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NEW QUESTION 14
For an option position with a delta of 0.3, calculate VaR if the VaR of the underlying is $100.

• A. 0
• B. 1
• C. 2
• D. 33.33

Answer: C

Explanation:
Explanation
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.)

 

NEW QUESTION 15
A key problem with return on equity as a measure of comparative performance is:

• A. that return on equity is not adjusted for risk
• B. that return on equity measures do not account for interest and taxes
• C. that return on equity ignores the effect of leverage on returns to shareholders
• D. that return on equity are not adjusted for cash flows being different from accounting earnings

Answer: A

Explanation:
Explanation
The major problem with using return on equity as a measure of performance is that return on equity is not adjusted for risk. Therefore, a riskier investment will always come out ahead when compared to a less risky investment when using return on equity as a performance metric.
Return on equity does not ignore the effect of leverage (though return on assets does) because it considers the income attributable to equity, including income from leveraged investments.
Return on equity is generally measured after interest and taxes at the company wide level, though at business unit level it may use earnings before interest and taxes. However this does not create a problem so long as all performance being covered is calculated in the same way.
Cash flows being different from accounting earnings can create liquidity issues, but this does not affect the effectiveness of ROE as a measure of performance.

 

NEW QUESTION 16
When combining separate bottom up estimates of market, credit and operational risk measures, a most conservative economic capital estimate results from which of the following assumptions:

• A. Assuming that market, credit and operational risk estimates are perfectly positively correlated
• B. Assuming that market, credit and operational risk estimates are perfectly negatively correlated
• C. Assuming that market, credit and operational risk estimates are uncorrelated
• D. Assuming that the resulting distributions have a correlation between 0 and 1

Answer: A

Explanation:
Explanation
If the risks are considered perfectly positively correlated, ie assumed to have a correlation equal to 1, the standard deviations can simply be added together. This gives the most conservative estimate of combined risk for capital calculation purposes. In practice, this is the assumption used most often.
If risks are uncorrelated, ie correlation is assumed to be zero, variances can be added or the standard deviation is the root of the sum of the squares of the individual standard deviations. This obviously gives a number lower than that given when correlation is assumed to be +1.
Similarly, assumptions of negative correlation, or any correlation other than +1 will give a standard deviation number that is smaller and therefore less conservative. Choice 'b' is the correct answer.

 

NEW QUESTION 17
The frequency distribution for operational risk loss events can be modeled by which of the following distributions:
I. The binomial distribution
II. The Poisson distribution
III. The negative binomial distribution
IV. The omega distribution

• A. I, III and IV
• B. I, II and III
• C. I and III
• D. I, II, III and IV

Answer: B

Explanation:
Explanation
The binomial, Poisson and the negative binomial distributions can all be used to model the loss event frequency distribution. The omega distribution is not used for this purpose, therefore Choice 'a' is the correct answer.
Also note that the negative binomial distribution provides the best model fit because it has more parameters than the binomial or the Poisson. However, in practice the Poisson distribution is most often used due to reasons of practicality and the fact that the key model risk in such situations does not arise from the choice of an incorrect underlying distribution.

 

NEW QUESTION 18
When performing portfolio stress tests using hypothetical scenarios, which of the following is not generally a challenge for the risk manager?

• A. Building a positive semi-definite covariance matrix
• B. Evaluating interrelationships between counterparties when considering liquidity risks
• C. Building a consistent set of hypothetical shocks to individual risk factors
• D. Considering back office capacity to deal with increased transaction volumes

Answer: D

Explanation:
Explanation
Choice 'c' relates to operational risk and process capabilities, generally not a concern when evaluating market risk of a portfolio. Choice 'a', Choice 'b' and Choice 'd' represent real concerns for the risk manager when building stress tests for the value of a portfolio.
Choice 'a' is relevant because certain shocks may be inconsistent with each other, and therefore implausible.
For example, an increase in futures prices may be inconsistent with without spot prices and/or interest rates increasing according to the no-arbitrage condition. Choice 'b' is relevant when modeling a covariance matrix in a stressed situation with higher correlations, as a hypothetical covariance matrix which is not positive semi-definite may give absurd results (negative variance). Choice 'd' is relevant as liquidity risks may affect the price that can be realized for positions held.

 

NEW QUESTION 19
If the 1-day VaR of a portfolio is $25m, what is the 10-day VaR for the portfolio?

• A. $7.906m
  $79.06m
• B. Cannot be determined without the confidence level being specified
• C. $250m

Answer: C

Explanation:
Explanation
The 10-day VaR is = $25m x SQRT(10) = $79.06m. Choice 'b' is the correct answer.

 

NEW QUESTION 20
Under the ISDA MA, which of the following terms best describes the netting applied upon the bankruptcy of a party?

• A. Closeout netting
• B. Multilateral netting
• C. Payment netting
• D. Chapter 11

Answer: A

Explanation:
Explanation
Netting is the ability to set just the net balances when amounts are both owed and due. Netting can take many forms. Payment netting is netting between counterparties that owe moneys to each other in the same currency under the same transaction (or master agreement). Closeout netting is when parties settle a net amount for the value of all outstanding transactions upon the occurrence of an event of default such as bankruptcy. Multiateral netting involves a third party that sets off exposures across counterparties that owe moneys to each other.
Closeout netting under the ISDA master agreement enables a party to terminate transactions early if an Event of Default or Termination Event occurs in respect of the other party. It involves the calculation and netting of the termination values of all transactions to produce a single amount payable between the parties. Closeout netting is therefore the correct answer.

