2010 GARP ERP Sample Questions

GLOBAL ASSOCIATION OF RI S K P R O F E S S I O N A L S
Energy Risk
Professional (ERP)
Sample
Questions
2010
ENERGY RISK PROFESSIONAL SAMPLE QUESTIONS
This document contains twenty (20) sample questions that model the
The ERP Examination is a comprehensive assessment, testing risk profes-
temperament of those that will be presented on the October 2010 Energy
sionals on a number of energy-related risk management concepts and
Risk Professional (ERPTM) examination.
approaches. One should note that it is very rare that an energy risk
professional will be faced with an issue that can immediately be slotted
All candidates are advised to closely review the 2010 ERP Study Guide for
into one category; in the real world, an energy risk professional must be
the primary and subtopics that will be covered in the October 2010 ERP
able to identify any number of risk-related issues and be able to manage
examination. As described in the 2010 ERP Study Guide, the examination
them effectively.
will cover physical operations and physical and financial markets for energy,
as well as risk management techniques in both areas. The topics selected by
Readings
the Energy Oversight Committee (EOC) reflect those that energy risk professionals working in practice today must master. The topics are reviewed
Questions for the ERP Examination are derived from the readings listed
yearly to ensure the ERP Examination is kept timely and relevant.
under each topic, which are outlined in greater detail with the 2010
ERP Study Guide. These readings were selected by the ERP EOC to assist
ERP Examination Approach
candidates in their review of the subjects covered by the examination.

It is strongly suggested that candidates review these readings in depth
The ERP is a practice-oriented examination. Its questions are derived from
prior to sitting for the examination.
a combination of science, industry practice, and theory, as well as realworld work experience. Candidates are expected to understand both
Sample Questions
physical and financial energy sectors, general and specific risk management
concepts and approaches, and how they are applied in an energy risk
This document contains a total of twenty (20) sample questions.
professionals day-to-day activities.
40% physical (8 questions total)

-
Two representative questions from each section
60% financial (12 questions total)

-
Two representative questions from each section
GARP, Global Association of Risk Professionals, Inc., 2010

It is illegal to reproduce this material in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc.
Energy Risk
Professional (ERP)
Sample
Questions
2010
2010 ERP SAMPLE QUESTIONS: CANDIDATE ANSWER SHEET
a.
b.
c.
a.
d.
1.
11.
2.
12.
3.
13.
4.
14.
5.
15.
6.
16.
7.
17.
8.
18.
9.
19.
10.
20.

b.
c.
d.
1. Which of these elements is an example of operational risk mitigation in oil drilling?

a.
b.
c.
d.
Regular testing for quality control

Soliciting public opinion on proposed drilling sites
Installation of a blowout preventer system
Ensuring the counter party in the lease agreement has sound credit
2. Which of the following statements regarding Value-at-Risk is false?

a.
b.
c.
d.
VaR assumes the portfolio does not change over time.

VaR is a single number measure of risk.
VaR does not estimate the absolute worst-case scenario.
VaR models are best used to predict future market behavior.
3. 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 $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 $62.00/bbl and the futures price is $61.10/bbl.
In this scenario, the effective price paid per barrel is
a.
b.
c.
d.
$61.10
$60.90
$62.10
$62.90
4. _____ risk in the natural gas market can be hedged with a _____.
a.
b.
c.
d.
Operational / futures contract

Counter-party / plain vanilla swap
Regulatory / letter of credit
Market price / forward contract

5. Which of the following are true for futures contracts?

I. As prices fluctuate, margin calls can be made any time.
II. Futures contracts are exchange traded derivatives.
III. To exit the commitment of a futures contract, a holder of a futures contract must sell the futures contract prior to the
settlement date.
IV. A holder of an option has the right, but not the obligation, to exercise that option, but the holder of a futures contract
has an obligation to fulfill the terms of the futures contract.
a.
b.
c.
d.
II, IV
II only
II, III, IV
I, III, IV
6. Given the following, simplified table of U.S. Gulf Coast refining margins at a given time, which is NOT true:
Light Crude
Medium Crude
Heavy Crude
Crude Price $/bbl

