Practice Exam 1
Questions 9- 10 use the information below:
A credit analyst at a regional commercial bank has been asked to assess the credit fundamentals related to four different energy companies. To complete the analysis the analyst has assembled the following data from the most recently published balance sheet for each entity:
Balance Sheet (in Millions USD) Company A Company B Company C Company D
Cash 1,675 5,643 7,610 15,376
Short-term investments 1,767 8,259 5,659 5,297
Accounts receivable 888 1,337 4,296 6,489
Inventory 4,467 21,785 2,145 45,832
Total current assets: 8,797 37,024 19,710 72,994
Property, plant and equipment 13,370 17,812 3,899 27,432
Total assets 22,167 54,836 23,609 100,426
Total current liabilities 5,770 12,893 4,252 48,659
Long term debt 10,000 15,555 3,210 0
Total liabilities 16,770 28,448 7,462 48,659
Total shareholder equity 6,397 26,388 16,147 51,767
9. Using the Quick Ratio as a guideline, which company has the highest relative short-term liquidity risk?
a. Company A b. Company B c. Company C d. Company D
Correct answer: d
Explanation: The Quick Ratio is a more conservative form of the Current Ratio which assumes that a firm will not be able to easily liquidate its inventory, and in a crisis that a firm will not get full market value for its inventory. Hence it is a measure of the liquid assets a firm has available to pay back its current obligations.
The formula for the Quick Ratio is as follows:
Current assets−Inventory Current Liabilities
In this case, Company D has the lowest Quick Ratio, at (72,994 – 45,832) / 48,659, or 0.52. This is because most of Company D’s current assets are held as inventory, which is not easily liquidated.
The Quick Ratios for companies A, B and C are 0.86, 1.18, and 4.13 respectively.
Reading reference: Betty Simkins and Russell Simkins, eds. Energy Finance and Economics: Analysis and
10. Which of the following relationships will provide the best measure of financial leverage used by each company?
a. Total Liabilities Total Shareholder Equity b. Long Term Debt
Total Current Assets c. Long Term Assets
Total Current Liabilities
d. Total Liabilities−Long Term Debt Total Assets
Correct answer: a
Explanation: One of the most important debt management ratios is the debt/equity ratio, which assesses the financial leverage of the firm by comparing its level of debt financing to its total net worth. This is expressed as Total liabilities/Total net worth, where total net worth is equal to the firm’s total shareholder equity.
Reading reference: Betty Simkins and Russell Simkins, eds. Energy Finance and Economics: Analysis and Valuation,Risk Management, and the Future of Energy, Chapter 9, page 200.
11. Coastal Petroleum (CP) operates refineries at strategic locations along the east and west coasts of Canada.
After consulting with the finance team, the risk management group implements a strategy to hedge market risk using crack spreads.
Use the following NYMEX futures data to price the November RBOB futures contract based on a 3:2:1 crack spread valued at USD 24.30/bbl.
• November WTI futures price: USD 103.60/bbl
• November Heating Oil futures price: USD 3.43/gal
a. USD 1.96/gal b. USD 2.85/gal c. USD 3.21/gal d. USD 3.70/gal Correct answer: b
Explanation: The correct answer is b. A 3:2:1 crack spread is three barrels of crude oil to two barrels of
gaso-12. Consider an African nation that exports domestically-produced crude oil. The crude has an API of 36° and a sulfur content of 0.73%. What best describes the pricing of the country’s crude oil exports assuming the London ICE Brent futures contract is used as the benchmark price?
a. Domestically produced crude oil should be priced at a discount to the Brent crude oil contract.
b. Domestically produced crude oil should be priced at parity to the Brent crude oil contract.
c. Domestically produced crude oil should be priced at a premium to the Brent crude oil contract.
d. Domestically produced crude oil and Brent crude have little correlation making the Brent futures contract a poor benchmark.
Correct answer: a
Explanation: Benchmark crudes serve as a pricing standard against which the value of other crude oils can be set. This crude oil would be classified as intermediate crude with a sulfur level slightly higher than Brent, mak-ing it likely to sell at a small discount to Brent.
