Erp Practice Exam2 2015

2015
ERP
Practice
Exam 2
Energy Risk Professional Examination (ERP) Practice Exam 2
TABLE OF CONTENTS
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
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.
Introduction
1. Plan a date and time to take the practice exam.
The ERP Exam is a practice-oriented examination. Its ques-
Set dates appropriately to give sucient study/review
tions are derived from a combination of theory, as set forth
time for the practice exam prior to the actual exam.
in the core readings, and real-world work experience.

Candidates are expected to understand energy risk man-
2. Simulate the test environment as closely as possible.
agement concepts and approaches and how they would
apply to an energy risk managers day-to-day activities.
erasers) available.
tion, testing an energy risk professional on a number of risk
material before beginning the practice exam.
immediately be slotted into just one category. In the real
Allocate 2 minutes per question for the practice

exam and set an alarm to alert you when a total of
number of risk-related issues and be able to deal with them
50 minutes have passed Complete the entire exam but
eectively.
note the questions answered after the 50-minute mark.
The ERP Practice Exam 2 has been developed to aid

candidates in their preparation for the ERP Examination.
Minimize possible distractions from other people,

cell phones, televisions, etc.; put away any study
an energy risk manager will be faced with an issue that can

world, an energy risk manager must be able to identify any
Have only the practice exam, candidate answer

sheet, calculator, and writing instruments (pencils,
The ERP Examination is also a comprehensive examinamanagement concepts and approaches. It is very rare that
Take the practice exam in a quiet place.
Follow the ERP calculator policy. Candidates are only
This practice exam is based on a sample of actual questions
allowed to bring certain types of calculators into the
from past ERP Examinations and is suggestive of the ques-
exam room. The only calculators authorized for use
tions that will be in the 2015 ERP Examination.
on the ERP Exam in 2015 are listed below, there will

be no exceptions to this policy. You will not be allowed
The ERP Practice Exam 2 contains 25 multiple choice
into the exam room with a personal calculator other
questions. The 2015 ERP Examination will consist

of a morning and afternoon session, each containing 70
than the following: Texas Instruments BA II Plus
multiple choice questions. The practice exam is designed to
(including the BA II Plus Professional), Hewlett Packard
be shorter to allow candidates to calibrate their prepared-
12C (including the HP 12C Platinum and the Anniversary
ness for the exam without being overwhelming.
Edition), Hewlett Packard 10B II, Hewlett Packard 10B II+

and Hewlett Packard 20B.
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.
3. After completing the ERP Practice Exam 2
Calculate your score by comparing your answer
Core readings were selected in consultation with the Energy
sheet with the practice exam answer key. Only
Oversight Committee (EOC) to assist candidates in their
include questions completed within the rst 50

minutes in your score.
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-
Use the practice exam Answers and Explanations to

better understand the correct and incorrect answers
dates review all core readings listed in the 2015 ERP Study
and to identify topics that require additional review.
Guide in-depth prior to sitting for the exam.
Consult referenced core readings to prepare for

the exam.
Suggested Use of Practice Exams

To maximize the eectiveness of the practice exams, candidates are encouraged to follow these recommendations:
Remember: pass/fail status for the actual exam is

based on the distribution of scores from all candidates, so use your scores only to gauge your own
progress and level of preparedness.
Energy Risk
Professional(ERP )
Examination
Practice Exam 2
Answer Sheet
a.
b.
c.
d.
a.
1.
18.
2.
19.
3.
20.
4.
21.
5.
22.
6.
23.
7.
24.
8.
25.
b.
c.
d.
9.
10.
11.
12.
13.
14.
Correct way to complete
15.
1.
16.
Wrong way to complete
17.
1.
Energy Risk
Professional(ERP )
Examination
Practice Exam 2
Questions
1.
The table below summarizes the projected crude oil production and annual expenses related to the development of a new oil reserve:
* Expenses in USD millions
Year 0 (now)
Year 1
Year 2
Year 3
Exploration
10
Upstream Development
25
Operating and Transportation
30
15
12
Crude Oil Production (in BBLs)
800,000
350,000
200,000
Use the following assumptions to calculate the projects NPV assuming that all cash flows occur at the end of
each year:
2.
Projected average price of crude oil produced: USD 88/bbl

