PRMIA 8008 Online Practice Questions and Exam Preparation

PRMIA 8008 Online Questions & Answers

• Question 191:

  Which of the following statements are true:

  I - The three pillars under Basel II are market risk, credit risk and operational risk.

  II - Basel II is an improvement over Basel I by increasing the risk sensitivity of the minimum capital requirements.

  III - Basel II encourages disclosure of capital levels and risks

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

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  Explanation

  The three pillars under Basel II are minimum capital requirements, supervisory review process and market discipline. Therefore statement I is false. The other two statements are accurate. Therefore Choice 'd' is the correct answer.

• Question 192:

  Which of the following is additive, ie equal to the sum of its components

  A. Incremental VaR
  B. Conditional VaR
  C. Specific VaR
  D. Component VaR
  D. Component VaR

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  Explanation

  Component VaR measures the proportion of total VaR that can be allocated to each asset in the portfolio. It is based upon the covariance matrix multiplied by the weights, and each row represents the component VaR for the asset in question. Since the total of such a matrix is the total VaR, component VaR is additive. Component VaR is used to assess the contribution of each asset in the portfolio to total risk and has the useful property of being additive so some sense can be made of the contribution of each asset to total risk. Incremental VaR, conditional VaR and VaR are sub-additive by definition, and therefore not the correct answer.

• Question 193:

  long bond position is hedged using a short position in the futures market. If the hedge performs as expected, then which of the following statements is most accurate:

  A. the investor will be able to avoid losses and will also be able to keep the gains on his positions
  B. the investor will be able to avoid losses
  C. the investor will be able to avoid losses but will also forgo the gains on his positions
  D. None of the above
  C. the investor will be able to avoid losses but will also forgo the gains on his positions

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  Explanation

  If the hedge performs as expected, then any PandL on the long bond position will be offset by identical losses (or gains) on the hedge. Since hedges are never perfect, and some residual risk such as basis risk, the inability to enter into an unrounded number of futures contracts will remain. However, the bulk of the risk would be mitigated, and the investor will be able to avoid any losses but will also forgo any gains. Therefore choice b is the correct answer and the rest are incorrect.

• Question 194:

  The loss severity distribution for operational risk loss events is generally modeled by which of the following distributions:

  I - the lognormal distribution II - The gamma density function III - Generalized hyperbolic distributions IV - Lognormal mixtures

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

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  Explanation

  All of the distributions referred to in the question can be used to model the loss severity distribution for op risk. Therefore Choice 'c' is the correct answer.

• Question 195:

  For a security with a daily standard deviation of 2%, calculate the 10-day VaR at the 95% confidence level. Assume expected daily returns to be nil.

  A. 0.02
  B. 0.104
  C. 0.1471
  D. None of the above.
  B. 0.104

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  Explanation

  If the daily standard deviation is 2%, the 10-day standard deviation will be 2%* 10 = 0.063245. The value of Z at the 95% confidence level is 1.64485. Therefore the VaR value is 1.64485 * 0.063245 = 10.4%. The other choices are incorrect.

• Question 196:

  Which of the following decisions need to be made as part of laying down a system for calculating VaR:

  I - The confidence level and horizon II - Whether portfolio valuation is based upon a delta-gamma approximation or a full revaluation III - Whether the VaR is to be disclosed in the quarterly financial statements IV - Whether a 10 day VaR will be calculated based on 10-day return periods, or for 1-day and scaled to 10 days

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

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  Explanation

  While conceptually VaR is a fairly straightforward concept, a number of decisions need to be made to select between the different choices available for the exact mechanism to be used for the calculations. The Basel framework requires banks

  to estimate VaR at the 99% confidence level over a 10 day horizon. Yet this is a decision that needs to be explicitly made and documented.

  Therefore 'I' is a correct choice.

