[Sep-2022] PRM Certification 8010 Exam Practice Dumps
2022 8010 Premium Files Test pdf - Free Dumps Collection
NEW QUESTION 39
Which of the following credit risk models includes a consideration of macro economic variables such asunemployment, balance of payments etc to assess credit risk?
- A. CreditPortfolio View
- B. The CreditMetrics approach
- C. The actuarial approach
- D. KMV's EDF based approach
Answer: A
Explanation:
Explanation
The correct answer is Choice 'd'. The following is a brief description of the major approaches available to model credit risk, and the analysis that underlies them:
1. CreditMetrics: based on the credit migration framework. Considers the probability of migration to other credit ratings and the impact of such migrationson portfolio value.
2. CreditPortfolio View: similar to CreditMetrics, but adds the impact of the business cycle to the evaluation.
3. The contingent claims approach: uses option theory by considering a debt as a put option on the assets of the firm.
4. KMV's EDF (expected default frequency) based approach: relies on EDFs and distance to default as a measure of credit risk.
5. CreditRisk+: Also called the 'actuarial approach', considers default as a binary event that either happens or does not happen. Thisapproach does not consider the loss of value from deterioration in credit quality (unless the deterioration implies default).
NEW QUESTION 40
Which of the following are valid approaches to leveraging external loss data for modeling operational risks:
I. Both internal and external losses can be fitted with distributions,and a weighted average approach using these distributions is relied upon for capital calculations.
II. External loss data is used to inform scenario modeling.
III. External loss data is combined with internal loss data points, and distributions fitted to the combined data set.
IV. External loss data is used to replace internal loss data points to create a higher quality data set to fit distributions.
- A. I, II and III
- B. I and III
- C. II and IV
- D. All of the above
Answer: A
Explanation:
Explanation
Internal loss data isgenerally the highest quality as it is relevant, and is 'real' as it has occurred to the organization. External loss data suffers from a significant limitation that the risk profiles of the banks to which the data relates is generally not known due to anonymization, and may likely may not be applicable to the bank performing the calculations. Therefore, replacing external loss data with external loss data is not a good idea. Statement IV is therefore incorrect.
All other approach described are valid approaches for the risk analyst to consider and implement. Therefore statements I, II and III are correct and IV is not.
NEW QUESTION 41
A zero coupon corporate bond maturing in an year has a probability of default of 5% and yields 12%. The recovery rate is zero. What is the risk free rate?
- A. 5.26%
- B. 5.00%
- C. 7.00%
- D. 6.40%
Answer: D
Explanation:
Explanation
The probability of default would make the expected value of the future cash flows from both the corporate bond and the risk free bond identical. If p be the probability of default, the cash flows from the risky corporate bond would be
= (cash flows in the event of default x probability of default) + (cash flows without default x (1 - probability of default))
=> 5%*0 + (1 - 5%)*(1 + 12%) = (1 + Rf).
therefore Rf = 6.4%
(In reality investors would demand a 'credit risk premium' over and above the expected default loss rate. They are unlikely to be happy with just being compensated with exactly the expected default loss rate plus the risk-fre rate because the expected default loss rate itself is uncertain. They would demand some premium over and above what the default rate alone might mathematically imply above the risk free rate. In this question, this credit risk premium is ignored.)
NEW QUESTION 42
For a back office function processing 15,000 transactions a day with an error rate of 10 basis points, what is the annual expected loss frequency (assume 250 days in a year)
- A. 0.06
- B. 0
- C. 1
- D. 2
Answer: B
Explanation:
Explanation
An error rate of 10 basis points means the number of errors expected in a day will be 15 (recall that 100 basis points = 1%). Therefore the total number of errors expected in a year will be 15 x250 = 3750. Choice 'a' is the correct answer.
NEW QUESTION 43
A bank extends a loan of $1m to a home buyer to buy a house currently worth $1.5m, with the house serving as the collateral. The volatility of returns (assumed normally distributed) on house prices in that neighborhood is assessed at 10% annually. The expected probability of default of the home buyer is 5%.
What is the probability that the bank will recover less than the principal advanced on this loan; assuming the probability of the home buyer's default is independent of the value of the house?
