major swap participant) or a Category 2 entity (financial entity), then the Category 1 or 2
entity has the reporting obligation.
Reading reference: Gordon Goodman. Swaps: Dodd-Frank Memories.



33. An analyst has been asked to estimate the volatility for Brent crude oil using the EWMA model with a decay
factor () of 0.93. The estimated volatility yesterday was 2.75% per day. The market price of Brent crude oil
was USD 56.22 yesterday and USD 55.94 the day before yesterday. Which of the following volatilities is the
best estimate of Brent crude oil volatility today?

A. 0.66%
B. 0.87%
C. 2.59%
D. 2.66%

Correct answer: D

Explanation: The correct application of the EWMA formula as follows:

Return =56.22/55.94-1=0.005.

Volatility = sqrt(0.93*0.0275^2+(1-0.93)*0.005^2) or 2.655%.

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.




34. In early March 2017, the spot price of Brent crude oil is USD 47.90/bbl and estimated monthly storage costs
are USD 0.75/bbl. Traders use the following data to assess the economics of a storage arbitrage transaction:
Brent crude oil futures contract prices:


US Treasury zero-coupon bond yields:

March 2017 through September 2017: 2.50%
October 2018: 3.75%

Calculate the breakeven forward price (in USD) required for a 6-month storage arbitrage to be profitable
assuming storage costs are paid at the beginning of each month.
A. 47.09
B. 53.03
C. 55.73
D. 58.53

Correct answer: B

Explanation: Minimum 6-month forward price = [USD 47.90 * exp (0.025)^(6/12)] + (Future value of storage
(USD 4.53) = 53.03

Reading reference: Robert McDonald, Fundamentals of Derivatives Markets, 3rd Edition, Chapter 6.



35. A power trader manages the following portfolio of power positions and natural gas hedges. The power and
gas positions have the following individual 1-day, 99% VaR amounts:

Power: 1.8 million
Natural gas: 2.0 million

If the correlation between power and natural gas price returns is 0.80, assuming a mean zero normal
distribution, which of the following amounts (in USD) best approximates the 1-day, 99% VaR of the portfolio?
A. 3.10 million
B. 3.20 million
C. 3.60 million
D. 3.80 million
Correct answer: C
Explanation: The 1-day, 99% portfolio VaR can be derived using the following relationship:
SQRT((1-day, 99% Power VaR)2+(1-day, 99% Gas VaR)2 + 2*(1-day, 99% Power VaR)*1-day, 99% Gas
VaR)*(Power,Gas))




36. When compared to pre-settlement risk, settlement risk exposures are typically:

A. Larger and occur more frequently.
B. Larger and occur less frequently.
C. c. Smaller and occur more frequently.
D. Smaller and occur less frequently.

Correct answer: B

Explanation: Settlement risk is the risk of counterparty default during the settlement of the transaction,
while pre-settlement risk occurs prior to the maturity and/or settlement. Settlement risk exposures are much
larger than pre-settlement risk exposures since settlement risk entails the full value of the underlying
contract, while pre-settlement risk is just the mark-to-market (i.e. profit). However, since settlement risk is
limited to an extremely short period of time in most cases relative to the length of the contract, settlement
risk events occur much less frequently.

Reading reference: Gregory, Counterparty Credit Risk and Credit Value Adjustment: A Continuing Challenge
for Global Financial Markets, 2nd Edition, Chapter 3.



37. Which of the following transactions will best reduce the gamma on a portfolio of options on NYMEX WTI
crude oil futures contracts?

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.

Correct answer: C

Explanation: Gamma is defined as the rate of change in an options delta per move in the underlying.
Because delta is defined as the rate of change in an options price per move in the underlying, delta is very
low for deep out-of-the-money options and very high for deep-in the money options. Delta changes most
rapidly when an option is at-the-money, so at-the-money options would have the highest gamma as well.




38. A global shipping company is short bunker fuel. To hedge the exposure it purchases fuel oil futures based on
the following historical return data:

Standard deviation of bunker fuel price returns: 8.43%
Standard deviation of fuel oil price returns: 9.98%
Correlation between bunker fuel and fuel oil price returns: 0.863

The minimum variance hedge ratio required to properly size the futures position is closest to:
A. 0.616.
B. 0.729.
C. 1.022.
D. 1.210.