Reading reference: Bassam Fattouh, An Anatomy of the Crude Oil Pricing System (The Oxford Institute for Energy Studies).
13. A local utility company contracts to purchase one hour of load from the grid in the day-ahead market under the following terms:
• 250 MW @ USD 52/MWh
What net settlement payment is required from the RTO under a contract for differences (CfD), assuming the spot market price for electricity is USD 70/MWh and the actual load for the utility is 300 MW for the con-tracted hour?
Explanation: The correct answer is d. Under a CfD market agreement, the amount beyond the contracted vol-ume is settled at the spot market price; in this case 50 MWh (300MW-250MW) at USD 70/MWh, or USD 3,500. The other 250 MW are paid for at the rate of USD 52/MWh as specified in the nominated contract and are not part of the CfD settlement.
a - (70-52)*50 b - (50*52)
c - [(52+70)/2]*50.
Reading reference: Steven Stoft, Power System Economics: Designing Markets for Electricity, Chapter 5.3, Congestion Pricing Fundamentals; Chapter 5.4, Congestion Pricing Method.
14. Use the daily high and low temperatures below to calculate Cooling Degree Days (CDD) for the following period:
High Low Average
Temperature Temperature Temperature
71°F 62°F 66.5°F
75°F 63°F 69.0°F
72°F 65°F 68.5°F
69°F 67°F 68°F
64°F 61°F 62.5°F
65°F 59°F 62°F
64°F 58°F 61°F
a. 9.5 b. 12 c. 14.5 d. 17
Correct answer: b
Explanation: The correct answer is b. Cooling Degree Days are the difference between the daily average tem-peratures and 65°F, as long as the average temperature is greater than 65 degrees. If the average temperature is 65 degrees or less on a given day then the CDDs for that day are zero. The average temperatures for this week are: 66.5, 69, 68.5, 68, 62.5, 62 and 61, for a total of 12 CDDs for the week.
Reading reference: Robert McDonald, Derivatives Markets, 3rd Edition, Chapter 6.
15. Assuming the correlation between Brent Crude Oil and Newcastle Coal is zero, what is the probability that Brent Crude Oil and Newcastle Coal prices will both increase more than 2% on a given day given the following probabilities:
• P [Brent Crude Oil price increases more than 2%]: 40%
• P [Newcastle Coal price increases more than 2%]: 15%
a. 6%
b. 9%
c. 11%
d. 55%
Correct answer: a
Explanation: Correct answer is a. The joint probability of two independent events represents the product of the probabilities for each independent outcome. In this case the joint probability is represented by P[B] * P[D] or 6%
B is incorrect: 9% = (P[B] + P[D])/P[B] * P[D]) C is incorrect: 11% = (P[B] * P[D])/P[B] + P[D] D in incorrect: 55% = P[B] + P[D]
Reading reference: Michael Miller. Mathematics and Statistics for Financial Risk Management. Chapter 2, page 27-28.
16. A hydroskimming refinery in South America uses the daily Brent crude oil spot price as a benchmark reference for its crude oil feedstock. Assuming the spot Brent price is USD 113.29/bbl, the refinery would most likely purchase which of the following crudes?
a. Canadian Oil Sands (bitumen) at USD 78.06/bbl b. Mexico Mayan Heavy at USD 101.30/bbl
c. West Texas Sour at USD 114.88/bbl d. Nigerian Bonny Light at USD 121.87/bbl
Correct answer: d
Explanation: The correct answer is d. The refinery is described as a hydroskimming facility making it a “simple”
refinery. Therefore it will yield the most gasoline by refining a light, sweet crude, which is choice d, even though Bonny Light is being offered at a premium to Brent (which it typically is). West Texas Sour is a medium weight oil that will require additional processing to remove the sulfur impurities, while the yield from the heavy Mayan crude will seriously reduce the amount of gasoline produced, both of which will negate the discount offered for these crudes. It is unlikely the refinery would even be able to process the raw Canadian bitumen.