Risk-adjusted discount rate: 12%
a.
b.
c.
d.
USD
USD
USD
USD
-1,486,000
-1,338,000
2,751,000
2,954,000
A newly discovered offshore natural gas field extends across the territorial waters of two countries. Both
nations seek to develop the field in order to meet domestic demand and earn LNG export revenues. How can
the two countries best maximize the future commercial viability of the natural gas reserve while minimizing
the potential for a conflict over mineral rights?
a.
b.
c.
d.
Establish independent drilling rights on the reserve and designate a third-party arbitrator to settle future
production disputes.
Establish a sliding scale production arrangement based on a pro-rata allocation of the total projected
recoverable gas volume per square nautical mile.
Establish a joint development zone that includes the shared portion of the reserve before either country
begins exploitation.
Establish a proportional claim on mineral rights development based on the United Nations Convention on
the Law of the Sea.
3.
Consider a very complex refinery with long-term crude oil supply contracts established with several producers
in the Persian Gulf, Venezuela, and West Africa. What type of shipping arrangement offers the refinery the
greatest economic flexibility and control over its product inventory?
a.
b.
c.
d.
4.
Which of the following legal structures will most evenly allocate risk among a group of individual investors
who participate in the development of an LNG liquefaction terminal that is attached to a natural gas field with
an expected life of 30 years?
a.
b.
c.
d.
5.
Joint venture agreement

Master limited partnership
Project bond
Unitization contract
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 countrys crude oil exports
most likely be priced?
a.
b.
c.
d.
CIF
DES
EFP
FOB
At a discount to the Brent crude oil contract.

At parity with the Brent crude oil contract.
At a premium to the Brent crude oil contract.
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. The
generator 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.
b.
c.
d.
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 refuses
delivery of the contracted volume of LNG?
a.
b.
c.
d.
8.
Anthracite
Bituminous
Lignite
Sub-Bituminous
A
A
A
A
credit support annex

force majeure clause
quick sale provision with liquidated damages
take-or-pay provision
The production manager for a natural gas producer is evaluating a range of potential storage options for several recently discovered reserves. Which natural gas storage option provides the greatest flexibility and ease
of use during extraction?
a.
b.
c.
d.
Above-ground tank storage

Aquifer storage
Depleted reservoir storage
Salt cavern storage
9.
Ocean Wind Authority (OWA) is the project sponsor for High Cliffs Wind (HCW), a new 1,000 MW offshore
wind turbine installation. HCW has a BBB credit rating based on the results of an initial feasibility study. OWA
has secured a Power Purchase Agreement (PPA) from Acme Power and Light (APL), a AA rated local electric
utility. Under terms of the PPA, APL has made a firm ten year commitment to purchase up to 90% of the
power generated by the facility after its expected completion in five years. Assuming OWA arranges bank
loans to fund the project, what will most likely be the terms of the lending arrangement?
a.
b.
c.
d.
10.
11.
Use the data below to calculate the implied market heat rate for a power grid supplied by a series of natural
gas-fired generators.
Grid load: 240,000 MWh

Market clearing price: USD 65.85/MWh
Natural gas price (daily average): USD 4.60/MMBtu
a.
b.
c.
d.
8.87 MMBtu/MWh
12.91 MMBtu/MWh
14.32 MMBtu/MWh
16.15 MMBtu/MWh
In the electricity markets, a financial tolling agreement is most similar to what type of contract?
a.
b.
c.
d.
A fifteen year amortizing term loan with recourse to the assets of HCW, priced as a BBB credit.
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.
A fifteen year amortizing, non-recourse term loan, priced as a AA credit.
A five year construction loan that converts to a ten year fully amortizing, non-recourse term loan, priced
as a AA credit.
An Asian-style option on electricity futures