Correct answer: B

Explanation: The minimum variance hedge ratio is calculated as:
H* = (a,b) * (a / b), where is the correlation coefficient between returns of the two commodities, a is
the commodity being hedged, and b is the commodity being used as a hedge.
Hence H = -0.863* (0.0843/0.0998), or -0.729. The negative sign indicates that you need to take the opposite
position in the hedge as the original position.
Reading reference: Michael Miller. Mathematics and Statistics for Financial Risk Management, 2nd Edition,
Chapter 3.



39. A petroleum producer is assessing macroeconomic risk associated with its production activity in a small,
oil-rich host country. A recent decline in global crude oil prices has weakened the local economy and
increased the probability that the government will default on its sovereign debt. Which of the following
describes the most likely outcome of a sovereign debt default by the host country?

A. Short-term political unrest that triggers a longer-term increase in financing costs.
B. Sharp increases in inflation and interest rates that create hyperinflation.
C. A deep economic recession that produces multiple years of negative year-over-year GDP growth.
D. Cancellation of outstanding sovereign debt obligations that results in a total loss of investor capital.

Correct answer: A

Explanation: 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.

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: 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.

D is incorrect: cf: p.24 Default has seldom involved total repudiation of the debt most defaults are
followed by negotiations for either a debt exchange or restructuring, where the defaulting government is
given more time

Reading reference: Aswath Damodaran. Country Risk: Determinants, Measures and Implications The 2015
Edition.



40. A netting set includes five equal counterparty exposures totaling EUR 4,750,000 with an average correlation
between the positions of 0.28. Assuming the future value of the exposures are normally distributed, which of
the following amounts (in EUR) represents the best estimate of the expected net exposure?

A. 794,000
B. 1,273,000
C. 1,944,000
D. 3,093,000

Correct answer: D
Explanation: Since the future value of the exposures are normally distributed, we can calculate the netting
factor using the following equation:
Netting factor = [sqrt (n + n (n-1) ] / n
Where n is the number of exposures and is the average correlation between the exposures.
Using n = 5 and = 0.28, in this case the netting factor is 0.651.
The answer is then 4,750,000 * 0.651 = 3,092,976.
Reading reference: Gregory, Counterparty Credit Risk and Credit Value Adjustment: A Continuing Challenge
for Global Financial Markets, 2nd Edition, Chapter 8.



41. The 4-year implied default probability associated with several midsize oil exploration and production
companies is summarized below:
Company Year 1 Year 2 Year 3 Year 4
W 0.04% 0.17% 0.37% 0.53%
X 0.42% 1.05% 1.61% 2.32%
Y 4.68% 8.41% 11.6% 13.8%
Z 26.5% 33.1% 39.0% 44.2%

Based on implied default probabilities, a Moodys/Standard & Poors rating of B1/B+ will most likely be
assigned to which of the following companies?

A. W
B. X
C. Y
D. Z

Correct answer: C

Explanation: A B1/B+ rating is a speculative, or junk, credit rating, which would represent a significant
4-year probability of default. It is not an investment-grade rating, but is also one of the higher speculative
ratings. A 4-year default probability of 0.5% would correspond to an investment-grade rating (potentially
A2/A or A3/A-), a 2.3% probability would fall into the low investment-grade category (Baa/BBB), and a 44.25%
probability would correspond to a much lower speculative grade rating in the Caa2/CCC range.

Reading reference: Burger, Graeber and Schindlmayr, Managing Energy Risk: A Practical Guide for Risk
Management in Power, Gas, and Other Energy Markets, 2ND Edition, Chapter 3.



42. Which of the following market factors will most likely be undetected by an LNG exporter that applies a KPI
analysis to its operations?

A. Fuel lost due to leakages in the LNG train.
B. Delays caused by operational inefficiencies in the LNG tanker loading process.
C. A decline in global gas prices due to a current economic downturn in Asia.
D. Anticipated natural gas shortages due to more stringent fracking regulations in the US.

