PRMIA Risk Management Frameworks, Operational Risk, Credit Risk, Counterparty Risk, Market Risk, ALM, FTP ? 2015 Edition Exam Practice Test

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Total 362 questions
Question 1

Which of the following correctly describes survivorship bias:



Answer : C

Survivorship bias is the tendency for failed companies, funds, investments and even entire markets (eg Russian stock market returns after the Communist revolution) to be excluded from performance studies because they no longer exist. Survivorship bias results in past results looking better than they actually were as data points relating to failures are not included.

A risk manager needs to be aware of survivorship bias when basing risk analysis on historical data and should question if failures (eg failed funds, delisted companies etc) have been included in the data he or she is relying upon.


Question 2

Which of the following statements are true in relation to the current state of the financial network?

I,Interconnectivity between countries has reduced while that between institutions in the same country has increased significantly

II,The degrees of separation between institutions has gone up

III,The average path length connecting any two given institutions has shrunk

IV. Knife-edge dynamics imply that systemic risk arises from the financial system flipping from risk sharing to risk spreading



Answer : C

Over the past decade or so, systemic risk has been increased by vastly increasing network complexities resulting from greater interconnectivity between institutions as well as countries. Therefore statement I is incorrect.

Statement II is incorrect and statement III is correct because the average path length between institutions, or their degree of separation where they are not directly dealing with each other but through other counterparties to which they are exposed (analogous to 6 degrees of separation, or the 'small world' property), has shrunk and not increased.

Statement IV correctly describes knife edge dynamics, which is another way of waying that the financial network displays a tipping point property.


Question 3

The degree distribution of the nodes of the financial network is:



Answer : D

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.


Question 4

Stress testing is useful for which of the following purposes:

I,For providing the risk manager with an intuitive check on his risk estimates

II,Providing a means of communicating risk implications using plausible scenarios that can be easily explained to a non-technical audience

III,Guarding against major errors in the form of model risk

IV. Complying with the requirements of Basel II.



Answer : A


Question 5

Which of the following statements are true with respect to stress testing:

I,Stress testing results in a dollar estimate of losses

II,The results of stress testing can replace VaR as a measure of risk as they are better grounded in reality

III,Stress testing provides an estimate of losses at a desired level of confidence

IV. Stress testing based on factor shocks can allow modeling extreme events that have not occurred in the past



Answer : A

Any stress test is conducted with a view to produce a dollar estimate of losses, therefore statement I is correct. However, these numbers do not come with any probabilities or confidence levels, unlike VaR, and statement III is incorrect. Stress testing can complement VaR, but not replace it, therefore statement II is not correct. Statement IV is correct as stress tests can be based on both actual historical events, or simulated factor shocks (eg, a factor, such as interest rates, moves by say 10-z).

Therefore Choice 'a' is correct.


Question 6

For a US based investor, what is the 10-day value-at risk at the 95% confidence level of a long spot position of EUR 15m, where the volatility of the underlying exchange rate is 16% annually. The current spot rate for EUR is 1.5. (Assume 250 trading days in a year).



Answer : C

The VaR for a spot FX position is merely a function of the standard deviation of the exchange rate. If V be the value of the position (in this case, EUR 15m x 1.5 = USD 22.5m), z the appropriate z value associated with the level of confidence desired, and be the standard deviation of the portfolio, the VaR is given by ZV.

In this case, the 10-day standard deviation is given by SQRT(10/250)*16%. Therefore the VaR is =1.645*15*1.5*(16%*SQRT(10/250)) = USD 1.1844m. Choice 'c' is the correct answer.


Question 7

For an equity portfolio valued at V whose beta is , the value at risk at a 99% level of confidence is represented by which of the following expressions? Assume represents the market volatility.



Answer : A

For the PRM exam, it is important to remember the z-multiples for both 99% and 95% confidence levels (these are 2.33 and 1.64 respectively).

The value at risk for an equity portfolio is its standard deviation multiplied by the appropriate z factor for the given confidence level. If we knew the standard deviation, VaR would be easy to calculate. The standard deviation can be derived using a correlation matrix for all the stocks in the portfolio, which is not a trivial task. So we simplify the calculation using the CAPM and essentially say that the standard deviation of the portfolio is equal to the beta of the portfolio multiplied by the standard deviation of the market.

Therefore VaR in this case is equal to Beta x Mkt Std Dev x Value x z-factor, and therefore Choice 'a' is the correct answer.


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