21.00
20.00
15.00
Simple
.10
(0.35)
(3.16)
Refining Margins$/bbl
Complex
.30
0.65
3.60
Very Complex
.35
1.52
4.60
a. Simple refineries break even more or less on light crude, but lose money handling heavier crudes.
b. Medium crudes are profitable in complex refineries but not in simple ones.
c. Complex refineries are highly profitable running heavy crude, but they may have difficulty competing for space against
very complex refineries running the same crude.
d. Heavy crude is too expensive and may have to come down in price to compete with medium and light crudes.
7. For the development of an off-shore drilling project, the _____ is the main determinant of cost.
a.
b.
c.
d.
basic engineering survey

reservoir type
cost associated with transporting equipment and bulk material
water depth

8. What measure of hedge effectiveness did FASB 133 recommend?

a.
b.
c.
d.
60/40 offset ratio

90/10 offset ratio
highly effective offset ratio
None of these
9. Taking into account a snapshot from the table below, one can calculate that the probability of a B2 rated bond defaulting in
the fourth year as _____, and survive until the end of year three is _____.
Default probability in %
Moodys Rating
B1
B2
B3
Caa1
a.
b.
c.
d.
1
4.680
7.1600
11.6200
17.3816
2
8.3800
11.6700
16.6100
23.2341
Year
3
11.5800
15.5500
21.0300
28.6386
4
13.8500
18.1300
24.0400
32.4788
5
16.1200
20.7100
27.0500
36.3137
2.58%; 84.45%
4.28%; 78.97%
5.91%; 71.36%
7.54%; 65.30%
10. Pipeline rates can be determined in a number of ways. The cost of alternative transportation method involves understanding
the rates charged by competing forms of transportation, including setting rates against costs of alternative forms of transportation such as ship, barge, rail, and truck. Considering the above mentioned method, if the cost of shipping 1,000 bbl of
crude from Tuscon, AZ to St. Louis, MO via truck is $25/bbl, and by rail is $21/bbl, all things being equal, an ideal charge on
a pipeline with existing capacity to transport 1,000 bbl should be:
a.
b.
c.
d.
$23.00 - $25.00/bbl
$19.50 - $21.00/bbl
$24.50 - $25.50/bbl
$21.00 - $22.50/bbl

11. Rank, in order of increasing costs, single investments of the liquefied natural gas chain.
a.
b.
c.
d.
Natural gas exploration; Receiving terminal; LNG ship; Liquefaction plant

LNG ship; Natural gas exploration; Liquefaction plant; Receiving terminal
Natural gas exploration; Liquefaction plant; LNG ship; Receiving terminal
Receiving terminal; LNG ship; Natural gas exploration; Liquefaction plant
12. Development of coal-to-liquid production plants in the United States is risky because
a.
b.
c.
d.
Technology to deal with concomitant carbon dioxide emissions have yet to be developed.
Coal is a relatively scarce resource in the U.S. and would require major transportation infrastructure investments.
U.S. operators have limited experience with gasifying American coal.
Coal-to-liquid technology is virtually non-existent in the U.S. and worldwide.
13. Which of the following is NOT a method for managing credit-risk exposure within energy markets?
a.
b.
c.
d.
Clearing OTC energy derivatives

Obtaining credit risk insurance
Purchasing commodity futures
Securing a financial guarantee via an Irrevocable Standby Letter of Credit
14. On January 1, a European-type call option for WTI crude with a strike price of $60/bbl and an expiration date of July 1 is
priced at $3.90 per barrel. At the same time, July WTI futures are priced $55/bbl. The risk free interest is 8% per annum.
The price of a WTI European Put option with a strike of $60/bbl and matures in 6 months is closest to:
a.
b.
c.
d.
$5.50
$6.50
$7.50
$8.50

15. You are trading in an electricity market, where the volatility of electricity generated by peak-period, gas fired plants is 28%
and increasing. What volatility would you then expect from electricity generated from baseload coal?
a.
b.
c.
d.
Greater than 28%

