PRMIA 8008 Online Practice Questions and Exam Preparation

PRMIA 8008 Online Questions & Answers

• Question 81:

  Which of the following is true in relation to a Contingency Funding Plan (CFP)?

  I - A CFP is like a disaster recovery plan to deal with a liquidity crisis II - A CFP should consider market stress conditions, but failures of payment systems are not relevant as they fall under the remit of operational risk III - Reputational damage may result if the market finds out that a firm has had to execute its CFP IV - Sources of emergency funding considered in the CFP should include the role of the central bank as the lender of last resort

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

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  Explanation

  A CFP is indeed a disaster recovery plan to deal with a liquidity crisis. Therefore statement I is correct.

  A CFP should consider market stress conditions, including wide scale failures of payment and settlement systems. Statement II is not correct. It is true that reputational damage may result if a firm has to activate its CFP - therefore the plan

  should consider internal and external communications, the timing of information release and the groups within the firm who need to know about the implementation of the plan. Reputational damage can only make any existing liquidity

  problems worse. Statement III is correct.

  Sources of emergency funding should not include funding from the central bank - unless as part of a regular lending facility. Its role as a lender of last resort can not be considered in a CFP. Statement IV is incorrect.

  Therefore only statements I and III are correct.

• Question 82:

  Under the KMV Moody's approach to credit risk measurement, which of the following expressions describes the expected 'default point' value of assets at which the firm may be expected to default?

  A. Short term debt + Long term debt
  B. 2* Short term debt + Long term debt
  C. Short term debt + 0.5* Long term debt
  D. Long term debt + 0.5* Short term debt
  C. Short term debt + 0.5* Long term debt

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  Explanation

  A situation where a firm has more liabilities than assets does not necessarily imply default, so long as the firm is able to pay its obligations when they come due. Therefore, short term debts have a greater bearing on a firm's default than longer term debt. However, this is not to say that merely having enough to pay off the short term debts (ie debts due within one year) is enough to avoid default. Over time, the long term debt will also be turning to short term debt, and it may not be possible for the firm to roll over its liabilities without lenders considering the long term debt. The KMV approach considers the entire short term debt and half of the long term debt as the critical value of assets below which default will be triggered. Therefore Choice 'c' is the correct answer.

• Question 83:

  Which of the following objectives are targeted by rating agencies when assigning ratings:

  I - Ratings accuracy II - Ratings stability III - High accuracy ratio (AR) IV - Ranked ratings

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

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  Explanation

  Rating agencies target both accuracy and stability when they assign ratings. These two objectives can sometimes conflict, so a balance needs to be struck between the two. Rating agencies do not target any particular 'accuracy ratio' or rankings. Therefore Choice 'c' is the correct answer.

• Question 84:

  A Monte Carlo simulation based VaR can be effectively used in which of the following cases:

  A. When returns data cannot be analytically modeled
  B. When returns are discontinuous or display large jumps
  C. Where analytical methods are too complex to effectively use
  D. All of the above
  D. All of the above

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  Explanation

  Monte Carlo simulations can be effectively used in all cases where an analytical estimate of the VaR cannot be made for any reason - which may include complexity of portfolios, discontinuities or non-linearity in returns or just the plain unavailability of closed form analytical models. Therefore Choice 'd' is the correct answer.

• Question 85:

  The unexpected loss for a credit portfolio at a given VaR estimate is defined as:

  A. max(Actual Loss - Expected Loss, 0)
  B. Actual Loss - Expected Loss
  C. Actual Loss - VaR
  D. VaR - Expected Loss
  D. VaR - Expected Loss

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  Explanation

  Unexpected loss for a credit portfolio refers to the excess of the VaR estimate over the average expected loss. The term 'unexpected loss' has this specific meaning in the context of credit risk, and not any other intuitive meaning. So if for a portfolio worth $100m expected losses are 4%, and the credit VaR at 99% is $12m, then unexpected losses at that VaR quintile are $8m. This is unrelated to actual realized losses versus expected losses. Therefore Choice 'd' is the correct answer and the others are not. Unexpected loss is used to determine the capital reserves to be maintained against a credit portfolio at a certain level of confidence.

• Question 86:

  What does a middle office do for a trading desk?

  A. Operations
  B. Transaction data entry
  C. Reconciliations
  D. Risk analysis
  D. Risk analysis

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  Explanation

  The 'middle office' is a term used for the risk management function, therefore Choice 'd' is the correct answers. The other functions describe what the 'back office' does (IT, accounting). The 'front office' includes the traders.

• Question 87:

  Loss from a lawsuit from an employee due to physical harm caused while at work is categorized per Basel II as:

  A. Employment practices and workplace safety
  B. Execution delivery and process management
  C. Unsafe working environment
  D. Damage to physical assets
  A. Employment practices and workplace safety

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  Explanation

  Choice 'a' 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 88:

  What is the 1-day VaR at the 99% confidence interval for a cash flow of $10m due in 6 months time? The risk free interest rate is 5% per annum and its annual volatility is 15%. Assume a 250 day year.

  A. 5500
  B. 1744500
  C. 109031
  D. 85123
  A. 5500

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  Explanation

  The $10m cash flow due in 6 months is equivalent to a bond with a present value of 10m/(1.05)^0.5 =$9,759,000. Essentially, the question requires us to calculate the VaR of a bond. The VaR of a fixed income instrument is given by Duration x Interest Rate x Volatility of the interest rate x z-factor corresponding to the confidence level. In this case, since the question requires us to calculate the value "closest to" the correct answer, we can use an estimate for the modified duration of the bond as equal to 0.5 years/(1+r) = 0.5/1.05 = 0.47 years. The VaR would be given by 0.5 * 5% * 15% * 2.326 * sqrt(1/250) * 9,759,000 = $5,384 which is closest to $5,500. Therefore Choice 'a' is the correct answer. Note that we have to multiply by sqrt(1/250) as the given volatility is annual and the question is asking for daily VaR. All other answers are incorrect.

• Question 89:

  If and are the expected rate of return and volatility of an asset whose prices are log- normally distributed, and a random drawing from a standard normal distribution, we can simulate the asset's returns using the expressions:

  A. - + .
  B. + .
  C. / .
  D. - .
  B. + .

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  Explanation

  A standard model for representing asset returns in finance is the Geometric Brownian Motion process, and returns according to this model can be estimated by the expression given in Choice 'b'. Note that prices according to this model are log-normally distributed, and returns are normally distributed.

• Question 90:

  A corporate bond has a cumulative probability of default equal to 20% in the first year, and 45% in the second year. What is the monthly marginal probability of default for the bond in the second year, conditional on there being no default in the first year?

  A. 3.07%
  B. 2.60%
  C. 15.00%
  D. 31.25%
  A. 3.07%

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  Explanation

  Note that marginal probabilities of default are the probabilities for default for a given period, conditional on survival till the end of the previous period. Cumulative probabilities of default are probabilities of default by a point in time, regardless of when the default occurs. If the marginal probabilities of default for periods 1, 2... n are p1, p2...pn, then cumulative probability of default can be calculated as Cn = 1 - (1 - p1)(1-p2)...(1-pn). For this question, we can calculate the marginal probability of default for year 2 by solving the equation [1 - (1 - 20%)(1 - P2) = 45%] for P2. Solving, we get the marginal probability of default during year 2 as 31.25%. Since this is the annual marginal probability of default, we will need to convert it to a monthly number, which we can do by solving the following equation where M1 is the monthly marginal probability of default. 1 - 31.25% = (1 - M1)^12, implying M1 = 3.07%