Correct answer: D

Explanation: KPIs monitor performance and as such are lagging indicators they collect information on
events that have already occurred. Anticipated natural gas shortages relate to a potential future event that
may affect the distribution network, this is not a risk that would be directly captured by KPIs (it would be
better captured by KRIs)

Reading reference: John Fraser and Betty Simkins, Enterprise Risk Management: Todays Leading Research
and Best Practices for Tomorrows Executives, Chapter 8.



43. A risk analyst has performed a regression analysis on ICE National Balancing Point (NBP) natural gas spot
price returns over the past 500 days in order to estimate the parameters for a simple mean reversion model.
Results from the regression analysis include the following coefficients for a linear relationship where:
y = 0.0285 x (Log of daily NBP Spot Prices) + 0.0188
Using the coefficients in the linear relationship, which of the following amounts (in days) is the best estimate
of the mean reversion rate for NBP natural gas spot prices?
A. 2
B. 9
C. 14
D. 21
Correct answer: C

Explanation: The mean reversion rate can be estimated from the regression results as follows:
0 = 0.0188 (Coefficient for Intercept)
1 = 0.0285 (Coefficient for Slope)
Assuming 500 data points t = 1/500 = 0.0020
Therefore, the mean reversion rate () can be estimated as (1/t) or 14 days
a is incorrect: 1 = 0.0285/ 0 = 0.0188 = 1.5

b is incorrect: 0 = 0.0188/ t 0.0020 = 9
d is incorrect: a spread of 7 days was added to the correct answer
Chapter 2.



44. Consider an electric utility company that serves a large region in the southeastern United States. The
company purchases exchange traded CDD contracts to help manage the economic risk associated with a
significant deviation from average temperatures during the summer. The chart below summarizes regional
average temperature data for one week during the peak summer cooling season:
High Low Average

Temperature Temperature Temperature
Sunday 86F 69F 78F
Monday 89F 71F 80F
Tuesday 91F 76F 84F
Wednesday 95F 80F 88F
Thursday 101F 81F 91F
Friday 93F 71F 82F
Saturday 82F 64F 73F

Calculate the number of Cooling Degree Days (CDD) for the week.
A. 7
B. 65
C. 91
D. 121

Correct answer: D
Explanation: To calculate Cooling Degree Days (CDD) for each day, if the average temperature is above 65
degrees, subtract the days average temperature from 65 to get that days CDD. If the average temperature
for that day is 65 degrees or below, the CDD for that day is zero. In this case, the CDD = 13 + 15 + 19 + 23 +
26 + 17 + 8 = 121.

Reading reference: Robert McDonald. Derivatives Markets, 3rd Edition. Chapter 6



45. A natural gas fired generation plant has a daily fuel requirement of 10,000 MMBtu. The risk management
team is using the following NYMEX gas forward curve to price a swap:
Henry Hub WaHa Location Day

USD/MMBtu USD/MMBtu Count
November 4.20 4.07 30
December 4.41 4.28 31
January 4.63 4.77 31

Ignoring the impact of discounting, which of the following amounts (in USD) most closely approximates the
fixed price on a November to January NYMEX Henry Hub strip?
A. 4.36
B. 4.38
C. 4.40
D. 4.42
Correct answer: D

Explanation: The fixed price on the Henry Hub strip can be approximated using the weighted average
monthly NYMEX values (NYMEX price x monthly volume x day count) and the correct day count.
A is incorrect: Made up number based on simple average of the WaHa location forward curve for Nov-Jan
and does not consider the number of days in the month.
B is iIncorrect: Accounts for the weighted average price using monthly WaHa location values (WaHa price x
monthly volume x day count) and the correct day count..but is based on WaHa location pricing.
C is incorrect: Made up number based on simple average of Nymex forward curve for Nov Jan and does not
consider the number of days in the month.
Reading reference: Vince Kaminski, Energy Markets, Chapter 11.



46. A bank has 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. Which of the following steps will
the bank most likely take if the refiner declares default 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 refiners estate.
D. File a claim with the central counterparty equivalent to the MtM value of the defaulted position.