A fixed-for-floating swap
An option on a commodity spread
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. Assuming
a merit order curve is used to set the equilibrium price, which of the following plants will be dispatched?
a.
b.
c.
d.
13.
Plant
Variable Cost
Capacity
USD 51/MWh
300 MW
USD 56/MWh
150 MW
USD 45/MWh
200 MW
Plant B only
Plant C only
Plant A and Plant C
All plants are dispatched
NuPower Electric purchased a 50 MW Financial Transmission Right (FTR) to mitigate the potential economic
impact of transmission congestion between Node A (Injection) and Node B (Sink). The purchase price of the
FTR is USD 5/MW.
LMP = USD 40/MW
LMP = USD 20/MW
At settlement, the Locational Marginal Price (LMP) for power at Nodes A and B is USD 40/MW and USD
20/MW respectively. Calculate the net profit or loss NuPower realized on the transaction.
a.
b.
c.
d.
- USD 9,000,000
- USD 1,000,000
USD 1,000,000
USD 9,000,000
Questions 14 15 use the information below

In early March 2014 the spot price of Brent crude oil is USD 107.90 and estimated monthly crude oil storage
costs 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

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 profitable
assuming storage costs are paid at the beginning of each month with no market convenience yield?
a.
b.
c.
d.
15.
111.09/bbl
113.79/bbl
115.73/bbl
118.53/bbl
What best approximates the zero coupon bond position required to synthetically replicate a long 18-month
forward position on 250,000 barrels of Brent crude oil?
a.
b.
c.
d.
10
USD
USD
USD
USD
USD
USD
USD
USD
24,781,000
25,982,000
26,270,000
27,732,000
16.
Use the temperature data below to calculate Cooling Degree Days (CDD) for a 7-day period:
High
Temperature
71F
75F
72F
69F
64F
65F
64F
a.
b.
c.
d.
17.
Average
Temperature
66.5F
69.0F
68.5F
68F
62.5F
62F
61F
9.5
12
14.5
17
What makes a hedging strategy based on purchasing options a more efficient risk management tool for producers
and end-users than forwards, futures, or swaps?
a.
b.
c.
d.
18.
Low
Temperature
62F
63F
65F
67F
61F
59F
58F
Certainty of cash outflows

Counterparty netting arrangements
Minimal collateral thresholds
Physical settlement
Assume an energy commodity position has an average 10-day price return of 0.75% and a daily standard deviation of 1.25%. If daily price returns are independent and normally distributed, what is the portfolios 10-day,
95% VaR?
a.
b.
c.
d.
5.75%
6.27%
6.43%
7.00%
11
19.
A crude oil trader holds a long position in 100 call options on Brent Crude oil futures. The trader has identified 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 and
gamma of the traders position assuming the following market risk characteristics for the positions:
Delta
Gamma
a.
b.
c.
d.
20.
Long Option
0.613
0.0723
Hedge Option
-0.55
-0.0950
Buy 76 options and sell 19 futures contracts.

Sell 76 options and buy 19 futures contracts.
Buy 111 options and buy 3 futures contracts.
The following table represents the distribution of operational loss events from a sample of drilling companies
over a 6-month period:
Loss Events
0
1
2
3
4
Percentage of Observations
18%
36%
29%
13%
4%
Calculate the standard deviation for the distribution of operational loss events assuming a mean of 1.49.
a.
b.
c.
d.
12
1.05
1.11
1.22
1.34
21.
A risk analyst has performed a regression analysis on ICE National Balancing Point (NBP) natural gas spot
price returns over the past 500 days in order to estimate the parameters for a simple mean reversion model.
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 NBP
natural gas spot prices?
a.
b.
c.
d.
22.
2
9
14
21
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
a.
b.
c.
d.
USD
USD
USD
USD
4,620,000
6,174,000
8,603,000
11,197,000
13
23.
Which of the following actions, if taken by a central counterparty, will most likely increase risk on an exchange
traded futures contract?
a.
b.
c.
d.
24.
What OTC derivative transaction provides the greatest economic benefit (to the counterparty identified) in a
bilateral netting arrangement?
a.
b.
c.
d.
25.
A
A
A
A
crude oil producer long a put option on WTI futures

gas-fired electric power generator long a natural gas swap
natural gas producer long a floor on natural gas
refinery long a straddle on gasoline futures
What best describes the correct application of Key Performance Indicators (KPIs) and Key Risk Indicators
(KRIs) in the context of an organizations risk management process?
a.
b.
c.
d.
14
Invoke netting agreements on contracts that are in default.

