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PRMIA 8010 exam covers various topics related to operational risk management, such as risk identification, assessment, monitoring, and reporting. 8010 exam consists of 100 multiple-choice questions and has a duration of 2.5 hours. It is conducted online and can be taken at any time, making it convenient for candidates who want to take the exam from their home or office.
NEW QUESTION # 122
Which of the following statements is true:
- A. Total expected losses are equal to the sum of individual underlying exposures while total unexpected losses are greater than the sum of unexpected losses on underlying exposures
- B. Total expected losses are equal to the sum of expected losses in the individual underlying exposures while total unexpected losses are less than the sum of unexpected losses on underlying exposures
- C. Total expected losses are greater than the sum of individual underlying exposures while total unexpected losses are less than the sum of unexpected losses on underlying exposures
- D. Both total expected losses and total unexpected losses are less than the sum ofexpected and unexpected losses on underlying exposures respectively
Answer: B
Explanation:
Explanation
Total expected losses which are average and anticipated are equal to the sum of expected losses in the underlying exposures. Total unexpected losses, which are the excess of worst case losses at a certain confidence level over the expected losses, benefit from the diversification effect and are lower than the sum of unexpected losses of the underlying exposures. Therefore Choice'c' is the correct answer. The other choices are incorrect.
NEW QUESTION # 123
The CDS rate on a defaultable bond is approximated by which of the following expressions:
- A. Hazard rate / (1 - Recovery rate)
- B. Loss given default x Default hazard rate
- C. Credit spread x Loss given default
- D. Hazard rate x Recovery rate
Answer: B
Explanation:
Explanation
The CDS rate is approximated by the [Loss given default x Default hazard rate]. Thus Choice 'b' is the correctanswer.
Note that this is also equal to the credit spread on the reference bond over the risk free rate. Therefore credit spreads and CDS rates are generally the same. Also, 'loss given default' is nothing but (1 - Recovery rate). This can besubstituted in the formula for the credit spread to get an alternative expression that directly refers to the recovery rate. Therefore all other choices are incorrect.
NEW QUESTION # 124
An assumption regarding the absence of ratings momentum is referred to as:
- A. Herstatt risk
- B. Markov property
- C. Time invariance
- D. Ratings stability
Answer: B
Explanation:
Explanation
Choice 'c' is the correct answer. The Markov property is the assumption that there is no ratings momentum, and that transition probabilities are dependent only upon where the rating currently is and where it is going to.
Where it has come from, or what the past changes in ratings have been, have no effect on the transition probabilities. ('Herstatt risk' refers to settlement risk, and is irrelevant.)
NEW QUESTION # 125
A stock that follows the Weiner process has its future price determined by:
- A. its standard deviation and past technical movements
- B. its expected return and standard deviation
- C. its current price, expected return and standard deviation
- D. its expected return alone
Answer: C
Explanation:
Explanation
The change in the price of a security that follows a Weiner process isdetermined by its standard deviation and expected return. To get the price itself, we need to add this change in price to the current price. Therefore the future price in a Weiner process is determined by all three of current price, expected return and standard deviation.
NEW QUESTION # 126
Which of the following belong in a credit risk report?
- A. Largest exposures by counterparty
- B. Exposures by country
- C. All of the above
- D. Exposures by industry
Answer: C
Explanation:
Explanation
All the listed variables are relevant to management monitoring the credit risk profile of an institution, therefore Choice 'd' is the correct answer.
NEW QUESTION # 127
There are three bonds in a diversified bond portfolio, whose default probabilities are independent of each other and equal to 1%, 2% and 3% respectively over a 1 year time horizon. Calculate the probability that exactly 1 of the three bonds will default.
- A. .011%
- B. 2%
- C. 5.8%
- D. 0%
Answer: C
Explanation:
Explanation
The probability that only one of thethree bonds will default is equal to the sum of the probabilities of the three scenarios where one bond defaults and the other two survive. This probability is given by 1%*(1 - 2%)*(1 -
3%) + (1 - 1%)*2%*(1 - 3%) + (1 - 1%)*(1 - 2%)*3% = 5.7818%. Choice 'c' is the correct answer.
NEW QUESTION # 128
The standalone economic capital estimates for the three uncorrelated business units of a bank are $100, $200 and $150 respectively. Whatis the combined economic capital for the bank?
