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

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Total 362 questions
Question 1

Which of the following is NOT true in respect of bilateral close out netting:



Answer : D

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.


Question 2

Which of the following best describes the concept of marginal VaR of an asset in a portfolio:



Answer : D

The correct answer is choice 'd'

Marginal VaR is just the change in total VaR from a $1 change in the value of the asset in the portfolio. All other answers are incorrect. Mathematically, it is expressed as follows, where VaRp is the VaR for the portfolio, and Vi is the value of the asset in question.

Other answers describe other VaR related concepts such as incremental VaR, Component VaR and Conditional VaR.


Question 3

In setting confidence levels for VaR estimates for internal limit setting, it is generally desirable:



Answer : D

If the confidence levels for a VaR estimate are set too high, there may never be any exceedences, ie actual losses will never exceed VaR estimates. For limit setting, we want actual losses to exceed the VaR estimates enough number of times as during the year so that the limits are considered seriously. If the VaR estimate is exceeded too many times, or never, then it is unlikely to be considered seriously. Therefore Choice 'd' is the correct answer.

The other answers are incorrect as they either require the VaR to be too high (ie zero or rare excess loss situations) or too low (ie there will be too many cases of excess loss situations to be taken seriously).


Question 4

Which of the following losses can be attributed to credit risk:

I,Losses in a bond's value from a credit downgrade

II,Losses in a bond's value from an increase in bond yields

III,Losses arising from a bond issuer's default

IV. Losses from an increase in corporate bond spreads



Answer : D

Losses due to credit risk include the loss of value from credit migration and default events (which can be considered a migration to the 'default' category). Therefore Choice 'd' is the correct answer. Changes in spreads or interest rates are examples of market risk events.

[Discussion: It may be argued that losses from spreads changing could be categorized as credit risk and not market risk. The distinction between credit and market risk is never really watertight.

The reason I have called it market risk in this question is because spreads can change due to two reasons: first, due to the individual issuer going down in their credit rating (whether issued or perceived, as we have witnessed in Europe sovereign debt), and second due to the spread for the overall category changing due to macro fundamentals with nothing changing for the individual issuer. For example the spread between municipal bonds and treasuries may be small during boom times and may expand during recessions - regardless of how the individual issuer has been doing. Clearly, the first case is credit risk and the second is probably market risk.

A change in overall corporate bond spreads is something I would consider akin to a rate change - which is why I have called it as not a part of credit risk. But an alternative perspective may not be incorrect either.]


Question 5

Which of the following is not a credit event under ISDA definitions?



Answer : C

According to ISDA, a credit event is an event linked to the deteriorating credit worthiness of an underlying reference entity in a credit derivative. The occurrence of a credit event usually triggers full or partial termination of the transaction and a payment from protection seller to protection buyer. Credit events include

- bankruptcy,

- failure to pay,

- restructuring,

- obligation acceleration,

- obligation default and

- repudiation/moratorium.

A rating downgrade is not a credit event.


Question 6

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 7

Once the frequency and severity distributions for loss events have been determined, which of the following is an accurate description of the process to determine a full loss distribution for operational risk?



Answer : B

Once the frequency distribution has been determined (for example, using the binomial, Poisson or the negative binomial distributions) and the severity distribution has also been determined (for example, using the lognormal, gamma or other functions), the loss distribution can be produced by a Monte Carlo simulation using successive drawings from each of these two distributions. It is assumed that the severity and frequency are independent of each other. The resulting distribution gives a distribution showing the losses for operational risk, from which there Op Risk VaR can be determined using the appropriate percentile. Therefore Choice 'b' is the correct answer.


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