[Dec 19, 2021] Fully Updated Dumps PDF - Latest 8008 Exam Questions and Answers
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NEW QUESTION 184
The backtesting of VaR estimates under the Basel accord requires comparing the ex-ante VaR to:
- A. the Basel accord does not require banks to backtest VaR estimates
- B. ex-ante VaR calculated for the subsequent periods
- C. realized profit and loss for the period
- D. hypothetical profit and loss keeping the positions constant
Answer: C
Explanation:
Explanation
Basel II requires financial institutions to compare their ex-ante VaR estimates to actual realized P&L.
Therefore Choice 'd' is the correct answer. A bank may use hypothetical P&L based upon constant positions to validate its model, but that is not required for Basel II.
NEW QUESTION 185
If the 1-day VaR of a portfolio is $25m, what is the 10-day VaR for the portfolio?
- A. $250m
- B. $7.906m
$79.06m - C. Cannot be determined without the confidence level being specified
Answer: A
Explanation:
Explanation
The 10-day VaR is = $25m x SQRT(10) = $79.06m. Choice 'b' is the correct answer.
NEW QUESTION 186
According to the Basel framework, reserves resulting from the upward revaluation of assets are considered a part of:
- A. Tier 2 capital
- B. All of the above
- C. Tier 3 capital
- D. Tier 1 capital
Answer: A
Explanation:
Explanation
According to the Basel II framework, Tier 1 capital, also called core capital or basic equity, includes equity capital and disclosed reserves.
Tier 2 capital, also called supplementary capital, includes undisclosed reserves, revaluation reserves, general provisions/general loan-loss reserves, hybrid debt capital instruments and subordinated term debt.
Tier 3 capital, or short term subordinated debt, is intended only to cover market risk but only at the discretion of their national authority.
NEW QUESTION 187
Under the KMV Moody's approach to calculating expecting default frequencies (EDF), firms' default on obligations is likely when:
- A. expected asset values one year hence are below total liabilities
- B. asset values reach a level below short term debt
- C. asset values reach a level below total liabilities
- D. asset values reach a level between short term debt and total liabilities
Answer: D
Explanation:
Explanation
An observed fact that the KMV approach relies upon is that firms do not default when their liabilities exceed assets, but when asset values are somewhere between short term liabilities and the total liabilities. In fact, the
'default point' in the KMV methodology is defined as the short term debt plus half of the long term debt. The difference between expected value of the assets in one year and this 'default point', when expressed in terms of standard deviation of the asset values, is called the 'distance-to-default'.
Therefore Choice 'd' is the correct answer. The other choices are incorrect.
NEW QUESTION 188
Which of the following is not true about the ISDA master agreement (ISDA MA):
- A. The ISDA MA describes the close out process
- B. The ISDA MA describes events of default, and termination events
- C. All transactions under the ISDA MA are considered separate obligations
- D. The CSA (Credit Support Annex) is one of the parts of the ISDA MA
Answer: C
Explanation:
Explanation
The ISDA MA provides a template that can be used by market participants to document derivative transactions. It has a core section that applies always, and various schedules that can be agreed to by the parties. The ISDA MA considerably facilitates closing transactions once the ISDA MA has been has been negotiated, without requiring a renegotiation each time.
A key feature of the ISDA MA is that it binds all transactions into a single net obligation. The ISDA Master
2002 states that "All transactions are entered into in reliance on the fact that this Master Agreement and all Confirmations form a single agreement between the parties ... and the parties would not otherwise enter into any Transactions." Therefore transactions under the ISDA MA are not considered separate obligations.
The ISDA MA does indeed define close out processes, default and termination events, and the CSA is one of the parts of the MA that describes the collateral related agreement.
NEW QUESTION 189
Which of the following statements are true:
I. The sum of unexpected losses for individual loans in a portfolio is equal to the total unexpected loss for the portfolio.
II. The sum of unexpected losses for individual loans in a portfolio is less than the total unexpected loss for the portfolio.
III. The sum of unexpected losses for individual loans in a portfolio is greater than the total unexpected loss for the portfolio.
IV. The unexpected loss for the portfolio is driven by the unexpected losses of the individual loans in the portfolio and the default correlation between these loans.
- A. I and II
- B. I, II and III
- C. II and IV
- D. III and IV
Answer: D
Explanation:
Explanation
Unexpected losses (UEL) for individual loans in a portfolio will always sum to greater than the total unexpected loss for the portfolio (unless all the loans are correlated in such a way that they default together).