- A. 0
- B. 1
- C. 2
- D. 3
Answer: C
Explanation:
Explanation
Since the business units are uncorrelated, we can get the combined EC as equal to the square root of the sum of the squares of the individual EC estimates.Therefore Choice 'a' is the correct answer.
[=SQRT(100^2+200^2+150^2)]
NEW QUESTION # 129
Under the CreditPortfolio View model of credit risk, the conditional probability of default will be:
- A. lower than the unconditional probability of default in an economic contraction
- B. lower than the unconditional probability of default in an economic expansion
- C. higherthan the unconditional probability of default in an economic expansion
- D. the same as the unconditional probability of default in an economic expansion
Answer: B
Explanation:
Explanation
When the economy is expanding, firms are less likely to default. Therefore the conditional probability of default, given an economic expansion, is likely to be lower than the unconditional probability of default.
Therefore Choice 'a' is the correct answerand the other statements are incorrect.
NEW QUESTION # 130
Which of the following decisions need to be made as part of laying down a system for calculating VaR:
I. The confidence level and horizon
II. Whether portfolio valuation is based upon a delta-gamma approximation or a full revaluation III. Whether the VaR is to be disclosed in the quarterly financial statements IV. Whether a 10 day VaR will be calculated based on 10-day return periods, or for 1-day and scaled to 10 days
- A. I, II and IV
- B. I and III
- C. All of the above
- D. II and IV
Answer: A
Explanation:
Explanation
While conceptually VaR is a fairly straightforward concept, a number of decisions need to be made to select between the different choices available for the exact mechanism to be used for the calculations.
The Basel framework requires banks toestimate VaR at the 99% confidence level over a 10 day horizon. Yet this is a decision that needs to be explicitly made and documented. Therefore 'I' is a correct choice.
At various stages of the calculations, portfolio values need to be determined. The valuation can be done using a 'full valuation', where each position is explicitly valued; or the portfolio(s) can be reduced to a handful of risk factors, and risk sensitivities such as delta, gamma, convexity etc be used to value the portfolio. The decisionbetween the two approaches is generally based on computational efficiency, complexity of the portfolio, and the degree of exactness desired. 'II' therefore is one of the decisions that needs to be made.
The decision as to disclosing the VaR in financial filings comes after the VaR has been calculated, and is unrelated to the VaR calculation system a bank needs to set up. 'III' is therefore not a correct answer.
Though the Basel framework requires a 10-day VaR to be calculated, it also allows the calculation of the 1-day VaR and and scaling it to 10 days using the square root of time rule. The bank needs to decide whether it wishes to scale the VaR based on a 1-day VaR number, or compute VaR for a 10 day period to begin with. 'IV' therefore is a decision tobe made for setting up the VaR system.
NEW QUESTION # 131
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 byincreasing the risk sensitivity of the minimum capital requirements.
III. Basel II encourages disclosure of capital levels and risks
- A. II and III
- B. I and II
- C. I only
- D. III only
Answer: A
Explanation:
Explanation
The three pillars under Basel II are minimum capital requirements, supervisory review process and market discipline. Therefore statement I is false. The other two statements are accurate. Therefore Choice 'd' is the correct answer.
NEW QUESTION # 132
Which of the following statements is true:
I. When averaging quantiles of two Pareto distributions, the quantiles of theaveraged models are equal to the geometric average of the quantiles of the original models based upon the number of data items in each original model.
II. When modeling severity distributions, we can only use distributions which have fewer parameters thanthe number of datapoints we are modeling from.
III. If an internal loss data based model covers the same risks as a scenario based model, they can can be combined using the weighted average of their parameters.
IV If an internal loss model and a scenario based model address different risks, the models can be combined by taking their sums.
- A. I and II
- B. III and IV
- C. II and III
- D. All statements are true
Answer: D
Explanation:
Explanation
Statement I is true, the quantiles of the averaged models are equal to the geometric average of the quantiles of the original models.
Statement II is correct, the number of data points from which model parameters are estimated must be greater than the number of parameters. So if a distribution, say Poisson, has one parameter, we need at least two data points to estimate the parameter. Other complex distributions may have multiple parameters for shape, scale and other things, and the minimum number of observations required will be greater than the number of parameters.
Statement III istrue, if the ILD data and scenarios cover the same risk, they are essentially different perspectives on the same risk, and therefore should be combined as weighted averages.