- A. 0
- B. More than 5%
- C. More than 1%
- D. Less than 1%
Answer: D
Explanation:
Explanation
The bank will not be able to recover the principal advanced on this loan if both the home buyer defaults, and the house value falls to less than $1m, ie the price moves adversely by more than$500k, which is
$-500k/$150k = -3.33. (Note that 150k is the 1 year volatility in dollars, ie $1.5m * 10%).
The probability of both these things happening together is just the product of the two probabilities, one of which we know to be 5%. The other is also certainly a small number, and intuitively it is clear that the probability of both the things happening together will be less than 1%.
For a more precise answer, we can calculate the probability of the house price falling by 3.33 standard deviations bycalculating the area under the standard normal curve to the left of -3.33. This indeed is a very small number (actually equal to NORMSINV(-3.33)=0.00043), which when multiplied by the probability of default of the home buyer at 5% is certainly going to be less than 1%. Therefore Choice 'b' is the correct answer.
NEW QUESTION 44
Under thebasic indicator approach to determining operational risk capital, operational risk capital is equal to:
- A. 25% of the average gross income (considering only the positive years) of the past three years
- B. 15% of the average gross income (considering only the positive years) of the past three years
- C. 15% of the average gross income of the past five years
- D. 15% of the average net income (considering only thepositive years) of the past three years
Answer: B
Explanation:
Explanation
Choice 'a' is the correct answer. According to theBasel II document, banks using the Basic Indicator Approach must hold capital for operational risk equal to the average over the previous three years of a fixed percentage (denoted alpha, and currently 15%) of positive annual gross income. Figures for anyyear in which annual gross income is negative or zero should be excluded from both the numerator and denominator when calculating the average.
NEW QUESTION 45
Which of the following formulae describes Marginal VaR for a portfolio p, where V_i is the value of the i-th asset in the portfolio? (All other notation and symbols have their usual meaning.) A)
B)
C)
D)
All of the above
- A. Option D
- B. Option C
- C. Option A
- D. Option B
Answer: A
Explanation:
Explanation
Marginal VaR of a component of a portfolio is the change in the portfolio VaR from a $1 change in the value of the component. It helps a risk analyst who may be trying to identify the best way to influence VaR by changingthe components of the portfolio. Marginal VaR is also important for calculating component VaR (for VaR disaggregation), as component VaR is equal to the marginal VaR multiplied by the value of the component in the portfolio.
Marginal VaR is by definitionthe derivative of the portfolio value with respect to the component i. This is reflected in Choice 'a' above. Using the definitions and relationships between correlation, covariance, beta and volatility of the portfolio and/or the component, we can show that the other two choices are also equivalent to Choice 'a'.
Therefore all the choices present are correct.
NEW QUESTION 46
When compared to a medium severity medium frequency risk, the operational risk capital requirement for a high severity very low frequency risk is likely to be:
- A. Higher
- B. Zero
- C. Lower
- D. Unaffected by differences in frequency or severity
Answer: B
Explanation:
Explanation
High frequency and low severity risks, for example the risks of fraud losses for a credit card issuer, may have high expected losses, but low unexpected losses. In other words, we can generally expect these losses to stay within a small expected and known range. The capital requirement will be the worst case losses at a given confidence level less expected losses, and in such cases this can be expected to below.
On the other hand, medium severity medium frequency risks, such as the risks of unexpected legal claims,
'fat-finger' trading errors, will have low expected losses but a high level of unexpected losses. Thus the capital requirement for suchrisks will be high.
It is also worthwhile mentioning high severity and low frequency risks - for example a rogue trader circumventing all controls and bringing the bank down, or a terrorist strike or natural disaster creating other losses - will probably have zero expected losses & high unexpected losses but only at very high levels of confidence. In other words, operational risk capital is unlikely to provide for such events and these would lie in the part of the tail that is not covered by most levels ofconfidence when calculating operational risk capital.
Note that risk capital is required for only unexpected losses as expected losses are to be borne by P&L reserves. Therefore the operational risk capital requirements for a low severity high frequency risk is likely to be low when compared to other risks that are lower frequency but higher severity.
Thus Choice 'c' is the correct answer.
