Erp Practice Exam2 2015

2015

ERPPractice Exam 2

© 2015 Global Association of Risk Professionals. All rights reserved. It is illegal to reproduce this material iin any format without prior written approval of GARP, Global Association of Risk Professionals, Inc.

Energy Risk Professional Examination (ERP®) Practice Exam 2

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1

ERP Practice Exam 2 Candidate Answer Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3

ERP Practice Exam 2 Questions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5

ERP Practice Exam 2 Answer Sheet/Answers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17

ERP Practice Exam 2 Explanations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19

TABLE OF CONTENTS

© 2015 Global Association of Risk Professionals. All rights reserved. It is illegal to reproduce this material 1in any format without prior written approval of GARP, Global Association of Risk Professionals, Inc.


IntroductionThe ERP Exam is a practice-oriented examination. Its ques-

tions 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 man-

agement concepts and approaches and how they would

apply to an energy risk manager’s day-to-day activities.

The ERP Examination is also a comprehensive examina-

tion, 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 and be able to deal with them

effectively.

The ERP Practice Exam 2 has been developed to aid

candidates in their preparation for the ERP Examination.

This practice exam is based on a sample of actual questions

from past ERP Examinations and is suggestive of the ques-

tions that will be in the 2015 ERP Examination.

The ERP Practice Exam 2 contains 25 multiple choice

questions. The 2015 ERP Examination will consist

of a morning and afternoon session, each containing 70

multiple choice questions. The practice exam is designed to

be shorter to allow candidates to calibrate their prepared-

ness for the exam without being overwhelming.

The ERP Practice Exam 2 does not necessarily cover

all topics to be tested in the 2015 ERP Examination. For

a complete list of topics and core readings, candidates

should refer to the 2015 ERP Examination Study Guide.

Core readings were selected in consultation with the Energy

Oversight Committee (EOC) to assist candidates in their

review of the subjects covered by the exam. Questions for

the ERP Examination are derived from these core readings

in their entirety. As such, it is strongly suggested that candi-

dates review all core readings listed in the 2015 ERP Study

Guide in-depth prior to sitting for the exam.

Suggested Use of Practice ExamsTo maximize the effectiveness of the practice exams, candi-

dates 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 2 minutes per question for the practice

exam and set an alarm to alert you when a total of

50 minutes have passed Complete the entire exam but

note the questions answered after the 50-minute mark.

• 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 2015 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 Exam 2 • Calculate your score by comparing your answer

sheet with the practice exam answer key. Only

include questions completed within the first 50

minutes in your score.

• 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 candi-

dates, so use your scores only to gauge your own

progress and level of preparedness.

Energy RiskProfessional(ERP®)ExaminationPractice Exam 2

Answer Sheet



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Questions



1. The table below summarizes the projected crude oil production and annual expenses related to the develop-ment of a new oil reserve:

* Expenses in USD millions Year 0 (now) Year 1 Year 2 Year 3

Exploration 10 0 0 0

Upstream Development 8 25 8 0

Operating and Transportation 3 30 15 12

Crude Oil Production (in BBLs) 0 800,000 350,000 200,000

Use the following assumptions to calculate the project’s NPV assuming that all cash flows occur at the end ofeach year:

• Projected average price of crude oil produced: USD 88/bbl • Risk-adjusted discount rate: 12%

a. USD -1,486,000b. USD -1,338,000c. USD 2,751,000d. USD 2,954,000

2. A newly discovered offshore natural gas field extends across the territorial waters of two countries. Bothnations seek to develop the field in order to meet domestic demand and earn LNG export revenues. How canthe two countries best maximize the future commercial viability of the natural gas reserve while minimizingthe potential for a conflict over mineral rights?

a. Establish independent drilling rights on the reserve and designate a third-party arbitrator to settle future production disputes.

b. Establish a sliding scale production arrangement based on a pro-rata allocation of the total projected recoverable gas volume per square nautical mile.

c. Establish a joint development zone that includes the shared portion of the reserve before either country begins exploitation.

d. Establish a proportional claim on mineral rights development based on the United Nations Convention on the Law of the Sea.

6 © 2015 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.


