PRMIA 8008 Online Practice Questions and Exam Preparation

PRMIA 8008 Online Questions & Answers

• Question 341:

  When combining separate bottom up estimates of market, credit and operational risk measures, a most conservative economic capital estimate results from which of the following assumptions:

  A. Assuming that the resulting distributions have a correlation between 0 and 1
  B. Assuming that market, credit and operational risk estimates are perfectly positively correlated
  C. Assuming that market, credit and operational risk estimates are perfectly negatively correlated
  D. Assuming that market, credit and operational risk estimates are uncorrelated
  B. Assuming that market, credit and operational risk estimates are perfectly positively correlated

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  Explanation

  Explanation

  If the risks are considered perfectly positively correlated, ie assumed to have a correlation equal to 1, the standard deviations can simply be added together. This gives the most conservative estimate of combined risk for capital calculation

  purposes. In practice, this is the assumption used most often.

  If risks are uncorrelated, ie correlation is assumed to be zero, variances can be added or the standard deviation is the root of the sum of the squares of the individual standard deviations. This obviously gives a number lower than that given

  when correlation is assumed to be +1. Similarly, assumptions of negative correlation, or any correlation other than +1 will give a standard deviation number that is smaller and therefore less conservative. Choice 'b' is the correct answer.

• Question 342:

  Which of the following are measures of liquidity risk

  I - Liquidity Coverage Ratio II - Net Stable Funding Ratio III - Book Value to Share Price IV - Earnings Per Share

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

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  Explanation

  In December 2009 the BIS came out with a new consultative document on liquidity risk. Given the events of 2007 - 2009, it has been clear that a key characteristic of the financial crisis was the inaccurate and ineffective management of liquidity risk The paper two separate but complementary objectives in respect of liquidity risk management: The first objective relates to the short-term liquidity risk profile of institution, and the second objective is to promote resiliency over longer-term time horizons. The paper identifies the following two ratios - you should be aware of these - though I am not sure if these will show up in the PRMIA exam:

  1. Liquidity Coverage Ratio addresses the ability of an institution to survive an acute liquidity risk stress scenario lasting one month. It is calculated as follows: Liquidity Coverage Ratio = Stock of high quality liquid assets/Net cash outflows over a 30- day time period

  2. Net Stable Funding Ratio has been developed to capture structural issues related to funding choices. Net Stable Funding Ratio = Available amount of stable funding/Required amount of stable funding Both ratios should be equal to or greater than 1. The statement contains detailed definitions of what is included or excluded from each of the terms used in the calculations for each of the ratios. In addition, the standard also describes the what the 'acute' scenario should include (things such as a 3 notch credit downgrade, reduction in retail deposits etc) Therefore Choice 'b' is the correct answer. Book Value to Share Price and Earnings Per Share are accounting measures unrelated to liquidity.

• Question 343:

  A risk analyst peforming PCA wishes to explain 80% of the variance. The first orthogonal factor has a volatility of 100, and the second 40, and the third 30. Assume there are no other factors. Which of the factors will be included in the final analysis?

  A. First, Second and Third
  B. First and Second
  C. First
  D. Insufficient information to answer the question
  C. First

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  Explanation

  The total variance of the system is 100^2 + 40^2 + 30^2 = 12500 (as variance = volatility squared). The first factor alone has a variance of 10,000, or 80%. Therefore only the first factor will be included in the final analysis, and the rest will be ignored. Interestingly, this example highlights one of the limitations of PCA. Obviously, the second and third factors are material when considering volatility, though the effect of squaring them to get the variance makes them appear less important than they are.

• Question 344:

  Which of the following is the most accurate description of EPE (Expected Positive Exposure):

  A. The maximum average credit exposure over a period of time
  B. The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date
  C. Weighted average of the future positive expected exposure across a time horizon.
  D. The average of the distribution of positive exposures at a specified future date
  C. Weighted average of the future positive expected exposure across a time horizon.

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  Explanation

  When a derivative transaction is entered into, its value generally is close to zero. Over time, as the value of the underlying changes, the transaction acquires a positive or negative value. It is not possible to predict the future value of the

  transaction in advance, however distributional assumptions can be made and potential exposure can be measured in multiple ways. Of all the possible future exposures, it is generally positive exposures that are relevant to credit risk because

  that is the only situation where the bank may lose money from a default of the counterparty.

  The maximum (generally a quantile eg, the 97.5th quantile) exposure possible over the time of the transaction is the 'Potential Future Exposure', or PFE. The average of the distribution of positive exposures at a specified date before the

  longest trade in the portfolio is called 'Expected Exposure', or EE. The expected positive exposure calculated as the weighted average of the future positive Expected Exposure across a time horize is called the EPE, or the 'Expected Positive

  Exposure'.

  The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date - is the 'fair value', as defined under FAS 157. Therefore the corect answer is that EPE is the weighted average of the future positive expected exposure across a time horizon.

• Question 345:

  Which of the following best describes the concept of marginal VaR of an asset in a portfolio:

  A. Marginal VaR is the value of the expected losses on occasions where the VaR estimate is exceeded.
  B. Marginal VaR is the contribution of the asset to portfolio VaR in a way that the sum of such calculations for all the assets in the portfolio adds up to the portfolio VaR.
  C. Marginal VaR is the change in the VaR estimate for the portfolio as a result of including the asset in the portfolio.
  D. Marginal VaR describes the change in total VaR resulting from a $1 change in the value of the asset in question.
  D. Marginal VaR describes the change in total VaR resulting from a $1 change in the value of the asset in question.

