PRMIA 8008 Exam Practice Test Instant Access

Question 1

Under the KMV Moody's approach to credit risk measurement, how is the distance to default converted to expected default frequencies?

AUsing a proprietary database based on historical information

BUsing migration matrices

CUsing a normal distribution

DUsing Monte Carlo simulations

Answer : A

KMV Moody's uses a proprietary database to convert the distance to default to expected default probabilities.

Question 2

Under the standardized approach to determining operational risk capital, operations risk capital is equal to:

Aa fixed percentage of the latest gross income of the bank

Ba varying percentage, determined by the national regulator, of the gross revenue of each of the bank's business lines

C15% of the average gross income (considering only the positive years) of the past three years

Da fixed percentage (different for each business line) of the gross income of the eight specified business lines, averaged over three years
Choice 'd' is the correct answer, as laid down in the Basel II document. The other choices are incorrect.

Answer : D

Question 3

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.

AI and II

BI, II and III

CIII and IV

DII and IV

Answer : C

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.

Question 4

The CDS quote for the bonds of Bank X is 200 bps. Assuming a recovery rate of 40%, calculate the default hazard rate priced in the CDS quote.

A0.80%

B5.00%

C3.33%

D2.00%

Answer : C

Hazard rate x Loss given default = CDS quote. In other words, Hazard rate x (1 - recovery rate) = CDS quote. We can therefore calculate the hazard rate for this problem as 200 bps/(1 - 40%) = 3.33%.

Question 5

Which of the following is not a parameter to be determined by the risk manager that affects the level of economic credit capital:

ARisk horizon

BConfidence level

CProbability of default

DDefinition of credit losses
Three parameters define economic credit capital: the risk horizon, ie the time horizon over which the risk is being assessed; the confidence level, ie the quintile of the loss distribution; and the definition of credit losses, ie whether mark-to-market losses are considered in addition to default-only losses. The probability of default is not a parameter within the control of the risk manager, but an input into the capital calculation process that he has to estimate. Therefore Choice 'c' is the correct answer.

Answer : C

Question 6

If the annual default hazard rate for a borrower is 10%, what is the probability that there is no default at the end of 5 years?

A39.35%

B50.00%

C59.05%

D60.65%

Answer : D

A default hazard rate is the rate of default in a continuous time setting. This question is asking for probability of survival at the end of 5 years. The formula to calculate the probability of survival at the end of t years where the default hazard rate is is e^(- *t) (or in Excel, =exp(-*t). Therefore the correct answer is Choice 'd'.

(It may be tempting to infer that if the probability of survival at the end of 1 year is 90% (1 - 10%), then the probability of survival in 5 years would be 90%^5. However this reasoning is not correct for the reason that the given rate is not the discrete rate of default, but the hazard rate which is nothing but the continuously compounded rate of default.)

Question 7

The loss severity distribution for operational risk loss events is generally modeled by which of the following distributions:

I,the lognormal distribution

II,The gamma density function

III,Generalized hyperbolic distributions

IV. Lognormal mixtures

AII and III

BI, II and III

CI, II, III and IV

DI and III
All of the distributions referred to in the question can be used to model the loss severity distribution for op risk. Therefore Choice 'c' is the correct answer.

Answer : C

PRMIA 8008 Risk Management Frameworks, Operational Risk, Credit Risk, Counterparty Risk, Market Risk, ALM, FTP – 2015 Edition Exam Practice Test