NEW QUESTION 47
Which of the following is the most important problem to solve for fitting a severity distribution for operational risk capital:
- A. The fit obtained should reduce the combination of the fitting and approximation errors to a minimum
- B. Determine plausible scenarios to fill the data gaps inthe internal and external loss data
- C. The risk functional's minimization should lead to a good estimate of the 0.999 quantile
- D. Empirical loss data needs to be extended to the ranges below the reporting threshold and above large value losses
Answer: C
Explanation:
Explanation
Ultimately, the objective of the operational risk severity estimation exercise is to calculate the 99.9th percentile loss over a one year horizon; and everything else we do with data, collecting loss information, modeling, curve fitting etc revolves around this objective. If we cannot estimate the 99.9th percentile loss accurately, then not much else matters. Therefore Choice 'a' is the correct answer.
Minimizing the combination of fitting and approximation errors is one of the things we do witha view to better estimating the operational loss distribution. Likewise, empirical loss data generally is range bound because corporations do not require employees to log losses less than an threshold, and high value losses are generally rare. This problemis addressed by extrapolating both large and small losses, something that impacts the performance of our model. Likewise, one of the objectives of scenario analysis is to fill data gaps by generating plausible scenarios. Yet while all these are real issues to address, the primary problem we are trying to solve is estimating the 0.999th quantile.
NEW QUESTION 48
Which of the following was not a policy response introduced by Basel 2.5 in response to the global financial crisis:
- A. Incremental Risk Charge (IRC)
- B. Stressed VaR (SVaR)
- C. Comprehensive Risk Model (CRM)
- D. Comprehensive Capital Analysis and Review (CCAR)
Answer: D
Explanation:
Explanation
The CCAR is a supervisory mechanism adopted by the US Federal Reserve Bank to assess capital adequacy for bank holding companies it supervises. Itwas not a concept introduced by the international Basel framework.
The other three were indeed rules introduced by Basel 2.5, which was ultimately subsumed into Basel III.
Stressed VaR is just the standard 99%/10 day VaR, calculated with theassumption that relevant market factors are under stress.
The Incremental Risk Charge (IRC) is an estimate of default and migration risk of unsecuritized credit products in the trading book. (Though this may sound like a credit risk term, it relates to market risk - for example, a bond rated A being downgraded to BBB. In the old days, the banking book where loans to customers are held was the primary source of credit risk, but with OTC trading and complex products the trading book also now holds a good dealof credit risk. Both IRC and CRM account for these.) While IRC considers only non-securitized products, the CRM (Comprehensive Risk Model) considers securitized products such as tranches, CDOs, and correlation based instruments.
The IRC, SVaR and CRMcomplement standard VaR by covering risks that are not included in a standard VaR model. Their results are therefore added to the VaR for capital adequacy determination.
NEW QUESTION 49
Which of the following should be included when calculating the Gross Income indicator used to calculate operational risk capital under the basic indicator and standardized approaches underBasel II?
- A. Fees paid to outsourcing service proviers
- B. Net non-interest income
- C. Insurance income
- D. Operating expenses
Answer: B
Explanation:
Explanation
Gross income is defined by Basel II (see para 650 of the Basel standard) as net interest income plus netnon-interest income. It is intended that this measure should: (i) be gross of any provisions (e.g. for unpaid interest); (ii) be gross of operating expenses, including fees paid to outsourcing service providers; (iii) exclude realised profits/losses from the sale of securities in the banking book; and (iv) exclude extraordinary or irregular items as well as income derived from insurance.
What this means is that gross income is calculated without deducting any provisions or operating expenses from net interest plus non-interest income; and does not include any realised profits or losses from the sale of securities in the banking book, and also does not include any extraordinary or irregular item or insurance income.
Therefore operating expenses are to be notto be deducted for the purposes of calculating gross income, and neither are any provisions. Profits and losses from the sale of banking book securities are not considered part of gross income, and so isn't any income from insurance or extraordinary items.
Of the listed choices, only net non-interest income needs to be included for gross income calculations, and the others are to be excluded. Therefore Choice 'd' is the correct answer. Try to remember the components of gross income from the definition abovebecause in the exam the question may be phrased differently.