Less than 28%
Unknowable
Equal to 28%
16. Emily Smith, ERP, manages the cost of jet fuel for a small charter airline company in the Northeastern United States. The
company is struggling, and a significant consideration for the company is to hedge against anticipated increases in fuel
costs in the coming six months. Due to the companys poor financial standingit 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 at the money call options on jet fuel
Enter into a long jet fuel futures position
Enter into a long jet fuel forward position
17. Which of the following is NOT a main driver behind investments in alternative energy projects?
a.
b.
c.
d.
Labor disputes
Oil and natural gas prices
Tax incentives
Public sentiment
18. The spot price volatility of WTI crude is 0.3, or 30%, and the spot price is $71.21. Assuming the return of WTI is normally
distributed with zero drift, over the next year one can roughly expect the price of WTI to be _____ 66% of the time.
a.
b.
c.
d.
$45.57 - $96.85
$49.85 - $94.18
$49.85 - $92.57
$45.57 - $94.96

19. You are estimating VaR for an energy portfolio that includes derivative positions. Due to a recent political event, you expect
unprecedented volatility in energy markets in the coming days. Given this situation, which method would be preferred to
determine VaR?
a.
b.
c.
d.
Delta Normal
Historical simulation
Monte Carlo simulation
Deterministic model
20. The FERC and EPA Act of 2005 reasserts the Federal Energy Regulatory Commissions roles in all of the following EXCEPT:
a.
b.
c.
d.
Supervising financial practices and corporate governance in energy markets

Supporting the principle of competition in wholesale power markets
Strengthening regulatory powers to ensure fair competition and avoid consumer exploitation
Developing a stronger energy infrastructure

Energy Risk
Professional (ERP)
Sample
Questions
Answers and
Explanations
2010
1. Which of these elements is an example of operational risk mitigation in oil drilling?

a.
b.
c.
d.
Regular testing for quality control

Soliciting public opinion on proposed drilling sites
Installation of a blowout preventer system
Ensuring the counter party in the lease agreement has sound credit
Correct answer: c.
Reason: Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems, or
from external events. As another precaution against unusual and even catastrophic surges in wellbore pressure, every well
is fitted with a blowout preventer system, hence 3 is correct.
Reference: Leffler: Chapter 4, p. 59
a. is an example of quality control, hence incorrect.
b. is an example of mitigating legal or reputational risk, hence incorrect.
d. is an example of credit/counter party risk mitigation, hence incorrect.
2. Which of the following statements regarding Value-at-Risk is false?

a.
b.
c.
d.
VaR assumes the portfolio does not change over time.

VaR is a single number measure of risk.
VaR does not estimate the absolute worst-case scenario.
VaR models are best used to predict future market behavior.
Correct answer: d.
Reason: VaR uses some model of what constitutes normal market behavior. Since the future cannot be known (or there
would be no need to VaR) the model must be based on statistical assumptions for how the market will behave.
Reference: Leppard: Chapter 8, p. 195

11
3. 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 $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 $62.00/bbl and the futures price is $61.10/bbl.
In this scenario, the effective price paid per barrel is
a.
b.
c.
d.
$61.10
$60.90
$62.10
$62.90
Correct answer: b.
Reason: 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
Reference: James: Chapter 13, p. 263
4.
_____ risk in the natural gas market can be hedged with a _____.
a.
b.
c.
d.
Operational / futures contract

Counter-party / plain vanilla swap
Regulatory / letter of credit
Market price / forward contract
Correct answer: d.
Reason: If a forward contract is used to make or take delivery of the underlying commodity, then it has eliminated market
risk by locking in the price of the physical commodity. A long forward contract can effectively be closed out by selling a
contract for the same physical specification, location, volume and month before physical delivery commences; the mark-tomarket value of a forward contract tells us the value of doing so at the current market level.
Reference: Leppard: Chapter 4, p. 43
12

5. Which of the following are true for futures contracts?

I. As prices fluctuate, margin calls can be made any time.
II. Futures contracts are exchange traded derivatives.
III. To exit the commitment of a futures contract, a holder of a futures contract must sell the futures contract prior to the
settlement date.
IV. A holder of an option has the right, but not the obligation, to exercise that option, but the holder of a futures contract
has an obligation to fulfill the terms of the futures contract.
a.
b.
c.
d.
II, IV
II only
II, III, IV
I, III, IV
Correct answer: c.
Reason: II, III, and IV are true.
An energy derivative is a contract that is derived from an underlying energy related commodity. Such a contract may be an
agreement to trade a commodity at some future date, a futures contract being one example.
A futures contract is an obligation to either take or make delivery of a specified number of units (gallons, barrels, bushels,
ounces, etc.) of a given commodity at a specified time and location in the future.
Every contract is interchangeable, which is one of the preexisting conditions needed for a successful futures contract. The
existing contract is canceled out by an opposite transaction. If one sells it, one needs to buy to offset it. If one buys it, and
gets long, one needs to sell to offset it.
In any discussion of futures it is important to be aware that there are margin calls that need to be made immediately
and daily.
Reference: Beutel: Chapter 5, p. 48-50; Burger, Graeber and Schindlmayr: Chapter 2, p. 47, 51-2

