PRMIA 8008 Online Practice Questions and Exam Preparation

PRMIA 8008 Online Questions & Answers

• Question 131:

  According to Basel II's definition of operational loss event types, losses due to acts by third parties intended to defraud, misappropriate property or circumvent the law are classified as:

  A. Internal fraud
  B. Execution delivery and system failure
  C. External fraud
  D. Third party fraud
  C. External fraud

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  Explanation

  Choice 'c' is the correct answer. Refer to the detailed loss event type classification under Basel II (see Annex 9 of the accord). You should know the exact names of all loss event types, and examples of each.

• Question 132:

  Which of the following is NOT an approach used to allocate economic capital to underlying business units:

  A. Stand alone economic capital contributions
  B. Marginal economic capital contributions
  C. Fixed ratio economic capital contributions
  D. Incremental economic capital contributions
  C. Fixed ratio economic capital contributions

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  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 ratio economic capital contribution'

• Question 133:

  A risk analyst analyzing the positions for a proprietary trading desk determines that the combined annual variance of the desk's positions is 0.16. The value of the portfolio is $240m. What is the 10-day stand alone VaR in dollars for the desk at a confidence level of 95%? Assume 250 trading days in a year.

  A. 12595200
  B. 157440000
  C. 6297600
  D. 31488000
  D. 31488000

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  Explanation

  The z value at the 95% confidence level is 1.64. Since the variance is 0.16, the annual volatility is 40%. Therefore the daily volatility is 40% x 10/250 = 8%. The VaR therefore is 8% x 1.64 x $240m = $31,488,000

• Question 134:

  The probability of default of a security over a 1 year period is 3%. What is the probability that it would not have defaulted at the end of four years from now?

  A. 11.47%
  B. 88.53%
  C. 12.00%
  D. 88.00%
  B. 88.53%

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  Explanation

  The probability that the security would not default in the next 4 years is equal to the probability of survival raised to the power four. In other words, =(1 - 3%)^4 = 88.53%. Choice 'b' is the correct answer.

• Question 135:

  If A and B be two uncorrelated securities, VaR(A) and VaR(B) be their values-at-risk, then which of the following is true for a portfolio that includes A and B in any proportion. Assume the prices of A and B are log-normally distributed.

  A. VaR(A+B) > VaR(A) + VaR(B)
  B. VaR(A+B) = VaR(A) + VaR(B)
  C. VaR(A+B) < VaR(A) + VaR(B)
  D. The combined VaR cannot be predicted till the correlation is known
  C. VaR(A+B) < VaR(A) + VaR(B)

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  Explanation

  First of all, if prices are lognormally distributed, that implies the returns (which are equal to the log of prices) are normally distributed. To say that prices are lognormally distributed is just another way of saying that returns are normally distributed. Since the correlation between the two securities is zero, this means their variances can be added. But standard deviations, or volatilities cannot be added (they will be the square root of sum of variances). VaR is nothing but a multiple of standard deviation, and therefore it is not additive if correlations are anything other than 1 (ie perfect positive, which would imply we are dealing with the same asset). Therefore VaR(A+B)=SQRT(VaR(A)^2 + VaR(B)^2). This implies the combined VaR of a portfolio with these two securities will be less than the sum of VaRs of the two individual securities. Thus Choice 'c' is the correct answer and the other choices are wrong.

• Question 136:

  The Options Theoretic approach to calculating economic capital considers the value of capital as being equivalent to a call option with a strike price equal to:

  A. The notional value of the debt
  B. The market value of the debt
  C. The value of the firm
  D. The value of the assets
  A. The notional value of the debt

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  Explanation

  The Options Theoretic approach to calculating economic capital is a top- down approach that considers the value of capital as being equivalent to a call option with a strike price equal to the notional value of the debt - ie, the shareholders have a call option on the assets of the firm which they can acquire by paying the debt holders a value equal to their notional claim (ie the face value of the debt). Therefore Choice 'a' is the correct answer and the other choices are incorrect.

• Question 137:

  Pick underlying risk factors for a position in an equity index option:

  I - Spot value for the index II - Risk free interest rate III - Volatility of the underlying IV - Strike price for the option

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

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  Explanation

  The index option is affected by the spot value for the underlying index, as also the risk free interest rate, or the zero rate for the duration of the option. It is also affected by the volatility of the underlying. The 'strike price' is set and is fixed at the

  time the option is purchased, and therefore is not a risk factor.

  Therefore other than IV, all other choices are valid risk factors that underlie an equity index option.

  Other instruments may have other risk factors - for example, a long forex position will have the spot exchange rate as the only risk factor.

• Question 138:

  The Altman credit risk score considers:

  A. A historical database of the firms that have defaulted
  B. A quadratic approximation of the credit risk based on underlying risk factors
  C. A combination of accounting measures and market values
  D. A historical database of the firms that have survived
  C. A combination of accounting measures and market values

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  Explanation

  A computation of Altman's Z-score considers the following ratios:

  -Working capital to total assets

  -Retained earnings to total assets

  -EBIT to total assets

  -Market cap to debt

  -Sales to total assets

  Nearly all the numbers above are accounting measures derived straight from the balance sheet or the income statement. Market capitalization is a market driven number. Therefore Choice 'c' is the correct answer as the Altman credit risk

  score considers both accounting and market based measures.

  Altman's score, though computationally straightforward and intuitively easy to understand, was introduced in the late sixties and has been very accurate in predicting corporate bankruptcies, which is why it continues to be used extensively.

• Question 139:

  If the loss given default is denoted by L, and the recovery rate by R, then which of the following represents the relationship between loss given default and the recovery rate?

  A. L = 1 + R
  B. R = 1 + L
  C. R = 1 / L
  D. R = 1 - L
  D. R = 1 - L

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  Explanation

  When a default occurs, the proportion of the exposure represented by the recovery rate is recovered. For example, if the recovery rate is 40% for a loan, the actual loss in the event of a default would be $60 for a $100 loan. In other words, the loss given default = 1 - recovery rate. Hence Choice 'd' is the correct answer. All other choices are incorrect.

• Question 140:

  Which of the following statements are true:

  I - A high score according to Altman's Z-Score methodology indicates a lower default risk II - A high score according to the Probit or Logit models indicates a higher default risk III - A high score according to Altman's Z-Score methodology indicates a higher default risk IV - A high score according to the Probit or Logit models indicates a lower default risk

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

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  Explanation

  A high score under the probit and logit models indicates a higher default risk, while under Altman's methodology it indicates a lower default risk. Therefore Choice 'd' is the correct answer.