NEW QUESTION 50
The VaR of a portfolio at the 99% confidence level is $250,000 when mean return is assumed to be zero. If the assumption of zero returns is changed to an assumption of returns of $10,000, what is the revised VaR?
- A. 0
- B. 1
- C. 2
- D. 3
Answer: D
Explanation:
Explanation
The exact formula for VaR is = -(Z + ), where Z is the z-multiple for the desired confidence level, and is the mean return. Now Z is always a negative number, or at least will certainly be provided the desired confidence level is greater than 50%, and is often assumed to be zero because generally for the short time periods for which market risk VaR is calculated, its value is very close to zero.
Therefore in practice the formula for VaR just becomes -Z, andsince Z is always negative, we normally just multiply the Z factor without the negative sign with the standard deviation to get the VaR.
For this question, there are two ways to get the answer. If we use the formula, we know that -Z= 250,000 (as
=0), and therefore -Z - = 250,000 - 10,000 = $240,000.
The other, easier way to think about this is that if the mean changes, then the distribution's shape stays exactly the same, and the entire distribution shifts to the right by $10,000 as the mean moves upby $10,000. Therefore the VaR cutoff, which was previously at -250,000 on the graph also moves up by 10k to -240,000, and therefore $240,000 is the correct answer.
The other choices are intended to confuse by multiplying the z-factor for the 99% confidence level with
10,000 etc.
NEW QUESTION 51
Which of the following is NOT an approach used to allocate economic capital to underlying business units:
- A. Stand alone economic capital contributions
- B. Fixed ratio economic capital contributions
- C. Incremental economic capital contributions
- D. Marginal economic capital contributions
Answer: B
Explanation:
Explanation
Other than Choice 'c', all others represent valid approaches to allocate economic capital to underlying business units. There is no such thing as 'fixed ratioeconomic capital contribution'
NEW QUESTION 52
Which of the following are ordered correctly in the order of debt seniority in a bankruptcy situation?
I. Equity, Subordinate debt, Senior debt
II. Senior debt, Preferred stock, Equity
III.Secured debt, Accounts payable, Preferred stock
IV. Secured debt, DIP financing, Equity
- A. II, III and IV
- B. I and IV
- C. II and III
- D. I
Answer: C
Explanation:
Explanation
In a bankruptcy, equity ranks last. Preferred equity is one level above equity. Senior debt gets paid outfirst compared to junior debt, and secured debt is paid out first to the extent of the asset securing it (after which it counts as unsecured debt). Accounts payable and other short term liabilities are treated like unsecured creditors. Debtor-in-possession(DIP) financing ranks higher than any other asset as it is financing secured after the bankruptcy to continue the business.
Based on the above, statement I does not represent a correct ordering of seniority as equity is paid last.
Similarly, DIP financingreceives higher priority than even secured debt, and therefore statement IV is incorrect. Therefore the only correct statements are II and III and Choice 'a' is the correct answer.
NEW QUESTION 53
Identify the correct sequence of events as it unfolded in the credit crisis beginning 2007:
I. Mortgage defaults increased
II. Collapse in prices of unrelated assets as banks tried to create liquidity III. Banks refused to lend or transact with each other IV. Asset prices for CDOs collapsed
- A. IV, I, II and III
- B. III, IV, I and II
- C. I, III, IV and II
- D. I, IV, III and II
Answer: D
Explanation:
Explanation
According to a paper by the BCBS, here is an excellent summary of what happened. Based on this, Choice 'c' is the correct answer.
"At the outset of the crisis, mortgage default shocks played a part in the deterioration of marketprices of collateralised debt obligations (CDOs). Simultaneously, these shocks revealed deficiencies in the models used to manage and price these products. The complexity and resulting lack of transparency led to uncertainty about the value of the underlying investment. Market participants then drastically scaled down their activity in the origination and distribution markets and liquidity disappeared. The standstill in the securitisation markets forced banks to warehouse loans that were intended to be soldin the secondary markets. Given a lack of transparency of the ultimate ownership of troubled investments, funding liquidity concerns were triggered within the banking sector as banks refused to provide sufficient funds to each other. This in turn led to the hoarding of liquidity, exacerbating further the funding pressures within the banking sector. The initial difficulties in subprime mortgages also fed through to a broader range of market instruments since the drying up of market and funding liquidity forced market participants to liquidate those positions which they could trade in order to scale back risk. An increase in risk aversion also led to a general flight to quality, an example of which was the high withdrawals by households from money market funds."