3. Consider a very complex refinery with long-term crude oil supply contracts established with several producersin the Persian Gulf, Venezuela, and West Africa. What type of shipping arrangement offers the refinery thegreatest economic flexibility and control over its product inventory?

a. CIFb. DESc. EFPd. FOB

4. Which of the following legal structures will most evenly allocate risk among a group of individual investorswho participate in the development of an LNG liquefaction terminal that is attached to a natural gas field withan expected life of 30 years?

a. Joint venture agreementb. Master limited partnershipc. Project bondd. Unitization contract

5. An African nation exports domestically-produced crude oil with an API of 36° and a sulfur content of 0.73%.Assuming the London ICE Brent futures contract is the benchmark, how will the country’s crude oil exportsmost likely be priced?

a. At a discount to the Brent crude oil contract.b. At parity with the Brent crude oil contract.c. At a premium to the Brent crude oil contract.d. Crude oil of this grade will have little price correlation with Brent making the Brent futures contract a

poor benchmark.



6. A state-owned electric power company in China operates several coal-fired steam generation plants. Thegenerator purchases its fuel supply from a local coal mine that produces moist coal with a low heating value.What type of coal has the power company most likely purchased?

a. Anthraciteb. Bituminousc. Lignited. Sub-Bituminous

7. An LNG export terminal has negotiated a long-term supply contract with a utility company in Asia.What contractual arrangement will best protect the LNG producer against economic loss if the utility refusesdelivery of the contracted volume of LNG?

a. A credit support annexb. A force majeure clause c. A quick sale provision with liquidated damagesd. A take-or-pay provision

8. The production manager for a natural gas producer is evaluating a range of potential storage options for sev-eral recently discovered reserves. Which natural gas storage option provides the greatest flexibility and easeof use during extraction?

a. Above-ground tank storageb. Aquifer storagec. Depleted reservoir storaged. Salt cavern storage



9. Ocean Wind Authority (OWA) is the project sponsor for High Cliffs Wind (HCW), a new 1,000 MW offshorewind turbine installation. HCW has a BBB credit rating based on the results of an initial feasibility study. OWAhas secured a Power Purchase Agreement (PPA) from Acme Power and Light (APL), a AA rated local electricutility. Under terms of the PPA, APL has made a firm ten year commitment to purchase up to 90% of thepower generated by the facility after its expected completion in five years. Assuming OWA arranges bankloans to fund the project, what will most likely be the terms of the lending arrangement?

a. A fifteen year amortizing term loan with recourse to the assets of HCW, priced as a BBB credit. b. A five year construction loan that converts to a ten year fully amortizing term loan, priced as a AA credit

with recourse to the assets of HCW.c. A fifteen year amortizing, non-recourse term loan, priced as a AA credit. d. A five year construction loan that converts to a ten year fully amortizing, non-recourse term loan, priced

as a AA credit.

10. Use the data below to calculate the implied market heat rate for a power grid supplied by a series of naturalgas-fired generators.

• Grid load: 240,000 MWh• Market clearing price: USD 65.85/MWh• Natural gas price (daily average): USD 4.60/MMBtu

a. 8.87 MMBtu/MWhb. 12.91 MMBtu/MWhc. 14.32 MMBtu/MWhd. 16.15 MMBtu/MWh

11. In the electricity markets, a financial tolling agreement is most similar to what type of contract?

a. An Asian-style option on electricity futuresb. A fixed-for-floating swapc. An option on a commodity spreadd. A strip of sequentially-dated futures



12. The equilibrium price for electricity on a power grid with total demand of 450 MW is USD 52/MWh. Assuminga merit order curve is used to set the equilibrium price, which of the following plants will be dispatched?

Plant Variable Cost Capacity

A USD 51/MWh 300 MW

B USD 56/MWh 150 MW

C USD 45/MWh 200 MW

a. Plant B onlyb. Plant C onlyc. Plant A and Plant Cd. All plants are dispatched

13. NuPower Electric purchased a 50 MW Financial Transmission Right (FTR) to mitigate the potential economicimpact of transmission congestion between Node A (Injection) and Node B (Sink). The purchase price of theFTR is USD 5/MW.

LMP = USD 40/MW LMP = USD 20/MW

A B

At settlement, the Locational Marginal Price (LMP) for power at Nodes A and B is USD 40/MW and USD20/MW respectively. Calculate the net profit or loss NuPower realized on the transaction.

a. - USD 9,000,000b. - USD 1,000,000c. USD 1,000,000d. USD 9,000,000



Questions 14 – 15 use the information belowIn early March 2014 the spot price of Brent crude oil is USD 107.90 and estimated monthly crude oil storagecosts are USD 0.75/bbl. Traders are using the following market data to identify potential market opportunities.