This is akin to the 'diversification effect' in market risk, in other words, not all the obligors would default together. So the UEL for the portfolio will always be less than the sum of the UELs for individual loans.
Therefore statement III is true.This 'diversification effect' will be affected by the default correlations between the obligors, in cases where the probability of various obligors defaulting together is low, the UEL for the portfolio would be much less than the UEL for the individual loans. Hence statement IV is true.I and II are false for the reasons explained above.
NEW QUESTION 190
Under the actuarial (or CreditRisk+) based modeling of defaults, what is the probability of 4 defaults in a retail portfolio where the number of expected defaults is 2?
- A. 2%
- B. 18%
- C. 9%
- D. 4%
Answer: C
Explanation:
Explanation
The actuarial or CreditRisk+ model considers default as an 'end of game' event modeled by a Poisson distribution. The annual number of defaults is a stochastic variable with a mean of and standard deviation equal to .
The probability of n defaults is given by (^n e^-) /n!, and therefore in this case is equal to (=2^4 * exp(-2))/FACT(4)) = 0.0902.
Note that CreditRisk+ is the same methodology as the actuarial approach, and requires using the Poisson distribution.
NEW QUESTION 191
What would be the consequences of a model of economic risk capital calculation that weighs all loans equally regardless of the credit rating of the counterparty?
I. Create an incentive to lend to the riskiest borrowers
II. Create an incentive to lend to the safest borrowers
III. Overstate economic capital requirements
IV. Understate economic capital requirements
- A. III only
- B. II and III
- C. I and IV
- D. I only
Answer: C
Explanation:
Explanation
If capital calculations are done in a standard way regardless of risk (as reflected by credit ratings), then it creates a perverse incentive for the lenders' employees to lend to the riskiest borrowers that offer the highest expected returns as there is no incentive to 'save' on economic capital requirements that are equal for both safe and unsafe borrowers. Therefore statement I is correct.
Given that the portfolio of such an institution is likely to then comprise poor quality borrowers, and economic capital would be based upon 'average' expected ratings, it is likely to carry lower economic capital given its exposures. Therefore any such economic risk capital model is likely to understate economic capital requirements. Therefore statement IV is correct.
Statements II and III are incorrect and Choice 'b' is the correct answer.
NEW QUESTION 192
The degree distribution of the nodes of the financial network is:
- A. best approximated by a beta distribution
- B. long tailed
- C. normally distributed
- D. non-linear
Answer: B
Explanation:
Explanation
The 'degree' of a node in a network measures the number of links to other nodes. For the financial network, each market participant can be thought of as a node. The 'degree distribution' can be thought of as the histogram of the number of links for each node.
The financial network has a degree distribution with rather long tails - and therefore Choice 'd' is the correct answer. The other choices are incorrect. Long tailed networks have the property that they are robust when affected by random disturbances, but susceptible to targeted attacks, for example on key hubs.
NEW QUESTION 193
For the purposes of calculating VaR, an FRA can be modeled as a combination of:
- A. a zero coupon bond and an interest rate swap
- B. a fixed rate bond and a zero coupon bond
- C. two zero coupon bonds
- D. a zero coupon bond and a floating rate note
Answer: C
Explanation:
Explanation
A forward rate agreement allows one of the parties to borrow an amount at a rate for a length of time, all of which are agreed in advance. Consider a "3 x 6" FRA. This allows a fixed rate borrowing starting at 3 months till the end of 6 months. This is economically equivalent to holding a zero coupon bond till the end of 6 months, and being short another zero coupon bond till the end of 3 months (or the other way round, depending upon which end of the FRA you are on). Therefore Choice 'c' is the correct answer.
NEW QUESTION 194
Calculate the 99% 1-day Value at Risk of a portfolio worth $10m with expected returns of 10% annually and volatility of 20%.
- A. 0
- B. 1
- C. 2
- D. 3
Answer: A
Explanation:
Explanation
Be wary of questions asking you to calculate VaR where the mean or expected returns are different from zero.
The VaR formula of z-value times standard deviation needs to have an adjustment for the expected return [ie use VaR = z-value times standard deviation minus expected return]. In this case, the standard deviation for 1 day for the portfolio is =SQRT(1/250)*20%*$10m = $126,491. The VaR is therefore (2.326 * $126,491) - ($10,000,000 * 10% * 1/250) = $290,218.