NEW QUESTION 54
Which of the following are true:
I. The total of the component VaRs for all components of a portfolio equals the portfolio VaR.
II. The total of the incremental VaRs for each position in a portfolio equals the portfolio VaR.
III. Marginal VaR and incremental VaR are identical for a $1 change in the portfolio.
IV. The VaR for individual components of a portfolio is sub-additive, ie the portfolio VaR is less than (or in extreme cases equal to) the sum of the individual VaRs.
V. The component VaR for individual components of a portfolio is sub-additive, ie the portfolio VaR is less than the sum of the individual component VaRs.
- A. I and II
- B. II and IV
- C. I,III and IV
- D. II and V
Answer: C
Explanation:
Explanation
Statement I is true - component VaR for individual assets in the portfolio add up to the total VaR for the portfolio. This property makes component VaR extremely useful for risk disaggregation and allocation.
Stateent II is incorrect, the incremental VaRs for the positions in a portfolio do not add up to the portfolio VaR, in fact their sum would be greater.
Statement III is correct. Marginal VaR for an asset or position in the portfolio is by definition the change in the VaR as a result of a $1 change in that position. Incremental VaR is the change in the VaR for a portfolio from a new position added to the portfolio - and if that position is $1, it would be identical to the marginal VaR.
Statement IV is correct, VaR is sub-additive due to the diversification effect. Adding up the VaRs for all the positions in a portfolio will add up to more than the VaR for the portfolio as a whole (unless all the positions are 100% correlated, which effectively would mean they are all identical securities which means the portfolio has only one asset).
Statement V is in incorrect. As explained for Statement I above, component VaR adds up to the VaR for the portfolio.
NEW QUESTION 55
As the persistence parameter under EWMA is lowered, which of the following would be true:
- A. The model will react faster to market shocks
- B. The model will react slower to market shocks
- C. High variance from the recent past will persist for longer
- D. The model will give lower weight to recent returns
Answer: A
Explanation:
Explanation
The persistence parameter, , is the coefficient of the prior day's variance in EWMA calculations. A higher value of the persistence parameter tends to 'persist' the prior value of variance for longer. Consider an extreme example - if the persistence parameter is equal to 1, the variance under EWMA will never change in response to returns.
1 - is the coefficient of recent market returns. As is lowered, 1 - increases,giving a greater weight to recent market returns or shocks. Therefore, as is lowered, the model will react faster to market shocks and give higher weights to recent returns, and at the same time reduce the weight on prior variance which will tend to persist for a shorter period.
NEW QUESTION 56
There are two bonds in a portfolio, each with a marketvalue of $50m. The probability of default of the two bonds over a one year horizon are 0.03 and 0.08 respectively. If the default correlation is zero, what is the one year expected loss on this portfolio?
- A. $1.38m
- B. $5.26m
- C. $5.5m
- D. $11m
Answer: C
Explanation:
Explanation
The probabilities of default of the two bonds are independent (as indicated by a zero default correlation). The various possible states of the portfolio are as follows:
First bond defaults, and the second does not: Probability * Loss = 0.03*0.92* $50m = $1.38m Second bond defaults, and the first does not: Probability * Loss = 0.97*0.08 * $50m = $3.88m Both bonds default: Probability * Loss = 0.03*0.08 * $100m = $0.24m Thus total expected loss on this portfolio = $5.5m. Since recovery rates are not provided, those should be assumed to be zero.
There is an easier way to solve this as well: default correlation does not affect expected losses, but their volatility. You can calculate the expected losses of the two bonds and add them up, ie, $50m*0.03+ $50m
*0.08 = $5.5m
NEW QUESTION 57
Which of the following need to be assumed to convert a transition probability matrix for a given time period to the transition probability matrix for another length of time:
I. Time invariance
II. Markov property
III. Normal distribution
IV. Zero skewness
- A. I, II and IV
- B. II and III
- C. III and IV
- D. I and II
Answer: D
Explanation:
Explanation
Time invariance refers to all timeintervals being similar and identical, regardless of the effects of business cycles or other external events. The Markov property is the assumption that there is no ratings momentum, and that transition probabilities are dependent only upon where the rating currently is and where it is going to.