Brent crude oil futures contract prices:• October 2014: USD 112.65• October 2015: USD 104.86

US Treasury zero-coupon bond yields:• March 2014 through September 2014: 2.50%• October 2015: 3.75%

14. What best approximates the breakeven forward price required for a 6-month storage arbitrage to be profitableassuming storage costs are paid at the beginning of each month with no market convenience yield?

a. USD 111.09/bblb. USD 113.79/bblc. USD 115.73/bbld. USD 118.53/bbl

15. What best approximates the zero coupon bond position required to synthetically replicate a long 18-monthforward position on 250,000 barrels of Brent crude oil?

a. USD 24,781,000b. USD 25,982,000c. USD 26,270,000d. USD 27,732,000



16. Use the temperature data below to calculate Cooling Degree Days (CDD) for a 7-day period:

High Low AverageTemperature Temperature Temperature

71°F 62°F 66.5°F75°F 63°F 69.0°F72°F 65°F 68.5°F69°F 67°F 68°F64°F 61°F 62.5°F65°F 59°F 62°F64°F 58°F 61°F

a. 9.5b. 12c. 14.5d. 17

17. What makes a hedging strategy based on purchasing options a more efficient risk management tool for producersand end-users than forwards, futures, or swaps?

a. Certainty of cash outflowsb. Counterparty netting arrangementsc. Minimal collateral thresholdsd. Physical settlement

18. Assume an energy commodity position has an average 10-day price return of 0.75% and a daily standard devi-ation of 1.25%. If daily price returns are independent and normally distributed, what is the portfolio’s 10-day,95% VaR?

a. 5.75%b. 6.27%c. 6.43%d. 7.00%



19. A crude oil trader holds a long position in 100 call options on Brent Crude oil futures. The trader has identi-fied a second option on the same underlying contract that can be used to hedge market risk in her position.

What combination of the hedge option and the underlying futures contract will best neutralize the delta andgamma of the trader’s position assuming the following market risk characteristics for the positions:

Long Option Hedge OptionDelta 0.613 -0.55Gamma 0.0723 -0.0950

a. Buy 76 options and sell 19 futures contracts.b. Sell 76 options and buy 19 futures contracts.c. Sell 111 options and buy 3 futures contracts.d. Buy 111 options and buy 3 futures contracts.

20. The following table represents the distribution of operational loss events from a sample of drilling companiesover a 6-month period:

Loss Events Percentage of Observations0 18%1 36%2 29%3 13%4 4%

Calculate the standard deviation for the distribution of operational loss events assuming a mean of 1.49.

a. 1.05b. 1.11c. 1.22d. 1.34



21. A risk analyst has performed a regression analysis on ICE National Balancing Point (NBP) natural gas spotprice returns over the past 500 days in order to estimate the parameters for a simple mean reversion model.

The regression analysis includes the following coefficients for a linear relationship where:

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

Using terms from the linear relationship above, what is the best estimate of the mean reversion rate for NBPnatural gas spot prices?

a. 2b. 9c. 14d. 21

22. Use data from the credit report below to approximate the original exposure on the underlying bond position.

• Obligor: XYZ Energy• Recovery rate: 32%• Loss given default: USD 5,850,000• Expected loss: USD 3,910,500




23. Which of the following actions, if taken by a central counterparty, will most likely increase risk on an exchangetraded futures contract?

a. Invoke netting agreements on contracts that are in default. b. Reduce margin requirements on contracts with low volatility and high liquidity.c. Auction the right to replace contracts that are in default.d. Increase margin requirements on contracts with large, highly concentrated positions.

24. What OTC derivative transaction provides the greatest economic benefit (to the counterparty identified) in abilateral netting arrangement?

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

25. What best describes the correct application of Key Performance Indicators (KPIs) and Key Risk Indicators(KRIs) in the context of an organization’s risk management process?

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.