Reading reference: William L. Leffler. Petroleum Refining in Nontechnical Language, 3rd Edition, Chapter 20.
17. Why is the time required for physical settlement of energy commodities typically longer than financially settled transactions?
a. Higher SDR reporting requirements b. Longer re-margining periods c. Lower liquidity
d. More frequent reconciliations
Correct answer: d
Explanation: There are longer settlement times for physically settled commodities because of a greater amount of potential reconciliations. Reconciliation has to wait until the transportation statements come in, and in cases where the actual delivery volume is different than the contracted volume (due to losses during transportation), a “true up” or “actualization” might have to be made. Physical futures typically settle on the 20th or 25th day, while financial derivatives settle on the 5th or 10th day.
Reading reference: ISDA, OTC Commodity Derivatives Trade Processing Lifecycle Events, pages 15-16.
18. Based on the following historical weekly price return data, what is the best estimate of annual volatility on the SP15 on-peak power futures contract?
Time Period Average Weekly Return (Log of
Price (USD/MWh) Price Changes)
Week 1 97.50
Week 2 95.00 -0.0260
Week 3 116.95 0.2079
Week 4 101.15 -0.1451
Variance 97.26 0.0323
Standard Deviation 9.86 0.1796
a. 23.3%
b. 61.6%
c. 129.5%
d. 135.5%
Correct answer: c
19. What is meant by the term “stranded gas”?
a. A gas deposit that cannot be commercially developed due to an ownership dispute.
b. A gas deposit located in a region with low demand and no access to transport or export facilities.
c. The volume of gas required after extraction to maintain operating pressure at an underground storage facility.
d. The volume of gas related to a default in a take-or-pay contract.
Correct answer: b
Explanation: The correct answer is b. Stranded gas is a term used to refer to any deposits of natural gas located in areas of low demand and/or without access to an export facility, such as a pipeline or LNG terminal.
The gas is said to be “stranded” since it cannot be brought to market, or no local market exists for it. Since pipelines and LNG terminals are capital intensive, much care must be used in evaluating the economic poten-tial of a “stranded” gas field. Note: choice “c” is the correct definition of “cushion gas”.
Reading reference: PriceWaterhouseCoopers. Today’s LNG Market Dynamics.
20. Which of the following depicts the relationship between the rated power of an onshore wind turbine and the prevailing wind speed?
Correct answer: b
Explanation: Correct answer is b. At low levels of wind speed the turbine has not reached its “cut-in” speed so does not produce any power at all. Once it reaches the cut in speed, the energy produced by the turbine increases slowly at first and then more and more quickly. Finally, at a certain wind speed (typically between 11 and 15 meters per second) the turbine reaches 100% of its rated power and continues to operate at that level
0 5 10 15 20
21. A risk manager at Krakov Airlines is analyzing changes in the EU Emissions Trading Scheme (ETS) program leading up to Phase III of the ETS. What action will Krakov be required to take to comply with the revised terms of the ETS?
a. No changes are required for Krakov to comply with the revised terms of the ETS.
b. Acquire allowances to cover its carbon emissions under the new terms of the ETS.
c. Install fuel-efficient engines in all its planes to comply with the new terms of the ETS.
d. Acquire LULUCF credits to comply with the new terms of the ETS.
Correct answer: b
Explanation: As part of the changes leading up to the implementation of Phase III of the EU ETS, the aviation industry was included for the first time in the ETS in 2012, the last year of Phase II. Therefore Krakov should acquire carbon allowances to cover its carbon emissions. LULUCF (land use, land-use change and forestry) credits are not acceptable to cover allowance requirements in the EU ETS program.
Reading reference: Larry Parker, “Climate Change and the EU Emissions Trading Scheme: Looking to 2020”.
22. How can Key Performance Indicators (KPIs) and Key Risk Indicators (KRIs) be applied to best achieve an organization’s risk management objectives?
a. Use KPIs exclusively to develop an effective forward looking assessment of trends in operational risk factors.
b. Integrate KPI objectives and KRI limits to create a single comprehensive risk-weighted metric.
c. Monitor KRIs to assess shifts in risk exposure and adjust business strategy and operational procedures to better meet return on risk objectives identified by KPIs.
d. Replace KPIs with KRIs and adjust company-wide risk capital allocations to account for the change in risk monitoring procedures.