Reduce margin requirements on contracts with low volatility and high liquidity.
Auction the right to replace contracts that are in default.
Increase margin requirements on contracts with large, highly concentrated positions.
Use KPIs exclusively to develop an effective forward looking assessment of trends in operational risk factors.
Integrate KPI objectives and KRI limits to create a single comprehensive risk-weighted metric.
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.
Replace KPIs with KRIs and adjust company-wide risk capital allocations to account for the change in risk
monitoring procedures.
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Energy Risk
Professional(ERP )
Examination
Practice Exam 2
Answers
a.
b.
c.
d.
1.
2.
3.
a.
18.
19.
20.
b.
c.
4.
21.
5.
22.
6.
24.
8.
25.
9.
10.
11.
12.
13.

Correct way to complete

1.
16.
17.
14.
15.
23.
7.
d.
Wrong way to complete

1.
17
Energy Risk
Professional(ERP )
Examination
Practice Exam 2
Explanations
1.
The table below summarizes the projected crude oil production and annual expenses related to the development of a new oil reserve:
* Expenses in USD millions
Year 0 (now)
Year 1
Year 2
Year 3
Exploration
10
Upstream Development
25
Operating and Transportation
30
15
12
Crude Oil Production (in BBLs)
800,000
350,000
200,000
Use the following assumptions to calculate the projects NPV assuming that all cash flows occur at the end of
each year:
Projected average price of crude oil produced: USD 88/bbl

Risk-adjusted discount rate: 12%
a.
b.
c.
d.
USD
USD
USD
USD
-1,486,000
-1,338,000
2,751,000
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)
70.4
30.8
17.6
Total costs (USD/ millions)
21
55
23
12
-21
+15.4
+7.8
+5.6
Cash flow
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 or
0.812, and Year 3: 1/(1+0.12)3, or 0.731. Then multiply each cash flow by the discount factor and sum the
results 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.
19
2.
A newly discovered offshore natural gas field extends across the territorial waters of two countries. Both
nations seek to develop the field in order to meet domestic demand and earn LNG export revenues. How can
the two countries best maximize the future commercial viability of the natural gas reserve while minimizing
the potential for a conflict over mineral rights?
a.
b.
c.
d.
Establish independent drilling rights on the reserve and designate a third-party arbitrator to settle future
production disputes.
Establish a sliding scale production arrangement based on a pro-rata allocation of the total projected
recoverable gas volume per square nautical mile.
Establish a joint development zone that includes the shared portion of the reserve before either country
begins exploitation.
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 occasions, is for the two nations to establish a joint development zone (JDZ) that encompasses the portions of the
reserve in both countrys territorial waters. The JDZ will include definitions of each nations claim and a unitization 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 producers
in the Persian Gulf, Venezuela, and West Africa. What type of shipping arrangement offers the refinery the
greatest economic flexibility and control over its product inventory?
a.
b.
c.
d.
CIF
DES
EFP
FOB
Answer: d
Explanation: The correct answer is d: under the terms of the FOB contract, the buyer is responsible for
arranging shipping and insurance charges providing flexibility in making these arrangements in the manner
that they wish and allowing for the possibility of saving money.
Strategy and Finance, Chapter 9, pages 346-347.
20
4.
Which of the following legal structures will most evenly allocate risk among a group of individual investors
who participate in the development of an LNG liquefaction terminal that is attached to a natural gas field with
an expected life of 30 years?
a.
b.
c.
d.
Joint venture agreement

Master limited partnership
Project bond
Unitization contract
Answer: a
Explanation: The correct answer is a, a joint venture structure is typically used in large scale oil and gas projects to share risk among project participants.
Reading reference: Andrew Inkpen and Michael Moffett, The Global Oil & Gas Industry: Management, Strategy
and 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 countrys crude oil exports
most likely be priced?
a.
b.
c.
d.
At a discount to the Brent crude oil contract.