 

NEW QUESTION 21
Ex-ante VaR estimates may differ from realized P&L due to:
I. the effect of intra day trading
II. timing differences in the accounting systems
III. incorrect estimation of VaR parameters
IV. security returns exhibiting mean reversion

• A. I, II and III
• B. I and III
• C. I, II and IV
• D. II, III and IV

Answer: A

Explanation:
Explanation
Ex-ante VaR calculations can differ from actual realized P&L due to a large number of reasons. I, II and III represent some of them. Mean reversion however has nothing to do with VaR estimates differing from actual P&L. Therefore Choice 'c' is the correct answer.

 

NEW QUESTION 22
Which of the following is not a permitted approach under Basel II for calculating operational risk capital

• A. the basic indicator approach
• B. the advanced measurement approach
• C. the internal measurement approach
• D. the standardized approach

Answer: C

Explanation:
Explanation
The Basel II framework allows the use of the basic indicator approach, the standardized approach and the advanced measurement approaches for operational risk. There is no approach called the 'internal measurement approach' permitted for operational risk. Choice 'a' is therefore the correct answer.

 

NEW QUESTION 23
According to Basel II's definition of operational loss event types, losses due to acts by third parties intended to defraud, misappropriate property or circumvent the law are classified as:

• A. Internal fraud
• B. Third party fraud
• C. Execution delivery and system failure
• D. External fraud

Answer: D

Explanation:
Explanation
Choice 'c' 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.

 

NEW QUESTION 24
Which of the following are valid approaches for extreme value analysis given a dataset:
I. The Block Maxima approach
II. Least squares approach
III. Maximum likelihood approach
IV. Peak-over-thresholds approach

• A. I, III and IV
• B. II and III
• C. All of the above
• D. I and IV

Answer: D

Explanation:
Explanation
For EVT, we use the block maxima or the peaks-over-threshold methods. These provide us the data points that can be fitted to a GEV distribution.
Least squares and maximum likelihood are methods that are used for curve fitting, and they have a variety of applications across risk management.

 

NEW QUESTION 25
A bullet bond and an amortizing loan are issued at the same time with the same maturity and with the same principal. Which of these would have a greater credit exposure halfway through their life?

• A. The amortizing loan
• B. Indeterminate with the given information
• C. They would have identical exposure half way through their lives
• D. The bullet bond

Answer: D

Explanation:
Explanation
A bullet bond is a bond that pays coupons covering interest during the life of the bond and the principal at maturity. An amortizing loan pays the interest as well as a part of the principal with every payment. Therefore, the exposure of the amortizing loan continually reduces, and approaches zero towards the end of its life. The bullet bond will always have a higher exposure at any time during its life when compared to an equivalent amortizing loan. Hence Choice 'd' is the correct answer.

 

NEW QUESTION 26
If the 99% VaR of a portfolio is $82,000, what is the value of a single standard deviation move in the portfolio?

• A. 0
• B. 1
• C. 2
• D. 3

Answer: C

Explanation:
Explanation
Remember that VaR is merely a multiple of the portfolio's standard deviation. The multiple is determined by the confidence level, and for a 99% confidence level this multiple is 2.3264 (=-NORMSINV(1%) in Excel).
Therefore one standard deviation at this level of confidence would be equal to VaR/2.3264.
In addition to the Z-value at 99% confidence, you should also remember what the Z value is for a 95% level of confidence, as PRM questions may expect you to know these. The standard Windows calculator allowed in the exam does not allow you to calculate these, so it is safer to just remember these values.

 

NEW QUESTION 27
Under the standardized approach to calculating operational risk capital, how many business lines are a bank's activities divided into per Basel II?

• A. 0
• B. 1
• C. 2
• D. 3

Answer: D

Explanation:
Explanation
In the Standardized Approach, banks' activities are divided into eight business lines: corporate finance, trading
& sales, retail banking, commercial banking, payment & settlement, agency services, asset management, and retail brokerage. Therefore Choice 'c' is the correct answer.

 

NEW QUESTION 28
Which of the following is the most important problem to solve for fitting a severity distribution for operational risk capital:

• A. Determine plausible scenarios to fill the data gaps in the internal and external loss data
• B. The fit obtained should reduce the combination of the fitting and approximation errors to a minimum
• C. Empirical loss data needs to be extended to the ranges below the reporting threshold and above large value losses
• D. The risk functional's minimization should lead to a good estimate of the 0.999 quantile

Answer: D

Explanation:
Explanation
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.

 

NEW QUESTION 29
According to the Basel framework, shareholders' equity and reserves are considered a part of:

• A. Tier 2 capital
• B. Tier 1 capital
• C. All of the above
• D. Tier 3 capital

Answer: B

Explanation:
Explanation
According to the Basel II framework, Tier 1 capital, also called core capital or basic equity, includes equity capital and disclosed reserves.
Tier 2 capital, also called supplementary capital, includes undisclosed reserves, revaluation reserves, general provisions/general loan-loss reserves, hybrid debt capital instruments and subordinated term debt.
Tier 3 capital, or short term subordinated debt, is intended only to cover market risk but only at the discretion of their national authority.

 

NEW QUESTION 30
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