PRMIA 8008 Online Practice Questions and Exam Preparation

PRMIA 8008 Online Questions & Answers

• Question 331:

  Which of the following data sources are expected to influence operational risk capital under the AMA:

  I - Internal Loss Data (ILD)

  II - External Loss Data (ELD)

  III - Scenario Data (SD)

  IV - Business Environment and Internal Control Factors (BEICF)

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

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  Explanation

  All four data sources are expected to be utilized as inputs as appropriate for operational risk calculations under the advanced measurement approach. Of these, the last one, BEICF, is slightly different from the rest as it does not yield data points that become the basis of curve fitting or other statistical computions underlying capital calculations. It includes items such as KRIs, risk assessments etc and allow the risk manager to assess the qualitative aspects of loss data.

• Question 332:

  The systemic manifestation of the liquidity crisis during the current credit crisis took many forms. Which of the following is not one of those forms?

  A. Drying up of liquidity in the cash market for treasury bonds
  B. Drying up of liquidity in the wholesale money markets
  C. Drying up of liquidity in the corporate bond markets
  D. Stress and large withdrawals from the money markets
  A. Drying up of liquidity in the cash market for treasury bonds

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  Explanation

  The stresses on liquidity that happened as part of the credit crisis beginning 2007-08 led to drying up of trading and liquidity crisis in the corporate bond markets, the auction rate securities markets, the wholesale (interbank lending) markets,

  the money markets, the markets for structured products, and even the otherwise liquid futures and forwards markets (as there was no liquidity available to fund the financing of futures). The one market that was not affected was the market for

  treasuries, in fact the flight to quality ensured that this market was very liquid (even though stressed from a pricing perspective as yields plummetted).

  Therefore Choice 'a' is the correct answer.

• Question 333:

  If the 1-day VaR of a portfolio is $25m, what is the 10-day VaR for the portfolio?

  A. $7.906m
  B. $79.06m
  C. $250m
  D. Cannot be determined without the confidence level being specified
  B. $79.06m

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  Explanation

  The 10-day VaR is = $25m x SQRT(10) = $79.06m. Choice 'b' is the correct answer.

• Question 334:

  Which of the following statements is true:

  I - Basel II requires banks to conduct stress testing in respect of their credit exposures inaddition to stress testing for market risk exposures II - Basel II requires pooled probabilities of default (and not individual PDs for each exposure) to be used for credit risk capital calculations

  A. I
  B. I and II
  C. II
  D. Neither statement is true
  B. I and II

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  Explanation

  The correct answer is choice 'b'

  Both statements are accurate. Basel II requires pooled probabilities of default to be applied to risk buckets that contain similar exposures. Also, stress testing is mandatory for both market and credit risk.

• Question 335:

  Which of the following is a cause of model risk in risk management?

  A. Programming errors
  B. Misspecification of the model
  C. Incorrect parameter estimation
  D. All of the above
  D. All of the above

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  Explanation

  Model risk is the risk that a model built for estimating a variable will produce erroneous estimates. Model risk is caused by a number of factors, including:

  a) Misspecifying the model: For example, using a normal distribution when it is not justified. b) Model misuse: For example, using a model built to estimate bond prices to estimate equity prices c) Parameter estimation errors: In particular,

  parameters that are subjectively determined can be subject to significant parameter estimation errors d) Programming errors: Errors in coding the model as part of computer implementation may not be detected by end users e) Data errors: Errors in data used for building the model may also introduce model risk Therefore the correct answer is d, as all the choices are a source of model risk.

• Question 336:

  For credit risk calculations, correlation between the asset values of two issuers is often proxied with:

  A. Credit migration matrices
  B. Transition probabilities
  C. Equity correlations
  D. Default correlations
  C. Equity correlations

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  Explanation

  Asset returns are relevant for credit risk models where a default is related to the value of the assets of the firm falling below the default threshold. When assessing credit risk for portfolios with multiple credit assets, it becomes necessary to know the asset correlations of the different firms. Since this data is rarely available, it is very common to approximate asset correlations using equity prices. Equity correlations are used as proxies for asset correlation, therefore Choice 'c' is the correct answer.

• Question 337:

  Under the contingent claims approach to measuring credit risk, which of the following factors does NOT affect credit risk:

  A. Cash flows of the firm
  B. Maturity of the debt
  C. Volatility of the firm's asset values
  D. Leverage in the capital structure
  A. Cash flows of the firm

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  Explanation

  Under the contingent claims approach, credit risk is modeled as the value of a put option on the value of the firm's assets with a strike equal to the face value of the debt and maturity equal to the maturity of the obligation. The cost of credit risk is determined by the leverage ratio, the volatility of the firm's assets and the maturity of the debt. Cash flows are not a part of the equation. Therefore Choice 'a' is the correct answer.

• Question 338:

  Which of the following statements are true:

  I - A transition matrix is the probability of a security migrating from one rating class to another during its lifetime.

  II - Marginal default probabilities refer to probabilities of default in a particular period, given survival at the beginning of that period.

  III - Marginal default probabilities will always be greater than the corresponding cumulative default probability.

  IV - Loss given default is generally greater when recovery rates are low.

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

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  Explanation

  Statement I is incorrect. A transition matrix expresses the probabilities of moving to a given set of ratings at the end of a period (usually one year) conditional upon a given rating at the beginning of the period. It does not make a reference to an individual security and certainly not to the probability of migrating to other ratings during its entire lifetime. Statement II is correct. Marginal default probabilities are the probability of default in a given year, conditional upon survival at the beginning of that year. Statement III is incorrect. Cumulative probabilities of default will always be greater than the marginal probabilities of default - except in year 1 when they will be equal. Statement IV is correct. LGD = 1 - Recovery Rate, therefore a low recovery rate implies higher LGD.

• Question 339:

  Which of the following credit risk models includes a consideration of macro economic variables such as unemployment, balance of payments etc to assess credit risk?

  A. KMV's EDF based approach
  B. The CreditMetrics approach
  C. The actuarial approach
  D. CreditPortfolio View
  D. CreditPortfolio View

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  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 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 340:

  Which of the following are a CRO's responsibilities:

  I - Statutory financial reporting II - Reporting to the audit committee III - Compliance with risk regulatory standards IV - Operational risk

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

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  Explanation

  Statutory financial reporting is the responsibility of the Chief Financial Officer, not the Chief Risk Officer. The head of internal audit reports to the audit committee of the board, not the CRO. Therefore statements I and II are incorect. The CRO is generally expected to drive risk and compliance with related regulatory standards. Market risk, credit risk and operational risk groups report into the CRO, so statements III and IV are correct.