Correct 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.)

If the MtM is negative, the solvent party immediately pays the insolvent party the MtM value.

If the MtM is positive, the solvent party becomes a creditor of the insolvent party in the amount of the claim,
the payment of which will later be addressed during the bankruptcy proceedings.

By immediately terminating the positions and creating a claim in the amount of the current MtM value, it
allows the solvent counterparty to immediately hedge the exact defaulted positions. This removes market
risk and trading uncertainty as otherwise the solvent party would otherwise have to contend with cashflow
mismatches and uncertain timing of potential payments during the bankruptcy process, as well as further
market moves in the defaulted positions over time.




47. Which of the following statements best describes the primary objective for structuring a stack-and-roll
position?
A. Hedge cross-commodity basis risk

B. Lock in a positive spread when there is an expectation that the forward curve will steepen.
C. Realize the spread on a series of call and put options on the same underlying prompt contract.
D. Manage commodity price risk when the market is perceived to lack liquidity in longer dated
futures contracts.
Correct answer: D

Explanation: Higher margin requirements could create a destabilizing effect on the market and potentially
introduces systemic risk. An example of this is a security where large concentrated positions are held. If the
CCP were to increase the margin requirement, firms holding these positions might be placed into margin calls
which could force them to sell the target security, creating even greater market impact and imposing strains
on the funding system and market liquidity.

Reading reference: Robert McDonald, Derivatives Markets, 3rd Edition, Chapter 6



48. A crude oil refiner structures a cross-hedge to protect the value of its asphalt production. The refiner
consumes 1.5 barrels of crude oil to produce 1 gallon of asphalt. If the hedge ratio is 0.1875, which of the
following number of crude oil futures contracts is required to hedge 42,000 gallons of asphalt production?

A. 1
B. 5
C. 8
D. 12

Correct answer: D

Explanation: Assuming 1.5 barrels of crude oil are required to produce 1 gallon of asphalt, then 63,000
barrels of crude are required to produce 42,000 gallons of asphalt (42,000*1.5 = 63,000). The spec for each
WTI contract is 1,000 barrels. Therefore, 12 WTI contracts, based on the hedge ratio (63,000 * 0.1875), are
required to hedge the asphalt production.

A is incorrect: Assumes 1 contract based on 42,000 gallons of asphalt production and WTI contract spec of
1,000 barrels times 42 gallons per barrel.
B is incorrect: Assumes asphalt gallons divided by 1.5 barrels multiplied by the hedge ratio
C is incorrect: Assumes 42,000 gallons of asphalt divided by 1,000 barrels per contract multiplied by the
hedge ratio.
Reading reference: Robert L. McDonald, Derivatives Markets, 3rd Edition. Chapter 4.



49. A risk analyst is developing a probability density function to model price returns associated with a portfolio of
electricity futures contracts. The analyst might choose to use a t-distribution as an alternative to a normal
distribution because the t-distribution can display:

A. Excess kurtosis.
B. Higher variance.
C. Mean reversion.
D. Negative skewness.

Correct answer: A
Explanation: Electricity price returns generally display high kurtosis which makes the Students t distribution
a more appropriate choice.
B is incorrect: Both distributions can be chosen to have high variances.
C is incorrect: the t-distribution and normal distribution are symmetric with a mean of zero.
D is incorrect: The t-distribution and normal distribution are symmetric.
Reading reference: Michael Miller, Mathematics and Statistics for Financial Risk Management, 2nd Edition,
Chapter 4.



50. Which of the following statements is a correct assumption to make when estimating the recovery rate for an
individual counterparty exposure?

A. The recovery rate is negatively correlated with default rates.
B. The recovery rate is positively correlated with counterparty credit spreads.
C. The recovery rate associated with subordinated debt is higher than senior unsecured debt.
D. The recovery rate associate with OTC derivative transactions is lower than subordinated debt.
Correct Answer: A

Explanation: Recovery rates are negatively correlated with overall default rates (cf: Gregory, chapter 10, p.
210.) They also tend to vary over time so in years with more defaults the recovery rates are lower. OTC
derivatives typically rank pari passu with senior debt in terms of priority for payoff, and the settled recovery
takes place after the actual recovery but is often lower.

