With regards to questions that require a written answer, I'm struggling to understand the scope of the points that an examiner is looking for.
As an example, question 1.iv of the September 2020 SP6 paper asks;
"Propose how the insurer could monitor its liquidity risk relating to the use of derivatives"
Within the mark scheme for this paper, the following responses earned marks:
- Liquidity risk arising from derivatives should be monitored as part of the insurer’s liquidity risk management framework ie liquidity risk should be assessed holistically [1⁄2]
- As liquidity is a significant threat to the functioning of the insurance company, it would be expected that the board or executive function would have to review and sign-off the liquidity risk management strategy.
- Any changes to the derivative portfolio, collateral requirement or discounting approach may impact the derivative portfolio’s liquidity needs. [1⁄2]
- Appropriate systems and processes should be put in place to ensure that the derivative portfolio is being monitored. [1⁄2]
- Assessing the hypothetical liquidity needs of its derivative portfolio (alongside the wider liquidity needs) under a series of stressed market conditions will enable the insurer to develop a robust liquidity risk management plan. [1]
- To measure the liquidity risk it is likely that the insurer will use liquidity scenario/stress testing. [1]
- To monitor liquidity risk, the insurer must first set its liquidity risk appetite – this is the amount of liquidity risk it is willing to accept. [1⁄2]
I've not sat an exam that requires many written answers before, and all of the above marks confused me. I interpreted the question at face value - "how can liquidity be measured" - and gave reference to measures such as the bid-ask spread. The above points (which constitute the majority of the marks for this question) I totally overlooked as they don't really seem to answer the question actually asked. The first point, for example, goes without saying, but (to me) it doesn't answer the question of how liquidity can be monitored.
In order not to overlook points such as the above, how can I know exactly what the examiner is looking for? Are there rules-of-thumb regarding what sorts of points are within the scope of the question asked?