Correct answer: c
Explanation: The correct answer is c. One problem with the use of KPIs for risk management is that they are backward-looking: they will only show how well the portfolio has met pre-determined goals. KRIs are an ongo-ing process of monitorongo-ing the portfolio performance to ensure that it stays within pre-determined risk measure-ments. Using them together as described in answer c is an effective risk-management strategy. Adjustments to the portfolio can be made in accordance to the KRIs that can ultimately help the portfolio reach the KPIs.
Reading reference: John Fraser and Betty Simkins, Enterprise Risk Management: Today’s Leading Research and Best Practices for Tomorrow’s Executives, Chapter 8, page 128.
23. Consider a European country that relies on the following mix of power generation sources to meet its domestic electricity requirements:
• Wind - 35%
• Gas - 30%
• Coal - 10%
• Nuclear - 20%
• Hydro - 5%
The national energy policy dictates that the country will actively expand its wind generation capacity. What best describes the economics of wind generation as it accounts for a larger portion of the country’s total domestic capacity?
a. High marginal costs and higher incremental balancing costs b. High marginal costs and lower incremental balancing costs c. Low marginal costs and higher incremental balancing costs d. Low marginal costs and lower incremental balancing costs
Correct answer: c
Explanation: The correct answer is c. Wind power has very low marginal cost given its high capital intensity and enters the merit order curve at a low level. However, given the intermittency of wind power production this will lead to higher balancing costs as more wind power enters the system.
Reading reference (new): IPCC, IPCC Special Report on Renewable Energy Sources and Climate Change Mitigation, Chapter 7: Wind Energy, pages 568, 583-588.
24. Calculate the difference in value between the 1-day 99% VaR and 1-day 95% VaR on the following position, assuming a normal distribution for daily price returns (round answer to nearest thousand)?
• December 2013 Brent Crude Oil Futures Contracts: 50
• Daily volatility: 1.92%
• Closing Brent Futures Price: USD 118.55
a. 71,000 b. 79,000 c. 107,000 d. 187,000
Correct answer: b
Explanation: The correct answer is b. The 99% VaR will use a confidence factor of 2.33 while the 95% VaR will use a confidence factor of 1.64. Therefore the 99% VaR is: 118.55 * 50 contracts * 0.0192 * 1000 barrels / contract * 2.33 = 265,172, while the 95% VaR is: 118.55 * 50 * 0.0192 * 1000 * 1.64 = 186,645. Hence the difference is 78,500. .
Reading reference: Allan Malz, Financial Risk Management: Models, History, and Institutions (Hoboken, NJ:
John Wiley and Sons, 2011), Chapter 3.
25. What perceived economic benefit would cause an oil refiner to prefer holding physical inventories of crude as an alternative to buying physical barrels of crude oil for future delivery, when crude oil futures prices are in backwardation?
a. Convenience yield b. Cost of carry
c. Mean reversion trends d. Seasonality
Correct answer: a
Explanation: The correct answer is a; convenience yield, a perceived benefit in some circumstances in holding physical stocks of a commodity rather than forward contracts for delivery in the future. The convenience yield is a factor that affects the formation of forward price curves for several energy commodities, particularly crude oil.
Reading reference: Vincent Kaminski, Energy Markets, Chapter 4.
26. Consider a long position in 100 NYMEX RBOB October 2012 futures contracts. The initial margin requirement is USD 2 million with a minimum margin balance of USD 1.5 million. Assume the account is open until
September 11 with no withdrawals. On what dates will additional margin need to be posted assuming the fol-lowing daily change in the value of the position?
