PRMIA 8008 Online Practice Questions and Exam Preparation

PRMIA 8008 Online Questions & Answers

• Question 91:

  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
  A. I, II and III

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  Explanation

  Internal loss data is generally 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.

• Question 92:

  Which of the following belong to the family of generalized extreme value distributions:

  I - Frechet II - Gumbel III - Weibull IV - Exponential

  A. IV
  B. I, II and III
  C. II and III
  D. All of the above
  B. I, II and III

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  Explanation

  Extreme value theory focuses on the extreme and rare events, and in the case of VaR calculations, it is focused on the right tail of the loss distribution. In very simple and non- technical terms, EVT says the following:

  1.Pull a number of large iid random samples from the population,

  2.For each sample, find the maximum,

  3.Then the distribution of these maximum values will follow a Generalized Extreme Value distribution.

  (In some ways, it is parallel to the central limit theorem which says that the the mean of a large number of random samples pulled from any population follows a normal distribution, regardless of the distribution of the underlying population.)

  Generalized Extreme Value (GEV) distributions have three parameters: (shape parameter), (location parameter) and (scale parameter). Based upon the value of , a GEV distribution may either be a Frechet, Weibull or a Gumbel. These are

  the only three types of extreme value distributions.

• Question 93:

  Company A issues bonds with a face value of $100m, sold at $98. Bank B holds $10m in face of these bonds acquired at a price of $70. Company A then defaults, and the recovery rate is expected to be 30%. What is Bank B's loss?

  A. $7m
  B. $4m
  C. $2.1m
  D. $4.9m
  B. $4m

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  Explanation

  The bank paid $7m for the bonds, and expected recovery is $3m (30% x $10m face). Therefore Bank B's loss is $4m ($7m - $3m). Choice 'b' is the correct answer. All other answers are incorrect.

• Question 94:

  The CDS quote for the bonds of Bank X is 200 bps. Assuming a recovery rate of 40%, calculate the default hazard rate priced in the CDS quote.

  A. 0.80%
  B. 5.00%
  C. 3.33%
  D. 2.00%
  C. 3.33%

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  Explanation

  Hazard rate x Loss given default = CDS quote. In other words, Hazard rate x (1 - recovery rate) = CDS quote. We can therefore calculate the hazard rate for this problem as 200 bps/(1 - 40%) = 3.33%.

• Question 95:

  The definition of operational risk per Basel II includes which of the following:

  I - Risk of loss resulting from inadequate or failed internal processes, people and systems or from external events II - Legal risk III - Strategic risk IV - Reputational risk

  A. I, II, III and IV
  B. II and III
  C. I and III
  D. I and II
  D. I and II

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  Explanation

  Operational risk as defined in Basel II specifically excludes strategic and reputational risk.

  Therefore Choice 'd' is the correct answer.

  Note that Basel II defines operational risk as follows:

  Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk, but excludes strategic and reputational risk.

• Question 96:

  Which of the following is NOT true in respect of bilateral close out netting:

  A. The net amount due is immediately receivable or payable
  B. All transactions are immediately closed out upon the occurrence of a credit event for either of the counterparties
  C. All transactions are netted against each other
  D. Transactions are separated by transaction type and immediately settled separately at each's replacement value
  D. Transactions are separated by transaction type and immediately settled separately at each's replacement value

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  Explanation

  Choice 'b', Choice 'c' and Choice 'a' correctly describe a bilateral close out netting as recommended by the ISDA. However Choice 'd' is not correct as it suggests individual settlement of transactions without netting which is the whole point of bilateral close out netting.

• Question 97:

  Which of the following statements are true:

  I - Liquidity risks during time of crisis may be exacerbated by large collateral calls continuing over a period of time.

  II - Stress tests are always separately modeled from VaR computations which cannot deal with stress scenarios of the kind considered in stress tests.

  III - A maximum loss scenario considers the maximum possible loss given a 'plausibility constraint' that is based upon the joint probability of such a loss happening

  A. I, II and III
  B. I and II
  C. II and III
  D. I and III
  D. I and III

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  Explanation

  If VaR is calculated based upon historical simulations, and these simulations are designed as to include all stress scenarios of interest, then VaR and stress tests can be a part of an integrated risk measurement system. Therefore it is not correct to say that stress tests are always separately modeled from VaR and II is false. I and III are true, and therefore Choice 'd' is the correct answer.

• Question 98:

  Under the standardized approach to calculating operational risk capital, how many business lines are a bank's activities divided into per Basel II?

  A. 7
  B. 15
  C. 8
  D. 12
  C. 8

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  Explanation

  In the Standardized Approach, banks' activities are divided into eight business lines:

  corporate finance, trading and sales, retail banking, commercial banking, payment and settlement, agency services, asset management, and retail brokerage. Therefore Choice 'c' is the correct answer.

• Question 99:

  Which of the following credit risk models relies upon the analysis of credit rating migrations to assess credit risk?

  A. KMV's EDF based approach
  B. The CreditMetrics approach
  C. The actuarial approach
  D. The contingent claims approach
  B. The CreditMetrics approach

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  Explanation

  The correct answer is Choice 'b'. 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).

• Question 100:

  Which of the following is not an approach used for stress testing:

  A. Algorithmic approaches
  B. Historical scenarios
  C. Monte Carlo simulation
  D. Hypothetical scenarios
  C. Monte Carlo simulation

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  Explanation

  Choice 'c' is the correct answer as Monte Carlo simulations are not used to generate stress scenarios. They are applicable to VaR calculations under certain situations, and are not used for stress tests. The other three represent valid approaches to stress testing.