At parity with the Brent crude oil contract.
At a premium to the Brent crude oil contract.
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 be
set. 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.
21
6.
A state-owned electric power company in China operates several coal-fired steam generation plants. The
generator 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.
b.
c.
d.
Anthracite
Bituminous
Lignite
Sub-Bituminous
Answer: c
Explanation: The correct answer is c; lignite is a type of soft coal with the lowest carbon content of the four
major 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 refuses
delivery of the contracted volume of LNG?
a.
b.
c.
d.
A
A
A
A
credit support annex

force majeure clause
quick sale provision with liquidated damages
take-or-pay provision
Answer: d
Explanation: The correct answer is d. A take-or-pay provision forces the customer to either take the volume
of gas specified by the contract whether it is needed or not or pay for the gas, even if it is never delivered. Answer c is incorrect because while a spot market is developing for LNG, it cannot be considered fully
liquid in that the exporter cannot be guaranteed that there would be a buyer available for this cargo.
Strategy and Finance, Chapter 9, page 336.
22
8.
The production manager for a natural gas producer is evaluating a range of potential storage options for several recently discovered reserves. Which natural gas storage option provides the greatest flexibility and ease
of use during extraction?
a.
b.
c.
d.
Above-ground tank storage

Aquifer storage
Depleted reservoir storage
Salt cavern storage
Answer: d
Explanation: The correct answer is d. Since salt caverns allow for the quickest withdrawal of stored gas
among all of the underground storage options, withdrawal can begin much more quickly than either aquifers
or 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 offshore
wind turbine installation. HCW has a BBB credit rating based on the results of an initial feasibility study. OWA
has secured a Power Purchase Agreement (PPA) from Acme Power and Light (APL), a AA rated local electric
utility. Under terms of the PPA, APL has made a firm ten year commitment to purchase up to 90% of the
power generated by the facility after its expected completion in five years. Assuming OWA arranges bank
loans to fund the project, what will most likely be the terms of the lending arrangement?
a.
b.
c.
d.
A fifteen year amortizing term loan with recourse to the assets of HCW, priced as a BBB credit.
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.
A fifteen year amortizing, non-recourse term loan, priced as a AA credit.
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 a
term loan. As a separate project company, the execution of a PPA with Acme Power and Light would be typical of a project finance agreement, a benefit to OWA is that they may then be able to use the utilitys higher
credit rating to reduce their own borrowing costs. The basic premise of a project finance agreement is that
the loan is based on the future cash flows of the project (in this case the PPA) and that lenders have little or
no recourse in the case of a default.
Reading reference: Chris Groobey, John Pierce, Michael Faber and Greg Broome. Project Finance Primer for
Renewable Energy and Clean Tech Projects.
23
10.
Use the data below to calculate the implied market heat rate for a power grid supplied by a series of natural
gas-fired generators.
Grid load: 240,000 MWh

Market clearing price: USD 65.85/MWh
Natural gas price (daily average): USD 4.60/MMBtu
a.
b.
c.
d.
8.87 MMBtu/MWh
12.91 MMBtu/MWh
14.32 MMBtu/MWh
16.15 MMBtu/MWh
Answer: c
Explanation: The correct answer is c. The implied market heat rate is calculated by dividing the cost of the
natural 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.
b.
c.
d.
An Asian-style option on electricity futures