Reading reference: Jon Gregory, Counterparty Credit Risk and Credit Value Adjustment: A Continuing



51. An energy futures portfolio consists of contracts covering 40,000 gallons of RBOB and 60,000 gallons of ULSD.
The current pricing for each prompt month contract is summarized below:
Bid (USD/gal) Offer (USD/gal)

RBOB 1.235 1.257
ULSD 1.108 1.129

Calculate the expected cost of liquidating the portfolio (in USD) under normal market conditions with
sufficient market liquidity.
A. 1,070
B. 1,250
C. 2,140
D. 2,510

Correct answer: A
Explanation: Cost of liquidation (normal market) is derived from the parameters below as follows:
The proportional bid-offer spread for RBOB is: 0.022/1.246 = 0.018

The proportional bid-offer spread for HO is: 0.021/1.119 = 0.019
The mid-market value of RBOB is: 1.246 * 40,000 = 49,840
The mid-market value of HO is: 1.119 * 60,000 = 67,110

The Cost of liquidation under normal market conditions = ((49,840 x 0.018)/2) + ((67,110 x 0.019)/2) = USD
1,070

An alternative method for calculating the expected cost is summarized below:

RBOB mid = 1.246
RBOB mid RBOB bid = 0.011
ULSD mid = 1.1185
ULSD mid ULSD bid = 0.0105
(0.011 * 40,000) + (0.0105 * 60,000) = 440 + 630 = USD 1,070

Reading reference: John Hull, Risk Management and Financial Institutions, 4th Edition, Chapter 24.



52. A refinery processes 6,000,000 barrels of crude oil per month. It creates a financial position that replicates a
3:2:1 refining spread to hedge its monthly production of gasoline and heating oil. To hedge the gasoline
portion of the 3:2:1 spread, the refinery will:

A. Buy 2,000 NYMEX RBOB futures contracts.
B. Buy 4,000 NYMEX RBOB futures contracts.
C. Sell 2,000 NYMEX RBOB futures contracts.
D. Sell 4,000 NYMEX RBOB futures contracts.

Correct answer: D
Explanation: The 3-2-1 crack spread represents the profit made per barrel of oil from selling refined
products such as gasoline and heating oil. The 3-2-1 indicates that 3 barrels of oil are used to produce 2
barrels worth of gasoline and 1 barrel worth of heating oil. Since gasoline futures and heating oil futures are
quoted in gallons, this has to be adjusted by 42 gallons per barrel. The 3-2-1 crack spread per barrel is
therefore equal to: (2* RBOB Futures Price * 42) + (Heating Oil Futures * 42) / (3* Crude Oil Futures). Since
the refinery processes 6,000,000 barrels, this implies that the equivalent of 4,000,000 barrels of gasoline
would be covered by the crack spread.
Since the refinery is hedging the crack spread, it should sell the futures on the refined product (locking in a
fixed sale price on its production) and buy the crude oil futures, locking in a fixed purchase price on its input.
The proper amount of RBOB futures contracts to sell is: 4,000,000 bbl * * 42 gallons per barrel / 42,000
gallons per contract = 4000.
Reading reference: Vincent Kaminski. Energy Markets, Chapter 18.



53. Management at a refinery strategically shifts production away from gasoline to increase its production of
distillates. Which of the following spread positions will best hedge production if distillates account for 50% of
the refiners new product mix?

A. 2:1:1 crack spread hedge
B. 4:3:1 crack spread hedge
C. 5:3:2 crack spread hedge
D. 6:2:1 crack spread hedge

Correct answer: A
Explanation: Heating oil and diesel are middle distillates of the crude oil refining process. Since their
operation configuration will change so that middle distillates will represent almost 50% of their output they
should change their hedge to map their new operational configuration. Middle distillates and gasoline (light
distillate) will represent almost equal portions of their output therefore they should place a 2:1:1 crack
spread hedge.