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Answers



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Explanations



1. The table below summarizes the projected crude oil production and annual expenses related to the develop-ment of a new oil reserve:

* Expenses in USD millions Year 0 (now) Year 1 Year 2 Year 3

Exploration 10 0 0 0

Upstream Development 8 25 8 0

Operating and Transportation 3 30 15 12

Crude Oil Production (in BBLs) 0 800,000 350,000 200,000

Use the following assumptions to calculate the project’s NPV assuming that all cash flows occur at the end ofeach year:

• Projected average price of crude oil produced: USD 88/bbl • Risk-adjusted discount rate: 12%

a. USD -1,486,000b. USD -1,338,000c. USD 2,751,000d. USD 2,954,000

Answer: d

Explanation: The correct answer is d. We must first figure out the total cash inflow or outflow expected for the four year period, as follows:

Year 0 Year 1 Year 2 Year 3

Total Income (USD/ millions) 0 70.4 30.8 17.6

Total costs (USD/ millions) 21 55 23 12

Cash flow -21 +15.4 +7.8 +5.6

The discount factors for the four years would be: Year 0: 1, Year 1: 1/(1+0.12) or 0.901, Year 2: 1/(1+0.12)2 or0.812, and Year 3: 1/(1+0.12)3, or 0.731. Then multiply each cash flow by the discount factor and sum theresults to get NPV: NPV = -37 + (15*0.893) + (8*0.797) + (6*0.712) = USD 2,954,000.

Reading reference: Andrew Inkpen and Michael H. Moffett. The Global Oil and Gas Industry: Management,Strategy and Finance, chapter 4, p. 142-143.



2. A newly discovered offshore natural gas field extends across the territorial waters of two countries. Bothnations seek to develop the field in order to meet domestic demand and earn LNG export revenues. How canthe two countries best maximize the future commercial viability of the natural gas reserve while minimizingthe potential for a conflict over mineral rights?

a. Establish independent drilling rights on the reserve and designate a third-party arbitrator to settle future production disputes.

b. Establish a sliding scale production arrangement based on a pro-rata allocation of the total projected recoverable gas volume per square nautical mile.

c. Establish a joint development zone that includes the shared portion of the reserve before either country begins exploitation.

d. Establish a proportional claim on mineral rights development based on the United Nations Convention on the Law of the Sea.

Answer: c

Explanation: Answer c is correct. The best strategy, and one that has been used successfully in many occa-sions, is for the two nations to establish a joint development zone (JDZ) that encompasses the portions of thereserve in both country’s territorial waters. The JDZ will include definitions of each nation’s claim and a uniti-zation agreement to maximize production for the entire reserve.

Reading reference: Andrew Inkpen and Michael Moffett. The Global Oil and Gas Industry: Management,Strategy and Finance, Chapter 4, pages 138-141.

3. Consider a very complex refinery with long-term crude oil supply contracts established with several producersin the Persian Gulf, Venezuela, and West Africa. What type of shipping arrangement offers the refinery thegreatest economic flexibility and control over its product inventory?

a. CIFb. DESc. EFPd. FOB

Answer: d

Explanation: The correct answer is d: under the terms of the FOB contract, the buyer is responsible forarranging shipping and insurance charges providing flexibility in making these arrangements in the mannerthat they wish and allowing for the possibility of saving money.

Reading reference: Andrew Inkpen and Michael Moffett. The Global Oil and Gas Industry: Management,Strategy and Finance, Chapter 9, pages 346-347.



4. Which of the following legal structures will most evenly allocate risk among a group of individual investorswho participate in the development of an LNG liquefaction terminal that is attached to a natural gas field withan expected life of 30 years?

a. Joint venture agreementb. Master limited partnershipc. Project bondd. Unitization contract

Answer: a

Explanation: The correct answer is a, a joint venture structure is typically used in large scale oil and gas proj-ects to share risk among project participants.

Reading reference: Andrew Inkpen and Michael Moffett, The Global Oil & Gas Industry: Management, Strategyand Finance, Chapter 9, pages 351-356.

5. An African nation exports domestically-produced crude oil with an API of 36° and a sulfur content of 0.73%.Assuming the London ICE Brent futures contract is the benchmark, how will the country’s crude oil exportsmost likely be priced?

a. At a discount to the Brent crude oil contract.b. At parity with the Brent crude oil contract.c. At a premium to the Brent crude oil contract.d. Crude oil of this grade will have little price correlation with Brent making the Brent futures contract a

poor benchmark.