A fixed-for-floating swap
An option on a commodity spread
A strip of sequentially-dated futures
Answer: c
Explanation: The correct answer is c.In a financial tolling agreement, no physical delivery of electricity is
required, the contract is instead settled against the market prices of fuel (usually natural gas) and electricity
and a formula within the contract. The tolling agreement is therefore essentially an option on the heat rate
spread between the input and output of the generator.
Reading reference: Vincent Kaminski. Energy Markets. Chapter 23, Electricity Market Transactions, pages 860-862.
24
12.
The equilibrium price for electricity on a power grid with total demand of 450 MW is USD 52/MWh. Assuming
a merit order curve is used to set the equilibrium price, which of the following plants will be dispatched?
a.
b.
c.
d.
Plant
Variable Cost
Capacity
USD 51/MWh
300 MW
USD 56/MWh
150 MW
USD 45/MWh
200 MW
Plant B only
Plant C only
Plant A and Plant C
All plants are dispatched
Answer: c
Explanation: The merit order curve dispatches generation in order of variable operating costs until total
capacity for the system is met. The last plant dispatched that fulfills the capacity requirement will set the
equilibrium price. In this case, Plant Cs entire capacity will be dispatched plus 125 MW of capacity from Plant
A in order to fulfill total grid demand.
Reading reference: Daniel Kirschen and Goran Strbac, Fundamentals of Power System Economics, Chapter 3.
25
13.
NuPower Electric purchased a 50 MW Financial Transmission Right (FTR) to mitigate the potential economic
impact of transmission congestion between Node A (Injection) and Node B (Sink). The purchase price of the
FTR is USD 5/MW.
LMP = USD 40/MW
LMP = USD 20/MW
At settlement, the Locational Marginal Price (LMP) for power at Nodes A and B is USD 40/MW and USD
20/MW respectively. Calculate the net profit or loss NuPower realized on the transaction.
a.
b.
c.
d.
- USD 9,000,000
- USD 1,000,000
USD 1,000,000
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 two
locations; in this case NuPower will receive the Node B price and pay the Node A price, so the FTR payout is
20 40, or - $ 20 per MWh. NuPower already spent USD 5/MW to buy the FTR, so therefore, the net loss per
MW is - USD 25. Total MWh for June 2014 = 30 * 24 * 50 = 36,000 MWh. Therefore, the total loss for
NuPower is 36,000 * (-25) = - USD 9,000,000.
Reading reference: Vincent Kaminski, Energy Markets, chapter 23, p. 849.
Questions 14 15 use the information below

In early March 2014 the spot price of Brent crude oil is USD 107.90 and estimated monthly crude oil storage
costs are USD 0.75/bbl. Traders are using the following market data to identify potential market opportunities.
Brent crude oil futures contract prices:

US Treasury zero-coupon bond yields:
March 2014 through September 2014: 2.50%
October 2015: 3.75%
26
14.
What best approximates the breakeven forward price required for a 6-month storage arbitrage to be profitable
assuming storage costs are paid at the beginning of each month with no market convenience yield?
a.
b.
c.
d.
USD
USD
USD
USD
111.09/bbl
113.79/bbl
115.73/bbl
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-month
forward position on 250,000 barrels of Brent crude oil?
a.
b.
c.
d.
USD
USD
USD
USD
24,781,000
25,982,000
26,270,000
27,732,000
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.
27
16.
Use the temperature data below to calculate Cooling Degree Days (CDD) for a 7-day period:
High
Temperature
71F
75F
72F
69F
64F
65F
64F
a.
b.
c.
d.
Low
Temperature
62F
63F
65F
67F
61F
59F
58F
Average
Temperature
66.5F
69.0F
68.5F
68F
62.5F
62F
61F
9.5
12
14.5
17
Answer: b
Explanation: The correct answer is b. Cooling Degree Days are the difference between the daily average temperatures less 65F, 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 producers
and end-users than forwards, futures, or swaps?
a.
b.
c.
d.
Certainty of cash outflows