  At various stages of the calculations, portfolio values need to be determined. The valuation can be done using a 'full valuation', where each position is explicitly valued; or the portfolio(s) can be reduced to a handful of risk factors, and risk

  sensitivities such as delta, gamma, convexity etc be used to value the portfolio. The decision between the two approaches is generally based on computational efficiency, complexity of the portfolio, and the degree of exactness desired. 'II'

  therefore is one of the decisions that needs to be made.

  The decision as to disclosing the VaR in financial filings comes after the VaR has been calculated, and is unrelated to the VaR calculation system a bank needs to set up. 'III' is therefore not a correct answer. Though the Basel framework

  requires a 10-day VaR to be calculated, it also allows the calculation of the 1-day VaR and and scaling it to 10 days using the square root of time rule. The bank needs to decide whether it wishes to scale the VaR based on a 1-day VaR

  number, or compute VaR for a 10 day period to begin with. 'IV' therefore is a decision to be made for setting up the VaR system.

• Question 197:

  Which of the following are considered properties of a 'coherent' risk measure: I - Monotonicity II - Homogeneity III - Translation Invariance IV - Sub-additivity

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

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  Explanation

  All of the properties described are the properties of a 'coherent' risk measure. Monotonicity means that if a portfolio's future value is expected to be greater than that of another portfolio, its risk should be lower than that of the other portfolio. For example, if the expected return of an asset (or portfolio) is greater than that of another, the first asset must have a lower risk than the other. Another example: between two options if the first has a strike price lower than the second, then the first option will always have a lower risk if all other parameters are the same. VaR satisfies this property. Homogeneity is easiest explained by an example: if you double the size of a portfolio, the risk doubles. The linear scaling property of a risk measure is called homogeneity. VaR satisfies this property. Translation invariance means adding riskless assets to a portfolio reduces total risk. So if cash (which has zero standard deviation and zero correlation with other assets) is added to a portfolio, the risk goes down. A risk measure should satisfy this property, and VaR does. Sub-additivity means that the total risk for a portfolio should be less than the sum of its parts. This is a property that VaR satisfies most of the time, but not always. As an example, VaR may not be sub-additive for portfolios that have assets with discontinuous payoffs close to the VaR cutoff quantile.

• Question 198:

  Which of the following are considered counterparty based credit enhancements?

  I - Collateral II - Credit default swaps III - Close out netting arrangements IV - Guarantees

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

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  Explanation

  Credit enhancements come in two varieties: counterparty based, where the exercise of the credit enhancement requires a third party to pay, and this includes guarantees and CDS contracts. Asset based credit enhancements are based upon a physical asset in possession, and these include collateral and balances owed on other trades or transactions, and availed through close out netting arrangements. Of the listed choices, I and III are asset based credit enhancements, and II and IV are third party based.

• Question 199:

  A risk management function is best organized as:

  A. integrated with the risk taking functions as risk management should be a pervasive activity carried out at all levels of the organization.
  B. report independently of the risk taking functions
  C. reporting directly to the traders, as to be closest to the point at which risks are being taken
  D. a part of the trading desks and other risk taking teams
  B. report independently of the risk taking functions

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  Explanation

  The point that this question is trying to emphasize is the independence of the risk management function. The risk function should be segregated from the risk taking functions as to maintain independence and objectivity. Choice 'd', Choice 'c' and Choice 'a' run contrary to this requirement of independence, and are therefore not correct. The risk function should report directly to senior levels, for example directly to the audit committee, and not be a part of the risk taking functions.

• Question 200:

  Which of the following will be a loss not covered by operational risk as defined under Basel II?

  A. Earthquakes
  B. Fat finger losses
  C. Systems failure
  D. Strategic planning
  D. Strategic planning

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  Explanation

  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.

  Therefore any losses from poor strategic planning will not be a part of operational risk.

  Choice 'd' is the correct answer.

  Note that floods, earthquakes and the like are covered under the definition of operational risk as losses arising from loss or damage to physical assets from natural disaster or other events.