ERAC Audit Procedures & Risk Mitigation 2 — Questions and Answers
Question 1: During an energy risk audit, which sampling technique is most appropriate when the auditor suspects fraud concentrated in high-value transactions?
- Random sampling
- Stratified sampling (Correct answer)
- Systematic sampling
- Cluster sampling
Correct answer: Stratified sampling
Stratified sampling divides the population into subgroups and oversamples high-risk strata, making it ideal when risk is concentrated in specific segments like high-value transactions.
Question 2: A natural gas distributor wants to hedge against price volatility. Which derivative instrument provides the right but not the obligation to purchase gas at a fixed price?
- Futures contract
- Swap agreement
- Call option (Correct answer)
- Forward contract
Correct answer: Call option
A call option grants the buyer the right, but not the obligation, to purchase the underlying commodity at a specified strike price before expiration.
Question 3: An energy auditor finds that a utility's Value at Risk (VaR) model uses a 95% confidence interval over a 10-day holding period. What does a VaR of $5 million mean in this context?
- Losses will never exceed $5M
- There is a 5% chance losses will exceed $5M over 10 days (Correct answer)
- Expected losses average $5M per day
- There is a 95% chance losses will exceed $5M
Correct answer: There is a 5% chance losses will exceed $5M over 10 days
A 95% VaR of $5M means there is a 5% probability that losses will exceed $5 million over the specified 10-day holding period.
Question 4: Which internal control is most effective at preventing unauthorized energy trades from being executed?
- Post-trade reconciliation
- Dual-control authorization with segregation of duties (Correct answer)
- Monthly position reports
- Annual external audit
Correct answer: Dual-control authorization with segregation of duties
Dual-control authorization combined with segregation of duties ensures no single individual can initiate and approve a trade, preventing unauthorized transactions.
Question 5: During a compliance audit, an auditor discovers that a power company's risk limits were breached for three consecutive days without escalation. This primarily indicates a failure in:
- Market risk measurement
- Limit monitoring and escalation procedures (Correct answer)
- Counterparty credit assessment
- Regulatory capital calculation
Correct answer: Limit monitoring and escalation procedures
Failure to escalate limit breaches within the required timeframe indicates a breakdown in the limit monitoring and escalation control procedures.
Question 6: What is the primary purpose of a mark-to-market (MTM) process in energy trading risk management?
- To calculate regulatory capital requirements
- To value open positions at current market prices for accurate risk exposure reporting (Correct answer)
- To determine counterparty credit scores
- To establish long-term hedging strategies
Correct answer: To value open positions at current market prices for accurate risk exposure reporting
Mark-to-market revalues open positions using current market prices, providing an accurate real-time picture of the portfolio's profit, loss, and risk exposure.
Question 7: An energy company's audit reveals that stress testing is performed only under historical scenarios. What gap does this represent in the risk mitigation framework?
- Insufficient backtesting frequency
- Absence of hypothetical or forward-looking stress scenarios (Correct answer)
- Lack of VaR model validation
- Failure to report to regulators
Correct answer: Absence of hypothetical or forward-looking stress scenarios
Relying solely on historical scenarios misses plausible but unprecedented events; a robust framework also includes hypothetical and forward-looking stress tests.
ERAC Audit Procedures & Risk Mitigation 2
During an energy risk audit, which sampling technique is most appropriate when the auditor suspects fraud concentrated in high-value transactions?