Answer: a

Explanation: Benchmark crudes serve as a pricing standard against which the value of other crude oils can beset. This crude oil would be classified as intermediate crude with a sulfur level slightly higher than Brent,making it likely to sell at a small discount to Brent.

Reading reference: Vincent Kaminski, Energy Markets, Chapter 17.



6. A state-owned electric power company in China operates several coal-fired steam generation plants. Thegenerator purchases its fuel supply from a local coal mine that produces moist coal with a low heating value.What type of coal has the power company most likely purchased?

a. Anthraciteb. Bituminousc. Lignited. Sub-Bituminous

Answer: c

Explanation: The correct answer is c; lignite is a type of soft coal with the lowest carbon content of the fourmajor types and a high moisture content.

Reading reference: Vincent Kaminski, Energy Markets, Chapter 26, p. 798.

7. An LNG export terminal has negotiated a long-term supply contract with a utility company in Asia.What contractual arrangement will best protect the LNG producer against economic loss if the utility refusesdelivery of the contracted volume of LNG?

a. A credit support annexb. A force majeure clause c. A quick sale provision with liquidated damagesd. A take-or-pay provision

Answer: d

Explanation: The correct answer is d. A take-or-pay provision forces the customer to either take the volumeof gas specified by the contract — whether it is needed or not — or pay for the gas, even if it is never deliv-ered. Answer c is incorrect because while a spot market is developing for LNG, it cannot be considered fullyliquid in that the exporter cannot be guaranteed that there would be a buyer available for this cargo.

Reading reference: Andrew Inkpen and Michael Moffett. The Global Oil and Gas Industry: Management,Strategy and Finance, Chapter 9, page 336.



8. The production manager for a natural gas producer is evaluating a range of potential storage options for sev-eral recently discovered reserves. Which natural gas storage option provides the greatest flexibility and easeof use during extraction?

a. Above-ground tank storageb. Aquifer storagec. Depleted reservoir storaged. Salt cavern storage

Answer: d

Explanation: The correct answer is d. Since salt caverns allow for the quickest withdrawal of stored gasamong all of the underground storage options, withdrawal can begin much more quickly than either aquifersor depleted reservoirs. Above ground tanks are typically not used for the storage of natural gas.

Reading reference: Vivek Chandra. Fundamentals of Natural Gas: An International Perspective, Chapter 2,pages 72-73.

9. Ocean Wind Authority (OWA) is the project sponsor for High Cliffs Wind (HCW), a new 1,000 MW offshorewind turbine installation. HCW has a BBB credit rating based on the results of an initial feasibility study. OWAhas secured a Power Purchase Agreement (PPA) from Acme Power and Light (APL), a AA rated local electricutility. Under terms of the PPA, APL has made a firm ten year commitment to purchase up to 90% of thepower generated by the facility after its expected completion in five years. Assuming OWA arranges bankloans to fund the project, what will most likely be the terms of the lending arrangement?

a. A fifteen year amortizing term loan with recourse to the assets of HCW, priced as a BBB credit. b. A five year construction loan that converts to a ten year fully amortizing term loan, priced as a AA credit

with recourse to the assets of HCW.c. A fifteen year amortizing, non-recourse term loan, priced as a AA credit. d. A five year construction loan that converts to a ten year fully amortizing, non-recourse term loan, priced

as a AA credit.

Answer: d

Explanation: Project finance lending structures typically include an initial construction loan that converts to aterm loan. As a separate project company, the execution of a PPA with Acme Power and Light would be typi-cal of a project finance agreement, a benefit to OWA is that they may then be able to use the utility’s highercredit rating to reduce their own borrowing costs. The basic premise of a project finance agreement is thatthe loan is based on the future cash flows of the project (in this case the PPA) and that lenders have little orno recourse in the case of a default.

Reading reference: Chris Groobey, John Pierce, Michael Faber and Greg Broome. Project Finance Primer forRenewable Energy and Clean Tech Projects.



10. Use the data below to calculate the implied market heat rate for a power grid supplied by a series of naturalgas-fired generators.