NEW QUESTION 195
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. I and II
- B. III only
- C. II and III
- D. I only
Answer: C
Explanation:
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.
NEW QUESTION 196
What percentage of average annual gross income is to be held as capital for operational risk under the basic indicator approach specified under Basel II?
- A. 0.08
- B. 0.15
- C. 0.125
- D. 0.12
Answer: B
Explanation:
Explanation
Banks using the basic indicator approach must hold 15% of the average annual gross income for the past three years, excluding any year that had a negative gross income. Therefore Choice 'd' is the correct answer.
NEW QUESTION 197
Which of the following statements is true:
I. When averaging quantiles of two Pareto distributions, the quantiles of the averaged models are equal to the geometric average of the quantiles of the original models based upon the number of data items in each original model.
II. When modeling severity distributions, we can only use distributions which have fewer parameters than the number of datapoints we are modeling from.
III. If an internal loss data based model covers the same risks as a scenario based model, they can can be combined using the weighted average of their parameters.
IV If an internal loss model and a scenario based model address different risks, the models can be combined by taking their sums.
- A. I and II
- B. II and III
- C. All statements are true
- D. III and IV
Answer: C
Explanation:
Explanation
Statement I is true, the quantiles of the averaged models are equal to the geometric average of the quantiles of the original models.
Statement II is correct, the number of data points from which model parameters are estimated must be greater than the number of parameters. So if a distribution, say Poisson, has one parameter, we need at least two data points to estimate the parameter. Other complex distributions may have multiple parameters for shape, scale and other things, and the minimum number of observations required will be greater than the number of parameters.
Statement III is true, if the ILD data and scenarios cover the same risk, they are essentially different perspectives on the same risk, and therefore should be combined as weighted averages.
But if they cover completely different risks, the models will need to be added together, not averaged - which is why Statement IV is true.
NEW QUESTION 198
Which loss event type is the loss of personally identifiable client information classified as under the Basel II framework?
- A. External fraud
- B. Information security
- C. Clients, products and business practices
- D. Technology risk
Answer: C
Explanation:
Explanation
Choice 'b' is the correct answer. All other answers are incorrect.
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.
NEW QUESTION 199
Which of the following statements are true:
I. Capital adequacy implies the ability of a firm to remain a going concern II. Regulatory capital and economic capital are identical as they target the same objectives III. The role of economic capital is to provide a buffer against expected losses IV. Conservative estimates of economic capital are based upon a confidence level of 100%
- A. I and III
- B. III
- C. I
- D. I, III and IV
Answer: C
Explanation:
Explanation
Statement I is true - capital adequacy indeed is a reference to the ability of the firm to stay a 'going concern'.
(Going concern is an accounting term that means the ability of the firm to continue in business without the stress of liquidation.) Statement II is not true because even though the stated objective of regulatory capital requirements is similar to the purposes for which economic capital is calculated, regulatory capital calculations are based upon a large number of ad-hoc estimates and parameters that are 'hard-coded' into regulation, while economic capital is generally calculated for internal purposes and uses an institution's own estimates and models. They are rarely identical.
Statement II is not true as the purpose of economic capital is to provide a buffer against unexpected losses.
Expected losses are covered by the P&L (or credit reserves), and not capital.
Statement IV is incorrect as even though economic capital may be calculated at very high confidence levels, that is never 100% which would require running a 'risk-free' business, which would mean there are no profits either. The level of confidence is set at a level which is an acceptable balance between the interests of the equity providers and the debt holders.
NEW QUESTION 200
A risk analyst uses the GARCH model to forecast volatility, and the parameters he uses are = 0.001%, = 0.05 and = 0.93. Yesterday's daily volatility was calculated to be 1%. What is the long term annual volatility under the analyst's model?
- A. 0.22 %
- B. 3.54 %
- C. 0.25 %
- D. 7.94 %
Answer: B
Explanation:
Explanation
The correct answer is choice 'a'
Recall the following summary of the GARCH model. The long term variance in a GARCH model is given by
/(1 - - ). In this case, this works out to =SQRT(0.001/(1 - 0.05 - 0.93)) * SQRT(250) = 3.54%. Yesterday's volatility of 1% is irrelevant to the question.
NEW QUESTION 201
If E denotes the expected value of a loan portfolio at the end on one year and U the value of the portfolio in the worst case scenario at the 99% confidence level, which of the following expressions correctly describes economic capital required in respect of credit risk?
