5- Consider the process model for loan risk assessment of Figure 5.22. Does it suffer from soundness problems? If so, what behavioural rules does it violate? If the model is unsound, how can it be fixed without removing any activity? Receive loan application Initial eligibility check not eligible eligible + Credit history check Check applicant's income sources Assess applicant's credit risk Appraisal of property to be mortgaged mortgageable Appraise other collateral not mortgageable Fig. 5.22 A process model for loan risk assessment Loan risk assessment Risk assessed Customer informed Application ineligible trase 6. Provide a review and explanation of the importance of risk management in banks, and explain the main techniques used to measure downside market risk. 7. Describe the main modelling approaches banks use to measure credit risk. 8. Discuss how banks use interest rate swaps and gap analysis to manage interest rate risk. Question 1 Provide a response for each of the following, which should be treated as separate scenarios. (a) Ahmad has just learned about derivatives and in particular, how they can be used to conduct arbitrage. Using the Cost of Carry model, he computed that the correct price for FBM KLCI futures should be 1,578.5 points. Meanwhile, the corresponding FBM KLCI futures contract is currently priced at 1,580 points. To carry out the arbitrage strategy, Ahmad decides to long the futures contract and simultaneously short the spot KLCI. Comment on this strategy. (4 marks) (b) Ahmad determined that the difference between the (correct) theoretical futures price and the observed futures price in the market is only very small, about 0.5 points. He still insists on carrying out an arbitrage strategy. What advice would you offer Ahmad? (4 marks) (c) Ahmad remarked the following: "Based on my calculations, there is opportunity to arbitrage the FBM KLCI using futures. My gut feeling is that there will be a big next Covid-19 wave and it will hit the Malaysian equities market. If this happens, I will make a lot more profit with my arbitrage strategy. If it doesn't pan out that way, I will still make a decent profit because my arbitrage strategy is a risk-free position." Comment on Ahmad's statement. (4 marks) (d) Ahmad claims that his computations show opportunity to arbitrage the FBM KLCI and to make a profit of RM200 per SIF contract. He plans to replicate this strategy 10 million times and hence will earn a total of RM2 billion in arbitrage profit. Will this arbitrage strategy make Ahmad an instant billionaire? Comment. (4 marks) (e) Ahmad just learned about "arbitrage trading program" or "programmed arbitrage" which involves using computer software to automate arbitrage strategies. These computer programs employ customized algorithms to scan market prices, identify pricing anomalies and execute arbitrage trades in an automated manner. Ahmad is keen to incorporate this in his pursuit of arbitrage profits but he is curious whether such an activity is Shari'ah compliant. He has approached you for advice. Provide your opinion on this matter. (4 marks) [Total: 20 marks]