• Grid load: 240,000 MWh• Market clearing price: USD 65.85/MWh• Natural gas price (daily average): USD 4.60/MMBtu

a. 8.87 MMBtu/MWhb. 12.91 MMBtu/MWhc. 14.32 MMBtu/MWhd. 16.15 MMBtu/MWh

Answer: c

Explanation: The correct answer is c. The implied market heat rate is calculated by dividing the cost of thenatural gas into the market clearing price for electricity: USD 65.85 / USD 4.60 = 14.32

Reading reference: Vincent Kaminski, Energy Markets, Chapter 22.

11. In the electricity markets, a financial tolling agreement is most similar to what type of contract?

a. An Asian-style option on electricity futuresb. A fixed-for-floating swapc. An option on a commodity spreadd. A strip of sequentially-dated futures

Answer: c

Explanation: The correct answer is c.In a financial tolling agreement, no physical delivery of electricity isrequired, the contract is instead settled against the market prices of fuel (usually natural gas) and electricityand a formula within the contract. The tolling agreement is therefore essentially an option on the heat ratespread between the input and output of the generator.

Reading reference: Vincent Kaminski. Energy Markets. Chapter 23, Electricity Market Transactions, pages 860-862.



12. The equilibrium price for electricity on a power grid with total demand of 450 MW is USD 52/MWh. Assuminga merit order curve is used to set the equilibrium price, which of the following plants will be dispatched?

Plant Variable Cost Capacity

A USD 51/MWh 300 MW

B USD 56/MWh 150 MW

C USD 45/MWh 200 MW

a. Plant B onlyb. Plant C onlyc. Plant A and Plant Cd. All plants are dispatched

Answer: c

Explanation: The merit order curve dispatches generation in order of variable operating costs until totalcapacity for the system is met. The last plant dispatched that fulfills the capacity requirement will set theequilibrium price. In this case, Plant C’s entire capacity will be dispatched plus 125 MW of capacity from PlantA in order to fulfill total grid demand.

Reading reference: Daniel Kirschen and Goran Strbac, Fundamentals of Power System Economics, Chapter 3.



13. NuPower Electric purchased a 50 MW Financial Transmission Right (FTR) to mitigate the potential economicimpact of transmission congestion between Node A (Injection) and Node B (Sink). The purchase price of theFTR is USD 5/MW.

LMP = USD 40/MW LMP = USD 20/MW

A B

At settlement, the Locational Marginal Price (LMP) for power at Nodes A and B is USD 40/MW and USD20/MW respectively. Calculate the net profit or loss NuPower realized on the transaction.

a. - USD 9,000,000b. - USD 1,000,000c. USD 1,000,000d. USD 9,000,000

Answer: a

Explanation: The correct answer is a: a total loss of USD 9,000,000. Financial Transmission Rights (FTRs) are financial instruments which pay the difference between prices at twolocations; in this case NuPower will receive the Node B price and pay the Node A price, so the FTR payout is20 – 40, or - $ 20 per MWh. NuPower already spent USD 5/MW to buy the FTR, so therefore, the net loss perMW is - USD 25. Total MWh for June 2014 = 30 * 24 * 50 = 36,000 MWh. Therefore, the total loss forNuPower is 36,000 * (-25) = - USD 9,000,000.

Reading reference: Vincent Kaminski, Energy Markets, chapter 23, p. 849.

Questions 14 – 15 use the information belowIn early March 2014 the spot price of Brent crude oil is USD 107.90 and estimated monthly crude oil storagecosts are USD 0.75/bbl. Traders are using the following market data to identify potential market opportunities.

Brent crude oil futures contract prices:• October 2014: USD 112.65• October 2015: USD 104.86

US Treasury zero-coupon bond yields:• March 2014 through September 2014: 2.50%• October 2015: 3.75%



14. What best approximates the breakeven forward price required for a 6-month storage arbitrage to be profitableassuming storage costs are paid at the beginning of each month with no market convenience yield?

a. USD 111.09/bblb. USD 113.79/bblc. USD 115.73/bbld. USD 118.53/bbl

Answer: b

Explanation: The correct answer is b. Minimum 6-month forward price = [USD 107.90 * exp (0.025)*(6/12)] + (Future value of storage (USD 4.53) = 113.79

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

15. What best approximates the zero coupon bond position required to synthetically replicate a long 18-monthforward position on 250,000 barrels of Brent crude oil?