- A. U
- B. U/E
- C. E - U
- D. E
Answer: C
Explanation:
Explanation
Economic capital in respect of credit risk is intended to absorb unexpected losses. Unexpected losses are the losses above and beyond expected losses and up to the level of confidence that economic capital is being calculated for. The capital required to cover unexpected losses in this case is E - U, and therefore Choice 'a' is the correct answer.
This question does raise an important point - are expected losses a part of economic capital, or are they not?
Different text books say different things, and sometimes they say both the things. I have tried to take an approach that uses what I read in the PRMIA handbook.
This
writeup - http://www.riskprep.com/all-tutorials/37-exam-3/111-credit-var-an-intuitive-understanding - may help clarify things further.
NEW QUESTION 202
Regulatory arbitrage refers to:
- A. All of the above
- B. the practice of structuring a financial institution's business as a bank holding company to arbitrage the differing capital and credit rating requirements for different business lines
- C. the practice of investing and financing decisions being driven by associated regulatory capital requirements as opposed to the true underlying economics of these decisions
- D. the practice of transferring business and profits to jurisdictions (such as those in other countries) to avoid or reduce capital adequacy requirements
Answer: C
Explanation:
Explanation
The correct answer is Choice 'c'. The other choices do not refer to 'regulatory arbitrage'.
NEW QUESTION 203
Under the KMV Moody's approach to credit risk measurement, how is the distance to default converted to expected default frequencies?
- A. Using a normal distribution
- B. Using Monte Carlo simulations
- C. Using migration matrices
- D. Using a proprietary database based on historical information
Answer: D
Explanation:
Explanation
KMV Moody's uses a proprietary database to convert the distance to default to expected default probabilities.
NEW QUESTION 204
The key difference between 'top down models' and 'bottom up models' for operational risk assessment is:
- A. Bottom up approaches to operational risk calculate the implied operational risk using available data such as income volatility, capital etc; while top down approaches use causal factors, risk drivers and other factors to get an aggregated estimate of risk.
- B. Top down approaches to operational risk are based upon an analysis of key risk drivers, while bottom up approaches consider causality in risk scenarios.
- C. Bottom up approaches to operational risk are based upon an analysis of key risk drivers, while top down approaches consider causality in risk scenarios.
- D. Top down approaches to operational risk calculate the implied operational risk using available data such as income volatility, capital etc; while bottom up approaches use causal factors, risk drivers and other factors to get an aggregated estimate of risk.
Answer: D
Explanation:
Explanation
Top down approaches rely upon available data such as total capital, income volatility, peer group information etc and attempt to imply the capital attributable to operational risk. They do not consider firm specific scenarios or causal factors. Bottom up approaches on the other hand attempt to determine operational risk capital based upon an identification and quantification of firm specific risks. Bottom up approaches help determine a traditional loss distribution from which capital requirements can be determined at a given level of confidence.
Therefore Choice 'd' is the correct answer.
NEW QUESTION 205
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, II and IV
- B. I and IV
- C. I and III
- D. II and IV
Answer: D
Explanation:
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.
NEW QUESTION 206
Altman's Z-score does not consider which of the following ratios:
- A. Working capital to total assets
- B. Market capitalization to debt
- C. Net income to total assets
- D. Sales to total assets
Answer: C
Explanation:
Explanation
A computation of Altman's Z-score considers the following ratios:
- Working capital to total assets
- Retained earnings to total assets
- EBIT to total assets
- Market cap to debt
- Sales to total assets
It does not consider Net Income to total assets, therefore Choice 'c' is the correct answer. This makes sense as net income is after interest and taxes, both of which are not relevant for considering the cash flows for debt servicing.
NEW QUESTION 207
Which of the following is NOT true in respect of bilateral close out netting:
- A. Transactions are separated by transaction type and immediately settled separately at each's replacement value
- B. All transactions are netted against each other
- C. All transactions are immediately closed out upon the occurrence of a credit event for either of the counterparties
- D. The net amount due is immediately receivable or payable
Answer: A
Explanation:
Explanation
Choice 'b', Choice 'c' and Choice 'a' correctly describe a bilateral close out netting as recommended by the ISDA. However Choice 'd' is not correct as it suggests individual settlement of transactions without netting which is the whole point of bilateral close out netting.
NEW QUESTION 208
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