PRMIA 8008 Exam Practice Test Instant Access

Question 1

Altman's Z-score does not consider which of the following ratios:

AMarket capitalization to debt

BSales to total assets

CNet income to total assets

DWorking capital to total assets

Answer : C

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.

Question 2

Which of the following is the most important problem to solve for fitting a severity distribution for operational risk capital:

AThe risk functional's minimization should lead to a good estimate of the 0.999 quantile

BDetermine plausible scenarios to fill the data gaps in the internal and external loss data

CEmpirical loss data needs to be extended to the ranges below the reporting threshold and above large value losses

DThe fit obtained should reduce the combination of the fitting and approximation errors to a minimum
Ultimately, the objective of the operational risk severity estimation exercise is to calculate the 99.9th percentile loss over a one year horizon; and everything else we do with data, collecting loss information, modeling, curve fitting etc revolves around this objective. If we cannot estimate the 99.9th percentile loss accurately, then not much else matters. Therefore Choice 'a' is the correct answer.
Minimizing the combination of fitting and approximation errors is one of the things we do with a view to better estimating the operational loss distribution. Likewise, empirical loss data generally is range bound because corporations do not require employees to log losses less than an threshold, and high value losses are generally rare. This problem is addressed by extrapolating both large and small losses, something that impacts the performance of our model. Likewise, one of the objectives of scenario analysis is to fill data gaps by generating plausible scenarios. Yet while all these are real issues to address, the primary problem we are trying to solve is estimating the 0.999th quantile.

Answer : A

Question 3

An error by a third party service provider results in a loss to a client that the bank has to make up. Such as loss would be categorized per Basel II operational risk categories as:

AExecution delivery and process management

BOutsourcing loss

CBusiness disruption and process failure

DAbnormal loss

Answer : A

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 4

The returns for a stock have a monthly volatilty of 5%. Calculate the volatility of the stock over a two month period, assuming returns between months have an autocorrelation of 0.3.

A8.062%

B7.071%

C5%

D10%
The square root of time rule cannot be applied here because the returns across the periods are not independent. (Recall that the square root of time rule requires returns to be iid, independent and identically distributed.) Here there is a 'autocorrelation' in play, which means one period's returns affect the returns of the other period.
This problem can be solved by combining the variance of the returns from the two consecutive periods in the same way as one would combine the variance of different assets that have a given correlation. In such cases we know that:
Variance (A + B) = Variance(A) + Variance(B) + 2*Correlation*StdDev(A)*StdDev(B).
The standard deviation can be calculated by taking the square root of the variance.
Therefore the combined volatility over the two months will be equal to =SQRT((5%^2) + (5%^2) + 2*0.3*5%*5%) = 8.062%. All other answers are incorrect.

Answer : A

Question 5

Which of the following statements is true:

I,Basel II requires banks to conduct stress testing in respect of their credit exposures in addition to stress testing for market risk exposures

II,Basel II requires pooled probabilities of default (and not individual PDs for each exposure) to be used for credit risk capital calculations

BI & II

CII

DNeither statement is true
The correct answer is choice 'b'
Both statements are accurate. Basel II requires pooled probabilities of default to be applied to risk buckets that contain similar exposures. Also, stress testing is mandatory for both market and credit risk.

Answer : B

Question 6

CreditRisk+, the actuarial model for calculating portfolio credit risk, is based upon:

Athe exponential distribution

Bthe normal distribution

Cthe Poisson distribution

Dthe log-normal distribution

Answer : C

CreditRisk+ treats default as a binary event, ignoring downgrade risk, capital structures of individual firms in the portfolio or the causes of default. It uses a single parameter, or the mean default rate, and derives credit risk based upon the Poisson distribution. Therefore Choice 'c' is the correct answer.

Question 7

According to the implied capital model, operational risk capital is estimated as:

AOperational risk capital held by similar firms, appropriately scaled

BTotal capital less market risk capital less credit risk capital

CCapital implied from known risk premiums and the firm's earnings

DTotal capital based on the capital asset pricing model
Operational risk capital estimated using the implied capital model is merely the capital that is not attributable to market or credit risk. Therefore Choice 'b' is the correct answer. All other responses are incorrect.

Answer : B

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