Answer: a

Explanation: The correct answer is a. The formula to solve is:

S0 = F0e-rT

S0 = 250,000*104.86 * e(-0.0375*1.5) = 24,781,112

Reading reference: Robert McDonald, Derivatives Markets, 3rd Edition, Chp 6, pages 189 - 191.



16. Use the temperature data below to calculate Cooling Degree Days (CDD) for a 7-day period:

High Low AverageTemperature Temperature Temperature

71°F 62°F 66.5°F75°F 63°F 69.0°F72°F 65°F 68.5°F69°F 67°F 68°F64°F 61°F 62.5°F65°F 59°F 62°F64°F 58°F 61°F

a. 9.5b. 12c. 14.5d. 17

Answer: b

Explanation: The correct answer is b. Cooling Degree Days are the difference between the daily average tem-peratures less 65°F, if more than 65 degrees. The average temperatures: 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.

17. What makes a hedging strategy based on purchasing options a more efficient risk management tool for producersand end-users than forwards, futures, or swaps?

a. Certainty of cash outflowsb. Counterparty netting arrangementsc. Minimal collateral thresholdsd. Physical settlement

Answer: a

Explanation: The correct answer is a. Producers and end-users have shown an increasing interest in usingoption-based strategies. This trend can be explained by the relative certainty of cash outflow offered byoptions versus the ongoing margining and collateralization requirements associated with forwards, futuresand swaps.. After an initial upfront cash flow (option premium), there are typically no other financial obliga-tions related to an option contract.

Reading reference: Vincent Kaminski. Energy Markets, Chapter 18, Page 667-668.



18. Assume an energy commodity position has an average 10-day price return of 0.75% and a daily standard devi-ation of 1.25%. If daily price returns are independent and normally distributed, what is the portfolio’s 10-day,95% VaR?

a. 5.75%b. 6.27%c. 6.43%d. 7.00%

Answer: a

Explanation: Correct answer is a.10 day mean return=0.75%10 day standard deviation =(square root of 10)x1.25%=3.9528%10-Day, 95% VaR=-(0.75%-1.645x3.9528%)= 5.75%.B - Incorrect: Assumes daily mean price return multiplied by square root of 10C - Incorrect: Assumes daily mean price return with no adjustment for timeD - Incorrect: Assumes a two tailed test (confidence interval of 1.96)

Reading reference: Allan Malz, Chapter 3.



19. A crude oil trader holds a long position in 100 call options on Brent Crude oil futures. The trader has identi-fied a second option on the same underlying contract that can be used to hedge market risk in her position.

What combination of the hedge option and the underlying futures contract will best neutralize the delta andgamma of the trader’s position assuming the following market risk characteristics for the positions:

Long Option Hedge OptionDelta 0.613 -0.55Gamma 0.0723 -0.0950

a. Buy 76 options and sell 19 futures contracts.b. Sell 76 options and buy 19 futures contracts.c. Sell 111 options and buy 3 futures contracts.d. Buy 111 options and buy 3 futures contracts.

Answer: a

Explanation: In order to do a delta - gamma hedge, the gamma must be neutralized first by using the optionprovided as a hedge. Since the delta and gamma of the given option are of the opposite side of the portfolioposition, the options must be bought to neutralize the gamma.

The number of contracts needed to neutralize the gamma are: (Gamma of position / Gamma of hedge) *Number of contracts, i.e. (0.0723/-0.0950) * 100, or 76.1. In other words, 0.76 of an option must be purchasedto hedge the gamma of every existing option in the position.

However, now that the gamma has been neutralized, there remains some residual delta due to the purchase ofthe option contracts required to hedge. The delta per contract is now: 0.613 + (-0.55*0.761), or 0.194. Deltacan be hedged with the underlying futures Since the residual delta is positive, then 19 futures contracts mustbe sold to hedge the residual delta of the original 100 contract position.

Choices c and d incorrectly neutralize delta first and then solve for residual gamma.

Reading reference: Les Clewlow and Chris Strickland. Energy Derivatives: Pricing and Risk Management, chapter 9,pp. 967-968.