Counterparty netting arrangements
Minimal collateral thresholds
Physical settlement
Answer: a
Explanation: The correct answer is a. Producers and end-users have shown an increasing interest in using
option-based strategies. This trend can be explained by the relative certainty of cash outflow offered by
options versus the ongoing margining and collateralization requirements associated with forwards, futures
and swaps.. After an initial upfront cash flow (option premium), there are typically no other financial obligations related to an option contract.
Reading reference: Vincent Kaminski. Energy Markets, Chapter 18, Page 667-668.
28
18.
Assume an energy commodity position has an average 10-day price return of 0.75% and a daily standard deviation of 1.25%. If daily price returns are independent and normally distributed, what is the portfolios 10-day,
95% VaR?
a.
b.
c.
d.
5.75%
6.27%
6.43%
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 10
C - Incorrect: Assumes daily mean price return with no adjustment for time
D - Incorrect: Assumes a two tailed test (confidence interval of 1.96)
Reading reference: Allan Malz, Chapter 3.
29
19.
A crude oil trader holds a long position in 100 call options on Brent Crude oil futures. The trader has identified 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 and
gamma of the traders position assuming the following market risk characteristics for the positions:
Delta
Gamma
a.
b.
c.
d.
Long Option
0.613
0.0723
Hedge Option
-0.55
-0.0950
Buy 76 options and sell 19 futures contracts.

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 option
provided as a hedge. Since the delta and gamma of the given option are of the opposite side of the portfolio
position, 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 purchased
to 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 of
the option contracts required to hedge. The delta per contract is now: 0.613 + (-0.55*0.761), or 0.194. Delta
can be hedged with the underlying futures Since the residual delta is positive, then 19 futures contracts must
be 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.
30
20.
The following table represents the distribution of operational loss events from a sample of drilling companies
over a 6-month period:
Loss Events
0
1
2
3
4
Percentage of Observations
18%
36%
29%
13%
4%
Calculate the standard deviation for the distribution of operational loss events assuming a mean of 1.49.
a.
b.
c.
d.
1.05
1.11
1.22
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 difference
between 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.
31
21.
A risk analyst has performed a regression analysis on ICE National Balancing Point (NBP) natural gas spot
price returns over the past 500 days in order to estimate the parameters for a simple mean reversion model.
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 NBP
natural gas spot prices?
a.
b.
c.
d.
2
9
14
21
Answer: c
Explanation: The mean reversion rate can be estimated from the regression results as follows:
0 = 0.0188 (Coefficient for Intercept)
1 = 0.0285 (Coefficient for Slope)
Assuming 500 data points t = 1/500 = 0.0020

Therefore the mean reversion rate () can be estimated as (1 0.0285/t 0.0020) or 14.25
a is incorrect: 1 = 0.0285/ 0 = 0.0188 = 1.5
b is incorrect: 0 = 0.0188/ t 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.
32
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
a.
b.
c.
d.
USD
USD
USD
USD
4,620,000
6,174,000
8,603,000
11,197,000
Answer: c
Explanation: The correct answer is c. 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
5,850,000 / (1-0.32) or approximately USD 8,602,941.
Reading reference: Allan Malz. Financial Risk Management, Models, History and Institutions, Chapter 6, pages
201 203.
23.
Which of the following actions, if taken by a central counterparty, will most likely increase risk on an exchange
traded futures contract?
a.
b.
c.
d.
Invoke netting agreements on contracts that are in default.

Reduce margin requirements on contracts with low volatility and high liquidity.
Auction the right to replace contracts that are in default.
Increase margin requirements on contracts with large, highly concentrated positions.
Answer: d
Explanation: A CCPs increasing of margin requirements could create destabilizing market impacts and therefore add systemic risk. An example of this is a contract with large concentrated positions. If the CCP were to
increase the margin requirement, firms holding these positions might be placed into margin calls which could
force them to sell the target security, creating even greater market impact and imposing strains on the funding system and market liquidity.
Reading reference: Jon Gregory. Counterparty Credit Risk: A Continuing Challenge for Global Financial
Markets, Chapter 7, p. 110.
33
24.
What OTC derivative transaction provides the greatest economic benefit (to the counterparty identified) in a
bilateral netting arrangement?
a.
b.
c.
d.
A
A
A
A
crude oil producer long a put option on WTI futures

