Erp Sampleqs2013

2013
ERP Examination Sample Questions
The following questions are samples of actual ERP questions from recent exams. Full explanations and reference information can be found in the 2013 Practice Exams, which are available through the GARP Digital Library and are free to paid ERP candidates.
Energy Risk Professional (ERP ) Examination

Sample Questions
Energy Risk Professional Examination (ERP) Sample Questions
1.
Which of the following is an example of basis risk? a. b. c. d. A A A A natural gas price spike occurs during peak electricity demand. power generator is unable to comply with FERC financial reporting regulations. megawatt of electricity costs USD 75 in Pennsylvania versus USD 82 in New York. power generation plant is unable to meet peak demand in a given market.
Correct answer: c Explanation: The correct answer is c. Decentralization introduces geographic basis risk, which is unique to energies. In financial markets, todays dollar is worth a dollar anywhere in the country, while in energy markets, price depends on location. A megawatt of electricity is priced according to its delivery point; the same holds true for natural gas. Location therefore, is a fundamental driver of price. Reading reference: Geman, Commodities and Commodity Derivatives: Modeling and Pricing for Agriculture, Metals and Energy, Chapter 1
2.
On July 20, Merg Refining knows it will need to purchase 20,000 barrels of crude in November. On NYMEX, oil futures contracts are traded for delivery every month. Thus, Merg decides to hedge using a mid-December contract. The futures price on July 20 is USD 60.00/bbl. On November 12, Merg is ready to purchase their needed crude and closes out its futures contract on that day; at this time the spot price is USD 62.00/bbl and the futures price is USD 61.10/bbl. In this scenario, the effective price paid per barrel is: a. b. c. d. USD USD USD USD 61.10 60.90 62.10 62.90
Correct answer: b Explanation: The effective price paid (in dollars per barrel) is the final spot price less the gain on the futures, or: 62.00 1.10 = 60.90 This can also be calculated as the initial futures price plus the final basis: 60.00 + 0.90 = 60.90 Reading reference: Geman, Commodities and Commodity Derivatives, chapter 1.
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3.
You are estimating VaR for an energy portfolio that includes derivative positions. Due to a recent political event, you expect unprecedented volatility in the energy markets in the coming days. Given this situation, which would be preferred method to use to determine VaR? a. b. c. d. Delta Normal Historical simulation Monte Carlo simulation Deterministic model
Correct answer: c Explanation: Monte Carlo simulation is the correct answer. Monte Carlo simulations can also be used in option price valuation. This technique simulates either the underlying market prices or the option underlying prices at the time of option expirationit is an excellent pricing technique, as all the complexities of multivariable markets can be factored in. A delta normal model cannot handle assets with non-linear payoff functions, and using a historical simulation is not advisable as unprecedented volatility is expected. A deterministic model would also not be used to calculate VaR since a deterministic model is a more general class of models, and deterministic models do not incorporate the potential for randomness in general. Reading reference: Clewlow and Strickland, Energy Derivatives: Pricing and Risk Management, chapter 10.
4.
On January 1, a European-type call option for WTI crude with a strike price of USD 60/bbl and an expiration date of July 1 is priced at USD 3.90 per barrel. At the same time, July WTI futures are priced at USD 55/bbl. The risk free interest is 8% per annum. The price of a WTI European Put option with a strike of USD 60/bbl and matures in 6 months would be closest to: a. b. c. d. USD USD USD USD 5.70 6.70 7.70 8.70
Correct answer: d Explanation: This question relates two conceptsput-call parity and the relationship between the price of the physical commodity and its representation as a commodity futures contract. The spot price of a commodity, S(t), is widely considered as the most important indicator of future spot prices and such acts as the chief factor determining the shape of the futures price curve. At maturity, the price of the physical, underlying, commodity and the financial commodity future, F(t,T) should be equal to preclude arbitrage. Because of the equilibrium assumption, the convergence of physical and financial prices holds true, which at expiration at time (T) can be expressed as F(t, T) = S(T) Up to expiration (i.e., where t<T) the equilibrium relationship between the spot price and the price of the futures contract can be expressed by the well-known cost-of-carry relationship:
[r(t)+c(t)-y(t)](T-t)
F(t, T) = S(t)e