20. The following table represents the distribution of operational loss events from a sample of drilling companiesover a 6-month period:

Loss Events Percentage of Observations0 18%1 36%2 29%3 13%4 4%

Calculate the standard deviation for the distribution of operational loss events assuming a mean of 1.49.

a. 1.05b. 1.11c. 1.22d. 1.34

Answer: a

Explanation: Correct answer is a. The first step is to calculate the variance, which is the probability weighted average of the squared differencebetween F and its mean. In other words, Variance = (0-1.49)2 * 18% + (1-1.49)2 * 36% + (2-1.49)2 * 29% + (3-1.49)2 * 13% + (4-1.49)2 * 4% = 1.110.

The standard deviation is the square root of the variance, ie. 1.053.

Reading reference: Michael Miller, chapter 3.



21. A risk analyst has performed a regression analysis on ICE National Balancing Point (NBP) natural gas spotprice returns over the past 500 days in order to estimate the parameters for a simple mean reversion model.

The regression analysis includes the following coefficients for a linear relationship where:

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

Using terms from the linear relationship above, what is the best estimate of the mean reversion rate for NBPnatural gas spot prices?

a. 2b. 9c. 14d. 21

Answer: c

Explanation: The mean reversion rate can be estimated from the regression results as follows:

α0 = 0.0188 (Coefficient for Intercept)

α1 = 0.0285 (Coefficient for Slope)

Assuming 500 data points Δt = 1/500 = 0.0020

Therefore the mean reversion rate (α) can be estimated as (α1 0.0285/Δt 0.0020) or 14.25

a is incorrect: α1 = 0.0285/ α0 = 0.0188 = 1.5

b is incorrect: α0 = 0.0188/ Δt 0.0020 = 9

d is incorrect: fictitiously derived by adding a spread of 7 to answer c.

Reading reference: Les Clewlow and Chris Strickland, Energy Derivatives: Pricing and Risk Management,Chapter 2, pages 28-29.



22. Use data from the credit report below to approximate the original exposure on the underlying bond position.

• Obligor: XYZ Energy• Recovery rate: 32%• Loss given default: USD 5,850,000• Expected loss: USD 3,910,500


Answer: c

Explanation: The correct answer is c. Since Loss Given Default = Exposure * (1-recovery rate), then the expo-sure is equal to the LGD divided by (1-recovery rate). Therefore the original exposure on the position is5,850,000 / (1-0.32) or approximately USD 8,602,941.

Reading reference: Allan Malz. Financial Risk Management, Models, History and Institutions, Chapter 6, pages201 – 203.

23. Which of the following actions, if taken by a central counterparty, will most likely increase risk on an exchangetraded futures contract?

a. Invoke netting agreements on contracts that are in default. b. Reduce margin requirements on contracts with low volatility and high liquidity.c. Auction the right to replace contracts that are in default.d. Increase margin requirements on contracts with large, highly concentrated positions.

Answer: d

Explanation: A CCP’s increasing of margin requirements could create destabilizing market impacts and there-fore add systemic risk. An example of this is a contract with large concentrated positions. If the CCP were toincrease the margin requirement, firms holding these positions might be placed into margin calls which couldforce them to sell the target security, creating even greater market impact and imposing strains on the fund-ing system and market liquidity.

Reading reference: Jon Gregory. Counterparty Credit Risk: A Continuing Challenge for Global FinancialMarkets, Chapter 7, p. 110.



24. What OTC derivative transaction provides the greatest economic benefit (to the counterparty identified) in abilateral netting arrangement?

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

Answer: b

Explanation: Answer b is correct. To provide economic benefit in a netting arrangement, a derivative posi-tion must have the potential to have a negative mark-to-market. Long option positions in which the premiumis 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 negativeMtM and therefore the greatest economic benefit in a netting arrangement.

Reading reference: Jon Gregory. Counterparty Credit Risk: A Continuing Challenge for Global FinancialMarkets, Chapter 4.

25. What best describes the correct application of Key Performance Indicators (KPIs) and Key Risk Indicators(KRIs) in the context of an organization’s risk management process?

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.

Answer: c

Explanation: The correct answer is c. One problem with the use of KPIs for risk management is that they arebackward-looking: they will only show how well the portfolio has met pre-determined goals. KRIs are anongoing process of monitoring the portfolio performance to ensure that it stays within pre-determined riskmeasurements. 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 portfolioreach the KPIs.

Reading reference: John Fraser and Betty Simkins, Enterprise Risk Management: Today’s Leading Researchand Best Practices for Tomorrow’s Executives, Chapter 8, page 128.

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