Where it has come from, or what the past changes in ratings have been, have no effect on the transition probabilities.
Rating agencies generally provide transition probability matrices for a given period of time, say a year. The risk analyst may need to convert these into matrices for say 6 months, 2 years or whatever time horizon he or she is interested in. Simplifying assumptions that allow him to do so using simple matrix multiplication include these two assumptions - time invariance and the Markov property. Thus Choice 'c' is the correct answer. The other choices (normal distribution and zero skewness) are non-sensical in this context.
NEW QUESTION 58
Which of the following credit risk models considers debt as including a put option on the firm's assets toassess credit risk?
- A. The contingent claims approach
- B. CreditPortfolio View
- C. The CreditMetrics approach
- D. The actuarial approach
Answer: A
Explanation:
Explanation
The correct answer is Choice 'c'. The following is a brief description of the major approaches available to model credit risk, and the analysis that underlies them:
1. CreditMetrics: based on the credit migration framework. Considers the probability of migration to other credit ratings and the impact of such migrations on portfolio value.
2. CreditPortfolio View: similar to CreditMetrics, but adds the impact of the business cycle to the evaluation.
3. The contingent claims approach: uses option theory by considering a debt as a put option on the assets of the firm.
4. KMV's EDF (expected default frequency) based approach: relies on EDFs and distance to default as a measure of credit risk.
5. CreditRisk+: Also called the 'actuarial approach', considers default as a binary event that either happens or does not happen. This approach does not consider the loss of value from deterioration in credit quality (unless the deterioration implies default).
NEW QUESTION 59
Which of the following statements are true:
I. Pre-settlement risk is the risk that one of the parties to a contract might default prior to the maturity date or expiry of the contract.
II. Pre-settlement risk can be partly mitigated by providing for early settlement in the agreements between the counterparties.
III. The current exposure from an OTC derivatives contract is equivalent to its current replacement value.
IV. Loan equivalent exposures are calculated even for exposures that are not loans as a practical matter for calculating credit risk exposure.
- A. II and III
- B. III and IV
- C. II and IV
- D. I, II, III and IV
Answer: D
Explanation:
Explanation
Pre-settlement risk is the risk that one of the counterparties defaults prior to the date for the maturity of the transaction in question. This may be an unrelated default, in fact there may have been no default on that particular contract, but the party may have defaulted on its other obligations, or filed for bankruptcy. To deal with such cases and to protect the interests of both the parties, it is common toprovide for immediate termination of positions and settlement based on the current replacement value of the contracts. Therefore statements I and II are correct.
Statement III is correct as well - the exposure from an OTC derivative contract derives fromits current replacement value, and not the notional. If the current replacement value is negative, then the credit exposure is considered equal to zero.
Statement IV is correct as it is quite common to restate all exposures - those from credit lines, OTC derivatives etc - in loan equivalent terms prior to estimating credit risk.
NEW QUESTION 60
The generalized Pareto distribution, when used in the context of operational risk, is used to model:
- A. Tail events
- B. Expected losses
- C. Unexpected losses
- D. Average losses
Answer: A
Explanation:
Explanation
Some risk experts have suggested the use of extreme value theory to model tail risk or extreme events for operational risk. The generalized Pareto model or the Peaks-over-Threshold (POT) model are often used to model extreme value distributions, and therefore Choice 'a' is the correct answer.
NEW QUESTION 61
Which of the following is not a tool available to financial institutions for managing credit risk:
- A. Credit derivatives
- B. Cumulative accuracy plot
- C. Collateral
- D. Third party guarantees
Answer: B
Explanation:
Explanation
Collateral, limits to avoid credit exposure concentrations, termination rights based upon credit ratings, third party guarantees and credit derivatives are all tools or instruments that financial institutions use to manage their credit risk. A cumulative accuracy plot measures the accuracy of ratings, and is not a tool for managing credit risk. Therefore Choice 'b' represents the correct answer.
NEW QUESTION 62
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