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  Explanation

  The correct answer is choice 'd'

  Marginal VaR is just the change in total VaR from a $1 change in the value of the asset in the portfolio. All other answers are incorrect. Mathematically, it is expressed as follows, where VaRp is the VaR for the portfolio, and Vi is the value of

  the asset in question.

  

  Other answers describe other VaR related concepts such as incremental VaR, Component VaR and Conditional VaR.

• Question 346:

  Consider a portfolio with a large number of uncorrelated assets, each carrying an equal weight in the portfolio. Which of the following statements accurately describes the volatility of the portfolio?

  A. The volatility of the portfolio is the same as that of the market
  B. The volatility of the portfolio will be close to zero
  C. The volatility of the portfolio will be equal to the square root of the sum of the variances of the assets in the portfolio weighted by the square of their weights
  D. The volatility of the portfolio will be equal to the weighted average of the volatility of the assets in the portfolio
  C. The volatility of the portfolio will be equal to the square root of the sum of the variances of the assets in the portfolio weighted by the square of their weights

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  Explanation

  When assets are uncorrelated, variances are additive. But volatility (which is standard deviation) is not. In the given situation, the total variance of the portfolio will be equal to the the square root of the sum of the variances of the assets in the portfolio weighted by the square of their weights. Its volatility will be the square root of this variance. Thus Choice 'c' is the correct answer. (This is because V(cA + dB) = c^2 V(A) + d^2 V(B) - refer tutorial on combining variances.) Choice 'd' is incorrect as it describes the calculation of variance, not volatility. Also, the presence of a large number of uncorrelated assets does not create a portfolio with volatility equal to zero or that of the market. The other choices are therefore incorrect.

• Question 347:

  Which of the following statements are true ?

  I - Risk governance structures distribute rights and responsibilities among stakeholders in the corporation II - Cybernetics is the multidisciplinary study of cyber risk and control systems underlying information systems in an organization III - Corporate governance is a subset of the larger subject of risk governance IV - The Cadbury report was issued in the early 90s and was one of the early frameworks for corporate governance

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

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  Explanation

  Governance structures specify the policies, principles and procedures for making decisions about corporate direction. They distribute rights and responsibiliies among stakeholders that typically include executive management, employees, the board etc. Statement I is therefore correct. "Cybernetics is a transdisciplinary approach for exploring regulatory systems, their structures, constraints, and possibilities. In the 21st century, the term is often used in a rather loose way to imply "control of any system using technology" (Wikipedia). Governance literature has been affected by cybernetics, which is not the same thing as information security or cyber security. Statement II is incorrect. Corporate governance includes risk governance, and not the other way round. Therefore statement III is incorrect. The Cadbury Report, titled Financial Aspects of Corporate Governance, was a report issued in the UK in December 1992 by "The Committee on the Financial Aspects of Corporate Governance". The report is eponymous with the chair of the committee, and set out recommendations on the arrangement of company boards and accounting systems to mitigate corporate governance risks and failures. Statement IV is therefore correct.

• Question 348:

  A long position in a credit sensitive bond can be synthetically replicated using:

  A. a long position in a treasury bond and a short position in a CDS
  B. a long position in a treasury bond and a long position in a CDS
  C. a short position in a treasury bond and a short position in a CDS
  D. a short position in a treasury bond and a long position in a CDS
  A. a long position in a treasury bond and a short position in a CDS

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  Explanation

  The correct answer is choice 'a'

  A long position in a credit sensitive bond is equivalent to earning the risk free rate and the spread on the bond. The risk free rate can be earned through a long position in a treasury bond, and the spread can be earned in the form of premiums

  on a CDS, which are received by the protection seller, ie the party short a CDS contract. Therefore we can get the same results as a long bond position using a combination of a long treasury bond and a short position in a CDS. Choice 'a' is

  the correct answer.

• Question 349:

  There are two bonds in a portfolio, each with a market value of $50m. The probability of default of the two bonds are 0.03 and 0.08 respectively, over a one year horizon. If the default correlation is 25%, what is the one year expected loss on this portfolio?

  A. $1.38m
  B. $11m
  C. $5.26m
  D. $5.5mc
  D. $5.5mc

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  Explanation

  We will need to calculate the joint probability distribution of the portfolio as follows.Probability of the joint default of both A and B =

  

  The marginal probabilities (ie the standalone probabilities of default of the two bonds) are known, and if we can calculate the probability of joint defaults of the two bonds, we can calculate the rest of the entries. We then multiply the probabilities with the expected loss under each scenario and add them up to get the total expected loss. The calculations are shown below. The expected loss is $5.5m, and therefore the correct answer is Choice 'd'.

  

• Question 350:

  A portfolio's 1-day VaR at the 99% confidence level is $250m. What is the annual volatility of the portfolio? (assuming 250 days in the year)

  A. $2,410.3m
  B. $1,699.4m
  C. $107.5m
  D. $3,952.8m
  B. $1,699.4m

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  Explanation

  This is easy to calculate as follows: At the 99% confidence level, the VaR=2.326 * Std Deviation (remember the z values at the 95% and 99% levels, the PRMIA exam may not give you these values). Thus the 1-day standard deviation is $250m/2.326, and the 250-day standard deviation is 250 * ($250m/2.326) = $1,699.4m. Remember: if you know the VaR, you know the standard deviation. Once you know the standard deviation for any period of time, you can convert it into standard deviation for another period using the square root of time rule. You can also calculate the VaR at a different confidence level too.