gas-fired electric power generator long a natural gas swap
natural gas producer long a floor on natural gas
refinery long a straddle on gasoline futures
Answer: b
Explanation: Answer b is correct. To provide economic benefit in a netting arrangement, a derivative position must have the potential to have a negative mark-to-market. Long option positions in which the premium
is paid upfront would be the least beneficial to a netting arrangement making a, b, and c incorrect. The long
(fixed- rate payer) position in a natural gas swap would have the greatest likelihood of creating a negative
MtM and therefore the greatest economic benefit in a netting arrangement.
Reading reference: Jon Gregory. Counterparty Credit Risk: A Continuing Challenge for Global Financial
Markets, Chapter 4.
25.
What best describes the correct application of Key Performance Indicators (KPIs) and Key Risk Indicators
(KRIs) in the context of an organizations risk management process?
a.
b.
c.
d.
Use KPIs exclusively to develop an effective forward looking assessment of trends in operational risk factors.
Integrate KPI objectives and KRI limits to create a single comprehensive risk-weighted metric.
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.
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 are
backward-looking: they will only show how well the portfolio has met pre-determined goals. KRIs are an
ongoing process of monitoring the portfolio performance to ensure that it stays within pre-determined risk
measurements. 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: Todays Leading Research
and Best Practices for Tomorrows Executives, Chapter 8, page 128.
34
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About GARP | The Global Association of Risk Professionals (GARP) is a not-for-profit global membership organization dedicated to
preparing professionals and organizations to make better informed risk decisions. Membership represents over 150,000 risk management practitioners and researchers from banks, investment management firms, government agencies, academic institutions, and
corporations from more than 195 countries and territories. GARP administers the Financial Risk Manager (FRM) and the Energy
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2015

Energy Risk Professional Examination (ERP) Practice Exam 2

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

Energy Risk Professional Examination (ERP) Practice Exam 2

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

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

Set dates appropriately to give sucient study/review

tions are derived from a combination of theory, as set forth

time for the practice exam prior to the actual exam.

in the core readings, and real-world work experience.

2. Simulate the test environment as closely as possible.

agement concepts and approaches and how they would

apply to an energy risk managers day-to-day activities.

tion, testing an energy risk professional on a number of risk

material before beginning the practice exam.

immediately be slotted into just one category. In the real

Allocate 2 minutes per question for the practice

number of risk-related issues and be able to deal with them

50 minutes have passed Complete the entire exam but

note the questions answered after the 50-minute mark.

The ERP Practice Exam 2 has been developed to aid

Minimize possible distractions from other people,

an energy risk manager will be faced with an issue that can

Have only the practice exam, candidate answer

Take the practice exam in a quiet place.

Follow the ERP calculator policy. Candidates are only

This practice exam is based on a sample of actual questions

allowed to bring certain types of calculators into the

from past ERP Examinations and is suggestive of the ques-

exam room. The only calculators authorized for use

tions that will be in the 2015 ERP Examination.

on the ERP Exam in 2015 are listed below, there will

The ERP Practice Exam 2 contains 25 multiple choice

into the exam room with a personal calculator other

questions. The 2015 ERP Examination will consist

than the following: Texas Instruments BA II Plus

multiple choice questions. The practice exam is designed to

(including the BA II Plus Professional), Hewlett Packard

be shorter to allow candidates to calibrate their prepared-

12C (including the HP 12C Platinum and the Anniversary

ness for the exam without being overwhelming.

Edition), Hewlett Packard 10B II, Hewlett Packard 10B II+

The ERP Practice Exam 2 does not necessarily cover

3. After completing the ERP Practice Exam 2

Calculate your score by comparing your answer

Core readings were selected in consultation with the Energy

sheet with the practice exam answer key. Only

Oversight Committee (EOC) to assist candidates in their

include questions completed within the rst 50

review of the subjects covered by the exam. Questions for

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

Use the practice exam Answers and Explanations to

and to identify topics that require additional review.

Guide in-depth prior to sitting for the exam.

Consult referenced core readings to prepare for

Suggested Use of Practice Exams

Remember: pass/fail status for the actual exam is

Energy Risk Professional Examination (ERP) Practice Exam 2

Correct way to complete

Wrong way to complete

Energy Risk Professional Examination (ERP) Practice Exam 2