PRMIA 8008 Online Practice Questions and Exam Preparation

PRMIA 8008 Online Questions & Answers

• Question 321:

  According to the Basel II standard, which of the following conditions must be satisfied before a bank can use 'mark-to-model' for securities in its trading book?

  I - Marking-to-market is not possible II - Market inputs for the model should be sourced in line with market prices III - The model should have been created by the front office IV - The model should be subject to periodic review to determine the accuracy of its performance

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

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  Explanation

  According to Basel II, where marking-to-market is not possible, banks may mark-to-model, where this can be demonstrated to be prudent. Marking-to-model is defined as any valuation which has to be benchmarked, extrapolated or otherwise

  calculated from a market input. When marking to model, an extra degree of conservatism is appropriate. Supervisory authorities will consider the following in assessing whether a mark-to-model valuation is prudent:

  Senior management should be aware of the elements of the trading book which are subject to mark to model and should understand the materiality of the uncertainty this creates in the reporting of the risk/performance of the business.

  Market inputs should be sourced, to the extent possible, in line with market prices. The appropriateness of the market inputs for the particular position being valued should be reviewed regularly.

  Where available, generally accepted valuation methodologies for particular products should be used as far as possible.

  Where the model is developed by the institution itself, it should be based on appropriate assumptions, which have been assessed and challenged by suitably qualified parties independent of the development process. The model should be

  developed or approved independently of the front office. It should be independently tested. This includes validating the mathematics, the assumptions and the software implementation.

  There should be formal change control procedures in place and a secure copy of the model should be held and periodically used to check valuations.

  Risk management should be aware of the weaknesses of the models used and how best to reflect those in the valuation output.

  The model should be subject to periodic review to determine the accuracy of its performance (e.g. assessing continued appropriateness of the assumptions, analysis of PandL versus risk factors, comparison of actual close out values to model

  outputs). ?Valuation adjustments should be made as appropriate, for example, to cover the uncertainty of the model valuation.

  The model should be created independent of the front office, and not by it. Therefore statement III does not represent an appropriate choice. Choice 'a' is the correct answer.

• Question 322:

  A cumulative accuracy plot:

  A. is a measure of the correctness of VaR calculations
  B. measures the accuracy of credit risk estimates
  C. measures accuracy of default probabilities observed empirically
  D. measures rating accuracy
  D. measures rating accuracy

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  Explanation

  A cumulative accuracy plot measures the accuracy of credit ratings assigned by rating agencies by considering the relative rankings of obligors according to the ratings given. Choice 'd' is the correct answer.

• Question 323:

  Which of the following statements are true in relation to Historical Simulation VaR?

  I - Historical Simulation VaR assumes returns are normally distributed but have fat tails II - It uses full revaluation, as opposed to delta or delta-gamma approximations III - A correlation matrix is constructed using historical scenarios IV - It particularly suits new products that may not have a long time series of historical data available

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

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  Explanation

  Historical Simulation VaR is conceptually very straightforward: actual prices as seen during the observation period (1 year, 2 years, or other) become the 'scenarios' forming the basis of the valuation of the portfolio. For each scenario, full revaluation is performed, and a PandL data set becomes available from which the desired loss quantile can be extracted. Historical simulation is based upon actually seen prices over a selected historical period, therefore no distributional assumptions are required. The data is what the data is, and is the distribution. Statement I is therefore not correct. It uses full revaluation for each historical scenario, therefore statement II is correct. Since the prices are taken from actual historical observations, a correlation matrix is not required at all. Statement III is therefore incorrect (it would be true for Monte Carlo and parametric Var). Historical simulation VaR suffers from the limitation that if enough representative data points are no available during the historical observation period from which the scenarios are drawn, the results would be inaccurate. This is likely to be the case for new products. Therefore Statement IV is incorrect.