13
6. Given the following, simplified table of U.S. Gulf Coast refining margins at a given time, which is NOT true:
Light Crude
Medium Crude
Heavy Crude
Crude Price $/bbl

21.00
20.00
15.00
Simple
.10
(0.35)
(3.16)
Refining Margins$/bbl
Complex
.30
0.65
3.60
Very Complex
.35
1.52
4.60
a. Simple refineries break even more or less on light crude, but lose money handling heavier crudes.
b. Medium crudes are profitable in complex refineries but not in simple ones.
c. Complex refineries are highly profitable running heavy crude, but they may have difficulty competing for space against
very complex refineries running the same crude.
d. Heavy crude is too expensive and may have to come down in price to compete with medium and light crudes.
Correct answer: d.
Reason: All of the above are true except for number four. In fact, the light crude may be too expensive and may have to
come down in price in order to compete with heavy crude.
Reference: Leffler: Chapter 20, p. 222
7. For the development of an off-shore drilling project, the _____ is the main determinant of cost.
a.
b.
c.
d.
basic engineering survey

reservoir type
cost associated with transporting equipment and bulk material
water depth
Correct answer: d.
Reason: The capital cost of developing an oil or gasfield may amount to several billion dollars. It is crucial that the key
parameters are identified and evaluated so that the project can be properly defined and its viability assessed, because some
of these parameters strongly influence the costs. Onshore, the nature of the terrain is the main determinant of costs.
Offshore it is the water depth, which may be conventional (to 300 m), deep (to 1500 m) or ultra-deep (over 1500 m).
A basic engineering survey represents about 2% of the technical costs of an off-shore drilling project, while transporting
equipment and bulk material represents about 7.5% of the total cost. Reservoir parameters determine the number of wells
required, and whether water or gas injection will be needed during the lifetime of the field.
Reference: Editions Technip: Chapter 4, p. 135-7
14

8. What measure of hedge effectiveness did FASB 133 recommend?

a.
b.
c.
d.
60/40 offset ratio

90/10 offset ratio
highly effective offset ratio
None of these
Correct answer: c.
Reason: FASB has chosen to use a highly effective offset ratio as a measure of hedge effectiveness, rather than
specifying a numeric ratio.
If the fair value hedge is fully effective, the gain or loss on the hedging instrument, adjusted for the component, if any, of
that gain or loss that is excluded from the assessment of effectiveness under the entitys defined risk management strategy
for that particular hedging relationship (as discussed in paragraph 63 in Section 2 of Appendix A), would exactly offset the
loss or gain on the hedged item attributable to the hedged risk. Any difference that does arise would be the effect of hedge
ineffectiveness, which consequently is recognized currently in earnings. The measurement of hedge ineffectiveness for a
particular hedging relationship shall be consistent with the entitys risk management strategy and the method of assessing
hedge effectiveness that was documented at the inception of the hedging relationship, as discussed in paragraph 20(a).
Nevertheless, the amount of hedge ineffectiveness recognized in earnings is based on the extent to which exact offset is
not achieved. Although a hedging relationship must comply with an entitys established policy range of what is considered
highly effective pursuant to paragraph 20(b) in order for that relationship to qualify for hedge accounting, that compliance does not assure zero ineffectiveness. Section 2 of Appendix A illustrates assessing hedge effectiveness and measuring
hedge ineffectiveness. Any hedge ineffectiveness directly affects earnings because there will be no offsetting adjustment of
a hedged items carrying amount for the ineffective aspect of the gain or loss on the related hedging instrument.
Reference: FASB 133, p.18-19