where: r(t) is the risk-free rate at time t, c(t) are the general storage, warehousing and other, similar, costs associated with holding the physical commodity in storage, and y(t) is the convenience yield earned from having the physical commodity in possession. The above relationship implies that the current price of the commodity is: USD 52.84, or 55 * e-0.04, assuming that storage costs are zero and there is no convenience yield. The traditional put-call parity can be expanded to include the futures contract as the underlying, and reads: C(t,T) P(t,T) = S(t) K(T) e-r(t)*(T-t), where K(T) is the strike price, S(t) is the current price of the underlying, and C(t,T) and P(t,T) are the prices of the call and put option respectively, at time t with a strike price of K(T). The current price of the underlying, S(t), WTI, is not given. Substituting in the put-call parity relation yields: 3.90 P(t,T) = 55 * e(-0.08 x 0.5) 60 e(-0.08 x 0.5) Which when solved for P gives USD 8.70. Reading reference: Geman, Commodities and Commodity Derivatives, Chapter 2, p. 10-11, 15-16
5.
Jean-Claude is the operator of a 100MW natural gas-fired power plant. He has just performed a spark spread calculation and has gotten a negative result. What should Jean-Claude do given the current economics of power production indicated by his spark spread calculation? a. b. c. d. Perform the calculation again since spark spreads cannot yield negative values. Switch to a lower-cost fuel that will allow the plant to run profitably. Modernize the generation equipment at the plant to make it more efficient. Stop power production until electricity rates rise to a point where he can sell power profitably.
Correct answer: d Explanation: The correct answer is d. Jean-Claude is most likely to simply shut the plant off until the electric rates rise to a point where he can sell his power profitably, making answer d correct. Spark spread calculations can yield negative values; and while answers b and c would change the inputs for the spark spread calculation, which may then give a positive value, neither may be a practical course of action nor can either action be done as quickly as can the decision to shut the power plant down temporarily. Reading reference: Davis Edwards, Energy Trading and Investing, Chapter 4.3, page 274
6.
The 3-month forward price for home heating oil is USD 3.50 per gallon a price that you view as being too high given that the spot price is USD 3.10 per gallon. If the monthly storage cost for heating oil is USD .02 per gallon and the annual risk-free interest rate is 6%, what is the cash and carry arbitrage profit per gallon that can be realized 3 months from today? a. b. c. d. USD 0.25 USD 0.29 USD 0.34 There is no arbitrage profit available in this situation.
Correct answer: b Explanation: The correct answer is b. This is a proper application of the concept of cash and carry arbitrage the forward is too high, so we buy the spot and short the forward. All other answers are incorrect. FV of Spot = 3.10*(1.015113) = 3.1470 FV of Storage = .02 + .02(1.00501) + .02(1.01005) = .0603 Total FV = 3.21 Forward Price of 3.50 > FV of Spot (including storage) 3.21 Arbitrage profit by selling forward short = .29 Reading reference: McDonald, Fundamentals of Derivatives Markets, Chapter 6.
7.
Which of the following process steps related to LNG is a part of the LNG train? a. b. c. d. Pipeline transport of natural gas from the production field to a liquefaction plant Removing impurities and cooling the natural gas until it becomes a liquid Shipping the LNG overseas to the destination port using an LNG tanker Regasification of the LNG at the destination port
Correct answer: b Explanation: The LNG train is the series of processes which take place at a liquefaction facility. These processes include the removal of impurities from the natural gas feedstock, liquefaction, and on-site storage of the LNG while it awaits transportation. Reading reference: Inkpen and Moffett, The Global Oil & Gas Industry: Management, Strategy and Finance, chapter 9, pp. 338-339.
8.
Emily Smith, ERP, manages the cost of jet fuel for a small charter airline company in the Northeastern United States. The company needs to hedge against anticipated increases in fuel costs in the coming six months. Due to the companys poor financial standing (it has limited ability to raise cash and its credit lines are very close to being completely drawn down), Emilys ability to reduce the impact of adverse price movements is largely limited. Given these constraints, which of the following alternatives could best mitigate the adverse effect of a significant increase in jet fuel prices? a. b. c. d. Buy out-of-money call options on jet fuel Buy in-the-money call options on jet fuel Enter into a long jet fuel futures position Enter into a long jet fuel forward position
