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

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Total 362 questions
Question 1

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



Answer : D


Question 2

The probability of default of a security over a 1 year period is 3%. What is the probability that it would have defaulted within 6 months?



Answer : C

The question is asking for the probability of default over a 6 month period when the probability of annual default is known. If we let the 6 month probability of defaut be 'd', then the probability of survival at the end of 1 year would be (1 - d)^2. This we know is equal to 1 - 3% = 0.97. Therefore we can calculate 'd' to be equal to 1.51%. Choice 'c' is the correct answer, the others are incorrect.

Note that an exam question may ask for probability of the security having survived after 6 months, in which case the answer might be 1 - 1.51%. Also note that such questions will always require you to use the probability of survival (1 - probability of default) for doing the calculations. That is because the probabilities of survival can be multiplied over periods of time, but not probabilities of default as the first default in any period is the 'game-over' event after which neither survival nor defaults mean anything. Therefore you generally always have to get the probability of survival till a point in time, and use that for any other calculations.


Question 3

For an option position with a delta of 0.3, calculate VaR if the VaR of the underlying is $100.



Answer : C

The first order approximation of the VaR of an option position is nothing but the VaR of the underlying multiplied by the option's delta. This is intuitive because the delta is the sensitivity of the option price to changes in the prices of the underlying, and in this case since the delta is 0.3 and the underlying's VaR is $100, the VaR of the options position is 0.3 x $100 = $30. Therefore Choice 'c' is the correct answer.

(Note that the second order approximation of the VaR of an options position considers the option gamma too, and VaR reduces if gamma increases.)


Question 4

An investor enters into a 5-year total return swap with Bank A, with the investor paying a fixed rate of 6% annually on a notional value of $100m to the bank and receiving the returns of the S&P500 index with an identical notional value. The swap is reset monthly, ie the payments are exchanged monthly. On Jan 1 of the fourth year, after settling the last month's payments, the bank enters bankruptcy. What is the legal claim that the hedge fund has against the bank in the bankruptcy court?



Answer : C

According to ISDA standard definitions, the legal claim for OTC derivatives is the current replacement value of the contract. Therefore Choice 'c' is the correct answer. None of the other choices are correct.


Question 5

Which of the following cannot be used to address the issue of heavy tails when modeling market returns



Answer : B

Normal mixtures, EVT and the t-distribution are all possible solutions addressing the issue of heavy tails in financial returns.

EWMA and GARCH address volatility clustering, which is the other problem when doing risk calculations. Therefore Choice 'b' is the correct answer as EWMA is not used to address heavy tails but volatility clustering.


Question 6

Which of the following was not a policy response introduced by Basel 2.5 in response to the global financial crisis:



Answer : B

The CCAR is a supervisory mechanism adopted by the US Federal Reserve Bank to assess capital adequacy for bank holding companies it supervises. It was not a concept introduced by the international Basel framework.

The other three were indeed rules introduced by Basel 2.5, which was ultimately subsumed into Basel III.

Stressed VaR is just the standard 99%/10 day VaR, calculated with the assumption that relevant market factors are under stress.

The Incremental Risk Charge (IRC) is an estimate of default and migration risk of unsecuritized credit products in the

trading book. (Though this may sound like a credit risk term, it relates to market risk - for example, a bond rated A being downgraded to BBB. In the old days, the banking book where loans to customers are held was the primary source of credit risk, but with OTC trading and complex products the trading book also now holds a good deal of credit risk. Both IRC and CRM account for these.)

While IRC considers only non-securitized products, the CRM (Comprehensive Risk Model) considers securitized products such as tranches, CDOs, and correlation based instruments.

The IRC, SVaR and CRM complement standard VaR by covering risks that are not included in a standard VaR model. Their results are therefore added to the VaR for capital adequacy determination.


Question 7

Which of the following is not a risk faced by a bank from holding a portfolio of residential mortgages?



Answer : D

Choice 'd' represents a risk that does not arise from its holdings of mortgages. Therefore Choice 'd' is the correct answer.

All the other risks identified are correct - the bank faces interest rate, default and prepayment risks on its mortgages.


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Total 362 questions