15
9. Taking into account a snapshot from the table below, one can calculate that the probability of a B2 rated bond defaulting in
the fourth year as _____, and survive until the end of year three is _____.
Default probability in %
Moodys Rating
1
B1
4.680
B2
7.1600
B3
11.6200
Caa1
17.3816
a.
b.
c.
d.
2
8.3800
11.6700
16.6100
23.2341
Year
3
11.5800
15.5500
21.0300
28.6386
4
13.8500
18.1300
24.0400
32.4788
5
16.1200
20.7100
27.0500
36.3137
2.58%; 84.45%
4.28%; 78.97%
5.91%; 71.36%
7.54%; 65.30%
Correct answer: a.
Reason: The unconditional default probability of a B2 rated bond in year four is calculated as 18.13 15.55 = 2.58%.
The probability the bond will survive to end of year three is calculated as 100 15.55 = 84.45%. Each probability
represents a cumulative default probability or the probability of default by that year.
Reference: Burger: Chapter 6, p. 269-70
16

10. Pipeline rates can be determined in a number of ways. The cost of alternative transportation method involves understanding
the rates charged by competing forms of transportation, including setting rates against costs of alternative forms of transportation such as ship, barge, rail, and truck. Considering the above mentioned method, if the cost of shipping 1,000 bbl of
crude from Tuscon, AZ to St. Louis, MO via truck is $25/bbl, and by rail is $21/bbl, all things being equal, an ideal charge on
a pipeline with existing capacity to transport 1,000 bbl should be:
a.
b.
c.
d.
$23.00 - $25.00/bbl
$19.50 - $21.00/bbl
$24.50 - $25.50/bbl
$21.00 - $22.50/bbl
Correct answer: b.
Reason: The cost of alternative transportation method involves understanding the rates charged by the competing forms
of transportationship, barge, rail, truck. The pipeline charge will be set equal to or slightly below those rates. Calculating
rates using this method can be very favorable for the pipeline owner, especially for long-distance transportation.
EOG Resources has paid as much as $25/bbl to ship crude by truck, but have switched to rail because this cost is just
uneconomical (Reuters: March 12, 2009).
Reference: Miesner and Leffler: Chapter 10, p. 221
11. Rank, in order of increasing costs, single investments of the liquefied natural gas chain.
a.
b.
c.
d.
Natural gas exploration; Receiving terminal; LNG ship; Liquefaction plant

LNG ship; Natural gas exploration; Liquefaction plant; Receiving terminal
Natural gas exploration; Liquefaction plant; LNG ship; Receiving terminal
Receiving terminal; LNG ship; Natural gas exploration; Liquefaction plant
Correct answer: a.
Reason: The heart of an LNG project and the largest single investment in the chain is the liquefaction plant. Figure 3-2 on
page 84 illustrates break-even costs for a greenfield LNG project off the U.S. east coast.
Reference: Tusiani: Chapter 3, p. 67-86

17
12. Development of coal-to-liquid production plants in the United States is risky because
a.
b.
c.
d.
Technology to deal with concomitant carbon dioxide emissions have yet to be developed.
Coal is a relatively scarce resource in the U.S. and would require major transportation infrastructure investments.
U.S. operators have limited experience with gasifying American coal.
Coal-to-liquid technology is virtually non-existent in the U.S. and worldwide.
Correct answer: c.
Reason: CTL production based on FT or MTG synthesis is ready for commercial development in the United States. There
is, however, some risk that first-of-a-kind FT or MTG CTL plants could experience severe performance shortfalls or other
operational problems, especially during their initial operating years. This risk stems from the limited commercial experience
in gasifying U.S. coals and the challenges associated with building a plant that is very large, highly integrated, and
technically complex.
Reference: Bartis, et al: Chapter 3, p. 41
13. Which of the following is NOT a method for managing credit-risk exposure within energy markets?
a.
b.
c.
d.
Clearing OTC energy derivatives

Obtaining credit risk insurance
Purchasing commodity futures
Securing a financial guarantee via an Irrevocable Standby Letter of Credit
Correct answer: c.
Reason: Methods for managing credit-risk exposure include: master netting; collateralization; financial guarantees; credit
insurance; credit derivatives; assignment; and clearing OTC energy derivatives. The purchase of commodity futures is a
hedging strategy.
Reference: James: Chapter 16, p. 319-21
18