54. Assume two 100 MW generators supply power to the grid at a cost of USD 45.00/MWh and
USD 85.00/MWh, respectively. Peak hourly demand is assumed to be uniformly distributed between
65 MWh and 185 MWh. Calculate the probability that the market clearing price during a peak hour is less
than USD 55.00/MWh.

A. 25.0%
B. 29.2%
C. 32.2%
D. 35.0%

Correct answer: B
Explanation: The price can only be set below USD55/MWh if demand is less than or equal to 100 MW.
Thus P(D<=100) = (100-65)/(185-65) = 0.292.
Reading reference: Michael Miller, Mathematics and Statistics for Financial Risk Management, 2nd Edition
Chapter 2.



55. A crude oil producer maintains a long put option position consisting of 500 contracts on crude oil futures with
a strike price of USD 35/bbl. The position is currently delta neutral with a gamma of 0.038 and a vega of 5.7.
The producer is required to neutralize gamma while keeping the position delta neutral.

An option with the following delta and gamma has been identified:

Delta: 0.52
Gamma: 0.048

Which of the following sets of transactions will the producer execute to neutralize the option positions
gamma and delta, respectively?
A. Sell 206 options; buy 396 futures.

B. Sell 328 options; buy 632 futures.
C. Sell 396 options; buy 206 futures.
D. Sell 632 options; buy 328 futures

Correct answer: C
Explanation: To hedge market risk in the position, the producer must first neutralize the positive gamma by
selling an appropriate number of option contracts based on the following:

(Gamma of position / Gamma of hedge) * Number of contracts, i.e. (0.038/0.048) * 500, or 396 contracts. In
other words, 0.792 of an option must be sold to immunize gamma in each option contract.

Once gamma is neutralized, the producer must purchase 206 Brent Crude oil futures contracts to neutralize
the residual delta as follows: 0 - (0.792*0.52) = 0.411 futures per option contract or 163 futures contracts.

Choices a and b incorrectly calculate the ratio (gamma of hedge/gamma of position) required to size the
number of option contracts required to immunize gamma.




56. A GARCH (1,1) model applies the following expression to estimate volatility:
t2 = + 2(t-1) + rt2
Where: rt = tt and t ~ N(0,1).
Assuming that factors and are both greater than zero, what assumption is required to ensure that
volatility estimates remain balanced and plausible?
A. + 1
B. + 1
C. 1 and 1
D. 1 and 1

Correct answer: A
Explanation: In order to keep this a stationary process and assure that the volatility stays near the initial
variable , the combined factors and 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



57. The following natural gas pricing data is available for the month of February:
Published AECO hub price: USD 2.03/MMBtu

Henry Hub settlement price: USD 1.96/MMBtu

The current pipeline capacity charge for gas shipments between Henry Hub and AECO is USD 0.08/MMBtu.
Calculate the realized AECO basis (in USD/MMBtu) for the month.
A. -0.15
B. -0.07
C. 0.01
D. 0.07

Correct answer: D

Explanation: The realized basis represents the monthly cash price (index/posting) less the NYMEX Final
Settlement for that same month. This would be 2.03 1.96 or 0.07. Since AECO is more expensive than
Henry Hub, this actually results in a positive basis.




58. A crude oil producer typically sells forward contracts to hedge price risk on its expected future production.
As an alternative to selling a forward contract at USD 35.00/bbl, the producer buys a 2-year put option on
crude oil futures. The put option has a USD 35.00/bbl strike and a premium of USD 3.25/bbl. If the
annualized risk-free rate is 1.50%, the economic return on the put option will outperform the economic
return on the forward contract when the price (in USD/bbl) of crude oil at option expiration is:

A. Below 31.65.
B. Above 31.65.
C. Below 38.35.
D. Above 38.35.

Correct answer: A

Explanation: Since the put premium is paid two years prior to the option payoff, the foregone interest cost
on the premium needs to be considered in calculating the profit in year two. The future value of the
premium in two years is USD 3.25 x (1.0150)^2 = 3.3482. Therefore, the put option will outperform the
forward strategy below a price of USD 35 - USD 3.35 or USD 31.65/bbl of crude oil.
B is incorrect: 35 3.25
C is incorrect: 35 + 3.25
D is incorrect: 35 + (3.25*1.0150)^2

Reading reference: Robert McDonald, Fundamentals of Derivatives Markets, 3rd Edition, Chapter 4.