Date RBOB (USD/gal) Gain/Loss per 100 contracts
September 4 4.05
September 5 3.89 -672,000
September 6 3.77 -504,000
September 7 3.79 84,000
September 10 3.62 -714,000
September 11 3.57 -210,000
a. September 5 b. September 5 and 6 c. September 5, 6 and 10 d. September 5, 6, 10 and 11
Correct answer: c
Explanation: Whenever the account incurs a loss bringing the balance below 1.5 million, a margin call will be incurred and the account will need to be brought back up to its initial margin requirement (not the maintenance level.)
Gain/Loss per Balance after Balance after any
Date 100 contracts Market Close Margin Call margin calls paid
September 4 2,000,000
September 5 -672,000 1,328,000 672,000 2,000,000
September 6 -504,000 1,496,000 504,000 2,000,000
September 7 84,000 2,084,000 - 2,084,000
September 10 -714,000 1,370,000 630,000 2,000,000
September 11 -210,000 1,790,000 - 1,790,000
Reading reference: IEA, “The Mechanics of the Derivatives Markets: What They Are and How They Function.”
(Special Supplement to the Oil Market Report, April 2011).
27. Calculate the spark spread for a combined cycle natural gas turbine plant based on the following assumptions:
• Average plant heat rate: 8,500 Btu/kWh
• Current price of natural gas: USD 5.00/MMBtu
• Current price of electricity: USD 30.00/MWh
a. USD 0.0125/kWh b. USD 0.1250/kWh c. USD -0.0125/kWh d. USD -0.1250/kWh
Correct answer: c
Explanation: Answer c is correct, the calculation for determining the spark spread in this scenario is as follows:
Spark Spread = Output Price – Input Price
Output Price = USD 30/MWh x 1MWh/1000kWh = USD 0.03/kWh
Input Price = 8500 Btu/kWh x USD 5/1,000,000Btu = USD 0.0425/kWh Therefore, the Spark Spread = -0.0125.
Reading reference: Vincent Kaminski, Energy Markets, Chapter 22, Analytical Tools.
28. What best describes the drift term in a single-factor, mean reverting model?
a. A deterministic variable that converges toward zero as the spot price moves closer to the forward price.
b. A deterministic variable that is highly correlated to the spread between the spot and forward price as the spot price moves closer to the forward price.
c. A stochastic variable that is highly correlated to the spread between the spot and forward price as the spot price moves closer to the long-term equilibrium price.
d. A stochastic variable that converges towards zero as the spot price moves closer to the long-term equilibrium price.
Correct answer: d
Explanation: The correct answer is d. In a single factor model the drift term is stochastic. As St approaches L, the drift term approaches zero and the time it takes for St to reach L tends to infinity (alternatively, St approaches L asymptotically).
29. What best explains the differentiation between risk appetite and risk tolerance?
a. Risk appetite is a willingness to embrace risk, while risk tolerance is an aversion to enduring risk.
b. Risk appetite expresses a range of risk levels an organization is willing to endure, while risk tolerance is a single definitive figure.
c. Risk appetite is a measure of how much risk an organization is willing to take on, while risk tolerance is used to communicate a level of acceptable risk.
d. Risk appetite cannot be derived empirically, while risk tolerance can.
Correct answer: c
Explanation: The correct answer is c; this is the correct definition of risk appetite and risk tolerance.
Reading reference: John Fraser and Betty Simkins, Enterprise Risk Management: Today’s Leading Research and Best Practices for Tomorrow’s Executives, Chapter 16, pages 287-289.
30. A credit risk analyst notices that data is missing from the following credit report:
Bond Name Koryo Energy
Exposure ?
Recovery rate 27%
Loss given default USD 4,506,700 Expected loss USD 3,372,800
What is the original exposure on the Koryo Energy bond position?
a. USD 4,620,270 b. USD 6,173,500 c. USD 12,491,800 d. USD 16,691,500
Correct answer: b
Explanation: The correct answer is b. Since Loss Given Default = Exposure * (1-recovery rate), then the exposure is equal to the LGD divided by (1-recovery rate). Therefore the original exposure on the position is 4,506,700 / (1-0.27) or approximately USD 6,173,500.
Reading reference: Allan Malz. Financial Risk Management, Models, History and Institutions, Chapter 6, pages 201 – 203.
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