14. On January 1, a European-type call option for WTI crude with a strike price of $60/bbl and an expiration date of July 1 is
priced at $3.90 per barrel. At the same time, July WTI futures are priced $55/bbl. The risk free interest is 8% per annum. The
price of a WTI European Put option with a strike of $60/bbl and matures in 6 months is closest to:
a.
b.
c.
d.
$5.50
$6.50
$7.50
$8.50
Correct answer: d.
Reason: This question relates two conceptsthe put 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:
F(t, T) = S(t)e[r(t)+c(t)-y(t)](T-t) ,
where, r(t) is the risk-free rate at 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 $52.84, 55 * exp(-0.04) = $52.84,
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) ,
K(T) the strike price, S(t) the current price of the underlying, and C(t,T) and P(t,T) the prices of call and put option
respectively, at 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 $8.70.
Reference: Geman: Chapter 2, p. 10-11, 15-16

19
15. You are trading in an electricity market, where the volatility of electricity generated by peak-period,
gas fired plants is 28% and increasing. What volatility would you then expect from electricity
generated from baseload coal?
a.
b.
c.
d.
Greater than 28%

Less than 28%
Unknowable
Equal to 28%
Correct answer: b.
Reason: The question implies the reader understands that in all likelihood the baseload material used for electricity
generation is coal (see below), and that natural gas trades higher than coal. In this case, baseload coal is being used to
provide a constant energy and natural gas is being used to supplement peak load energy demands.
Of all the fossil fuels, coal is the most widely used. According to the EIA, during 2004, 50% of the nations electric power
was generated at coal-fired plants. Based upon 2004 net generation shares by energy source, nuclear and natural gas are
next in popularity after coal.
While base load is constant and fairly predictable, electric utilities must be prepared at all times for the sometimes unpredictable demand seasonal weather changes cause. An increase in demand is referred to as peak load and intermediate load.
Reference: Warkentin-Glenn: chapter 1, p. 10, 17
20

16. Emily Smith, ERP, manages the cost of jet fuel for a small charter airline company in the Northeastern United States.
The company is struggling, and a significant consideration for the company is to hedge against anticipated increases in
fuel costs in the coming six months. Due to the companys poor financial standingit 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 at 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.
Reason: There are some companies whose credit risk is such that it is much easier for them 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 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. With limited credit lines, 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.
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.
In this scenario, an out-of-the-money call should be cheaper than an at-the-money call. On the other hand, it only protects
against significant price movements, and even then only a small portion of the adverse movement's negative effects will be
offset.
For a futures position, the cash outlay would be smaller for the option than the futures margin position
To trade forward, you should need to post collateral or reduce counterparty credit risk for the other party.
Reference: Kaminski: Chapter 2, p. 67

21
17. Which of the following is NOT a main driver behind investments in alternative energy projects?
a.
b.
c.
d.
Labor disputes
Oil and natural gas prices
Tax incentives
Public sentiment
Correct answer: a.
Reason: The following items, while not comprehensive, serve as a good starting point for understanding alternative energy
drivers: oil and natural gas prices; taxes, politics, and regulations; geopolitical environment; technological advancements;
supply chain costs; and sentiment.
Reference: Fisher Investments: Chapter 6, p. 167-8
18. The spot price volatility of WTI crude is 0.3, or 30%, and the spot price is $71.21. Assuming the return of WTI is normally
distributed with zero drift, over the next year one can roughly expect the price of WTI to be _____ 66% of the time.
b.
b.
c.
d.
$45.57 - $96.85
$49.85 - $94.18
$49.85 - $92.57
$45.57 - $94.96
Correct answer: c.
Reason: 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 $20, then over the next
year we canvery roughlyexpect the price to be within the $18 to $22 range 66% of the time.
For this problem, $49.85 and $92.57 represent the plus/minus 30% volatility range off of $71.21.
Reference: Pilopovic: Chapter 8, p. 217
22

19. You are estimating VaR for an energy portfolio that includes derivative positions. Due to a recent political event, you expect
unprecedented volatility in energy markets in the coming days. Given this situation, which method would be preferred to
determine VaR?
a.
b.
c.
d.
Delta Normal
Historical simulation
Monte Carlo simulation
Deterministic model
Correct answer: c.
Reason:
a. Delta Normal would not work because there are assets with non-linear payoff functions, hence I incorrect.
b. Historical simulation would not work because unprecedented volatility is expected, hence incorrect.
c. Monte Carlo simulation is the only justifiable 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.
d. Deterministic model is invented, hence incorrect.
Reference: Pilopovic: Chapter 9, p. 265
20. The FERC and EPA Act of 2005 reasserts the Federal Energy Regulatory Commissions roles in all of the following EXCEPT:
a.
b.
c.
d.
Supervising financial practices and corporate governance in energy markets