Correct answer: a. Explanation: A long option strategy makes the most sense for this company. For companies with substantial credit risk, it is often much easier to buy options rather than sell options. This is because the option buyer normally pays the upfront premium one or two business days after transacting, and thus poses a far lower credit risk than an option seller, who does not settle his or her obligations until maturity (or upon early exercise). Given smaller credit exposure, companies of lesser credit-standing can normally transact on equal terms with top credits when they are pure options buyers. Furthermore, when comparing options to futures and forwards, futures and forwards (assuming they are margined) pose a potential collateral requirement in the future which would be a problem for the company in the example given its limited credit lines. No collateral is required in purchasing a long option position. In this scenario, an out-of-the-money call would be cheaper than an in-the-money call. Since an out-of-the-money call only protects against significant price movements, it would only offset a portion of a potential adverse movement in jet fuel prices. However, given the firms very limited access to cash, an out-of-the-money call would be preferable in this situation. Typical examples of companies using this kind of option strategy might be a privately owned shipping company which buys an OTC fuel oil cap as a hedge against an increase in bunker fuel prices, or a small charter airline that buys a jet fuel cap. Typically, these would settle in cash against the monthly average price of an appropriate index. Reading reference: Kaminski, Managing Energy Price Risk, Chapter 2, p. 67
9.
The spot price volatility of WTI crude is 0.3, or 30%, and the current spot price is USD 71.21. Assuming the return of WTI is normally distributed with zero drift, within what price range over the next year can the price of WTI be expected to trade 66% of the time? a. b. c. d. USD USD USD USD 45.57 - 96.85 49.85 - 94.18 49.85 - 92.57 45.57 - 94.96
Correct answer: c Explanation: Volatility roughly represents the percentage of the price range within which we can expect to see the prices 66% of the time. For example, if the spot price volatility is 0.1, or 10%, and if the spot price is currently USD 20, then over the next year we canvery roughlyexpect the price to be within the 18 to 22 range 66% of the time. In this case, USD 49.85 and USD 92.57 represent the plus/minus 30% volatility range from USD 71.21. Reading reference: Pilipovic, Energy Risk: Valuing and Managing Energy Derivatives, Chapter 8, p. 217
10.
How does the cost structure of a windpower facility compare to that of a conventional carbon-based plant such as a natural gas facility? a. b. c. d. Windpower Windpower Windpower Windpower is is is is more capital intensive and more fuel intensive than more capital intensive but less fuel intensive than a less capital intensive but more fuel intensive than a less capital intensive but more fuel intensive than a a conventional carbon-based plant. conventional carbon-based plant. conventional carbon-based plant. conventional carbon-based plant.
Correct answer: b Explanation: Wind power is much more capital intensive than conventional carbon-based plants due to the significant upfront cost of the turbine installation. According to the EWEA study, approximately 75% of the total cost of energy for a wind turbine is related to upfront capital costs associated with the installation and grid connection. However, once operational, the turbine has virtually zero fuel costs and only minor operating and maintenance (O&M) costs. This compares to a conventional plant, where 40-70% of the total cost of energy comes from fuel and O&M. Reading reference: European Wind Energy Association, The Economics of Wind Energy, p. 29.
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Creating a culture of risk awareness.
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About GARP | The Global Association of Risk Professionals (GARP) is a not-for-prot global membership organization dedicated to preparing professionals and organizations to make better informed risk decisions. Membership represents over 150,000 Members and Aliates from banks, investment management rms, government agencies, academic institutions, and corporations from more than 195 countries and territories. GARP administers the Financial Risk Manager (FRM) and the Energy Risk Professional (ERP) Exams; certications recognized by risk professionals worldwide. GARP also helps advance the role of risk management via comprehensive professional education and training for professionals of all levels. www.garp.org.
2013 Global Association of Risk Professionals. All rights reserved. 12-17-12

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2013

ERP Examination Sample Questions

Energy Risk Professional (ERP ) Examination

Energy Risk Professional Examination (ERP) Sample Questions

Energy Risk Professional Examination (ERP) Sample Questions

Energy Risk Professional Examination (ERP) Sample Questions

Energy Risk Professional Examination (ERP) Sample Questions

Energy Risk Professional Examination (ERP) Sample Questions

Energy Risk Professional Examination (ERP) Sample Questions

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Creating a culture of risk awareness.

2013 Global Association of Risk Professionals. All rights reserved. 12-17-12

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