• Question 324:

  If X represents a matrix with ratings transition probabilities for one year, the transition probabilities for 3 years are given by the matrix:

  A. P ^ (-3)
  B. P x P x P
  C. 3 [P ^ (-1)]
  D. 3 [P]
  B. P x P x P

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  Explanation

  Assuming time invariance and the Markov property, it is easy to calculate the transition matrix for any time period as P^n, where P is the given transition matrix for one period and n the number of time periods that we need to compute the new transition matrix for. Thus Choice 'b' is the correct answer.

• Question 325:

  The standalone economic capital estimates for the three uncorrelated business units of a bank are $100, $200 and $150 respectively. What is the combined economic capital for the bank?

  A. 269
  B. 72500
  C. 21
  D. 450
  A. 269

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  Explanation

  Since the business units are uncorrelated, we can get the combined EC as equal to the square root of the sum of the squares of the individual EC estimates. Therefore Choice 'a' is the correct answer. [=SQRT(100^2+200^2+150^2)]

• Question 326:

  If the duration of a bond yielding 10% is 6 years, the volatility of the underlying interest rates 5% per annum, what is the 10-day VaR at 99% confidence of a bond position comprising just this bond with a value of $10m? Assume there are 250 days in a year.

  A. 233000
  B. 139800
  C. 984000
  D. 279600
  B. 139800

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  Explanation

• Question 327:

  A bank holds $10m of a corporate debt that it has purchased CDS protection against. What is the impact on the short term liquidity of the bank in the event of a default by the corporate on its bonds?

  A. An immediate reduction in available liquidity
  B. A short term increase in available liquidity
  C. No impact
  D. Cannot be determined without information on recovery rates
  B. A short term increase in available liquidity

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  Explanation

  The immediate impact of the default would be to improve the liquidity available in the short term due to the pay out from the CDSs. It is also important to consider the impact on liquidity from the occurence of a default even in situations where CDS protection may not have been purchased. In such cases, there may be a nearer term payout in the form of the recovery rate. Of course, recovery payments are generally not realized for longer periods of time as court cases linger on, but there is a good likelihood that a payment, albeit lower in total, is likely to be realized sooner than the maturity of the bond in cases where the bond is a longer term bond. At the same time, any interest payments, and the final principal payment, which may have been included in liquidity projections, will not occur.

• Question 328:

  A bank holds a portfolio of corporate bonds. Corporate bond spreads widen, resulting in a loss of value for the portfolio. This loss arises due to:

  A. Liquidity risk
  B. Credit risk
  C. Market risk
  D. Counterparty risk
  C. Market risk

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  Explanation

  The difference between the yields on corporate bonds and the risk free rate is called the corporate bond spread. Widening of the spread means that corporate bonds yield more, and their yield curve shifts upwards, driving down bond prices. The increase in the spread is a consequence of the market risk from holding these interest rate instruments, which is a part of market risk. If the reduction in the value of the portfolio were to be caused by a change in the credit rating of the bonds held, it would have been a loss arising due to credit risk. Counterparty risk and liquidity risk are not relevant for this question. Therefore Choice 'c' is the correct answer.

• Question 329:

  Which of the following methods cannot be used to calculate Liquidity at Risk?

  A. Monte Carlo simulation
  B. Analytical or parametric approaches
  C. Historical simulation
  D. Scenario analysis
  B. Analytical or parametric approaches

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  Explanation

  Analytical or parametric approaches are not useful at all for liquidity at risk calculations because there are no neat distributions available to parameterize the large number of factors that affect the calculations of liquidity inflows and outflows. Historical simulations, Monte Carlo and scenario analysis (which can complement historical scenarios) are all valid choices

• Question 330:

  Which of the following best describes Altman's Z-score

  A. A calculation of default probabilities
  B. A regression of probability of survival against a given set of factors
  C. A numerical computation based upon accounting ratios
  D. A standardized z based upon the normal distribution
  C. A numerical computation based upon accounting ratios

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  Explanation

  Choice 'c' correctly describes Altman's z-score. All other choices are incorrect.