Supporting the principle of competition in wholesale power markets
Strengthening regulatory powers to ensure fair competition and avoid consumer exploitation
Developing a stronger energy infrastructure
Correct answer: a.
Reason: Supervising financial practices and corporate governance are powers granted under the Sarbanes-Oxley Act of
2002 and applies to all corporations and industries, not just those in energy markets.
Reference: FERP & EPA Act 2005

23
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risk awareness.TM
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Risk Professionals
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2010 GARP ERP Sample Questions

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2010 GARP ERP Sample Questions

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GLOBAL ASSOCIATION OF RI S K P R O F E S S I O N A L S

ENERGY RISK PROFESSIONAL SAMPLE QUESTIONS

The ERP Examination is a comprehensive assessment, testing risk profes-

temperament of those that will be presented on the October 2010 Energy

sionals on a number of energy-related risk management concepts and

Risk Professional (ERPTM) examination.

able to identify any number of risk-related issues and be able to manage

examination. As described in the 2010 ERP Study Guide, the examination

yearly to ensure the ERP Examination is kept timely and relevant.

ERP Examination Approach

candidates in their review of the subjects covered by the examination.

The ERP is a practice-oriented examination. Its questions are derived from

prior to sitting for the examination.

This document contains a total of twenty (20) sample questions.

professionals day-to-day activities.

40% physical (8 questions total)

Two representative questions from each section

60% financial (12 questions total)

Two representative questions from each section

GARP, Global Association of Risk Professionals, Inc., 2010

ENERGY RISK PROFESSIONAL SAMPLE QUESTIONS

2010 ERP SAMPLE QUESTIONS: CANDIDATE ANSWER SHEET

GARP, Global Association of Risk Professionals, Inc., 2010

ENERGY RISK PROFESSIONAL SAMPLE QUESTIONS

1. Which of these elements is an example of operational risk mitigation in oil drilling?

Regular testing for quality control

2. Which of the following statements regarding Value-at-Risk is false?

VaR assumes the portfolio does not change over time.

Operational / futures contract

GARP, Global Association of Risk Professionals, Inc., 2010

ENERGY RISK PROFESSIONAL SAMPLE QUESTIONS

5. Which of the following are true for futures contracts?

Crude Price $/bbl

basic engineering survey

GARP, Global Association of Risk Professionals, Inc., 2010

ENERGY RISK PROFESSIONAL SAMPLE QUESTIONS

8. What measure of hedge effectiveness did FASB 133 recommend?

60/40 offset ratio

GARP, Global Association of Risk Professionals, Inc., 2010

ENERGY RISK PROFESSIONAL SAMPLE QUESTIONS

Natural gas exploration; Receiving terminal; LNG ship; Liquefaction plant

Clearing OTC energy derivatives

GARP, Global Association of Risk Professionals, Inc., 2010

ENERGY RISK PROFESSIONAL SAMPLE QUESTIONS

Greater than 28%

Buy out of money call options on jet fuel

GARP, Global Association of Risk Professionals, Inc., 2010

ENERGY RISK PROFESSIONAL SAMPLE QUESTIONS

Supervising financial practices and corporate governance in energy markets

GARP, Global Association of Risk Professionals, Inc., 2010

ENERGY RISK PROFESSIONAL SAMPLE QUESTIONS

1. Which of these elements is an example of operational risk mitigation in oil drilling?

Regular testing for quality control

2. Which of the following statements regarding Value-at-Risk is false?

VaR assumes the portfolio does not change over time.

GARP, Global Association of Risk Professionals, Inc., 2010

ENERGY RISK PROFESSIONAL SAMPLE QUESTIONS

Operational / futures contract

GARP, Global Association of Risk Professionals, Inc., 2010

ENERGY RISK PROFESSIONAL SAMPLE QUESTIONS

5. Which of the following are true for futures contracts?

GARP, Global Association of Risk Professionals, Inc., 2010

ENERGY RISK PROFESSIONAL SAMPLE QUESTIONS

Crude Price $/bbl