59. Which of the following corporate stakeholders will typically serve as the first line of defense within an
effective ERM framework?
A. Chief Risk Officer

B. Chief Compliance Officer
C. Individual business line managers
D. Functionally independent corporate risk department

Correct answer: C

Explanation: In an effectively implemented ERM framework, Managers of individual business lines are the
first line of defense. The second line of defense lies with the functionally independent corporate risk
function, followed by an independent review/audit with credible challenge knowledge. The Chief Data Officer
(CDO) establishes data policies/standards and serves as a champion for firm-wide data quality.

Reading reference: Management Solutions. Operational Risk Management in the Energy Industry.



60. A risk analyst at a refinery is calculating the 10-day, 95% VaR on a 100,000 barrel Brent crude oil position
currently valued at USD 3,250,000. Using a daily returns for Brent crude oil prices over the past 12 months,
the analyst applies a simple moving average to estimate the volatility factor used in the VaR model. Noticing
higher crude oil price volatility over the past month, the analyst applies an EWMA with a lambda of 0.99 to
adjust the volatility factor used in the VaR model. Applying the new volatility estimate will most likely cause
the new VaR amount to:

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.

Correct answer: A

Explanation: Applying a decay factor of 0.99 will place a slightly greater weight on more recent observations.
Therefore, the standard deviation and VaR should increase only slightly.



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2017 Erp Part II Practice Exam

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ERP Part II

Take the practice exam in a quiet place.

1. 16. 31. 46.

2. 17. 32. 47.

3. 18. 33. 48.

4. 19. 34. 49.

5. 20. 35. 50.

6. 21. 36. 51.

7. 22. 37. 52.

8. 23. 38. 53.

9. 24. 39. 54.

10. 25. 40. 55.

11. 26. 41. 56.

12. 27. 42. 57.

13. 28. 43. 58.

14. 29. 44. 59.

15. 30. 45. 60.

Trade date: June 25

MtM value Collateral value

WTI Futures Price WTI Futures Price

A. Long May and short June futures; USD -90

RBOB Strike Price Call Premium Put Premium

1.54 0.128 0.092

1.57 0.105 0.087

A. A long 50 call and a long 60 call

Current market pricing for bunker fuel is summarized below:

Spot price: USD 184/MT

dS = ((t) log(S))Sdt + (t)Sdz + kSdq

Contract Option Strike (USD) Expiration

Brent crude oil futures contract prices:

October 2017: USD 51.24/bbl

Standard deviation of bunker fuel price returns: 8.43%

Company Year 1 Year 2 Year 3 Year 4

W 0.04% 0.17% 0.37% 0.53%

X 0.42% 1.05% 1.61% 2.32%

Y 4.68% 8.41% 11.6% 13.8%

Z 26.5% 33.1% 39.0% 44.2%

y = 0.0285 x (Log of daily NBP Spot Prices) + 0.0188

High Low Average

Henry Hub WaHa Location Day

Bid (USD/gal) Offer (USD/gal)

A. Sell 206 options; buy 396 futures.

Where: rt = tt and t ~ N(0,1).

Published AECO hub price: USD 2.03/MMBtu

A. Chief Risk Officer

1. B 16. C 31. A 46. C

2. A 17. C 32. B 47. D

3. C 18. C 33. D 48. D

4. A 19. B 34. B 49. A

5. D 20. D 35. C 50. A

6. B 21. B 36. B 51. A

7. B 22. D 37. C 52. D

8. A 23. A 38. B 53. A

9. D 24. B 39. A 54. B

10. B 25. B 40. D 55. C

11. C 26. B 41. C 56. A

12. C 27. C 42. D 57. D

13. C 28. A 43. C 58. A

14. B 29. C 44. D 59. C

15. A 30. D 45. D 60. A

Reading reference: Jon Gregory. Central Counterparties, Chapter 3.

MtM value Collateral value

WTI Futures Price WTI Futures Price

A. Long May and short June futures; USD -90