But if they cover completely different risks, the models will need to be added together, not averaged - which is why Statement IV is true.
NEW QUESTION # 133
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 # 134
Which of the following best describes Altman's Z-score
- A. A standardized z based upon the normal distribution
- B. A numerical computation based upon accounting ratios
- C. A regression of probability of survival against a given set of factors
- D. A calculation of defaultprobabilities
Answer: B
Explanation:
Explanation
Choice 'c' correctly describes Altman's z-score. All other choices are incorrect.
NEW QUESTION # 135
Which of the following statements is true in respect of a non financial manufacturing firm?
I. Market risk is not relevant to the manufacturing firm as it does not take proprietary positions II. The firm faces market risks as an externality which it must bear and has no control over III. Market risks can make a comparative assessment of profitability over time difficult IV. Market risks for a manufacturing firm are not directionally biased and do not increase the overall risk of the firm as they net to zero over a long term time horizon
- A. I and II
- B. III and IV
- C. III only
- D. IV only
Answer: C
Explanation:
Explanation
A non-financial firm such as a manufacturing company faces market risks similar to those faced by financial firms, except perhaps for not being exposed to risks from the equity markets. Non financial firms commonly face interest rate risks in respect of their debts, commodity price risks in respect of their inputs and products, and foreign currency risks in respect of their overseas operations. It is therefore not correct to say that the manufacturing firm does not face market risk because it does not take proprietary positions. While decisions on positions may not be actively taken, positions in foreign exchange (eg, through overseas debtors owing foreign currency, or liabilities in foreign currencies to overseas suppliers), commodities (through exposure to the need for raw material and inventory of finished goods) and interest rates (through debt financed, whether at fixed or floating rates) exist and create market risk much in the same way as they would for a proprietary position. Therefore statement I is incorrect.
While the firm faces market risks as an externality (as do financial firms for that matter, though often they seek such exposure to profit from their view on which way the externality will express itself), it is incorrect to say that these risks must be borne. They can be measured and hedged. Therefore statement II is incorrect.
The results of a manufacturing firm will include gains and losses arising from exposure to market risk, and will cloud the true profitability of the business. A firm with significant unhedged overseas sales may show vastly different results across time periods due to the FX gains and losses, making comparative assessment of profitability difficult. Therefore statement III is correct.
Market risks for a manufacturing firm may be directionally biased in terms of exposure, ie there may be a consistent 'long' position in a particular commodity that the firm produces, and a consistent 'short' position in the commodities consumed. In the same way, directional biases may exist in FX or interest rate exposures too.
Regardless of the bias, the existence of market risk exposures increase the volatility of the income stream and make the firm more risky, even though the long term expected returns from such exposures is zero (ie, returns may be zero but standard deviation is not). Therefore statement IV is not correct as market risks form non financialfirms do increase the overall risk of the firm.
NEW QUESTION # 136
Which of the following best describes a 'break clause ?
- A. A break clause describes rights and obligations when the derivative contract is broken
- B. A break clause gives either party to a transaction the right to terminate the transaction at market price at future date(s)
- C. A break clause sets out the conditions under which the transaction will be terminated upon non-compliance with the ISDA MA
- D. A break clausedetermines the process by which amounts due on early termination will be determined
Answer: B
Explanation:
Explanation
A break close, also called a 'mutual put', gives either party the right to terminate a transaction at market price at a given date, or dates in the future. These are usually availed of in longer dated transactions, eg 10 years and over. For example, a 15-year swap might have a mutual put in year 5, and every 2 years thereafter.
All other choices are incorrect.
NEW QUESTION # 137
There are two bonds in a portfolio, each with a market value of $50m. The probability of default of the two bonds are 0.03 and 0.08 respectively, over a one year horizon. If the default correlation is 25%, what is the one year expected loss on this portfolio?
- A. $5.5mc
- B. $1.38m
- C. $11m
- D. $5.26m
Answer: A
Explanation:
Explanation
We will need to calculate the joint probability distribution of the portfolio as follows.Probability of the joint default of both A and B =
The marginal probabilities (ie the standalone probabilities of default of the two bonds) are known, and if we can calculate the probability of joint defaults of the two bonds, we can calculate the rest of the entries. We thenmultiply the probabilities with the expected loss under each scenario and add them up to get the total expected loss.
The calculations are shown below. The expected loss is $5.5m, and therefore the correct answer is Choice 'd'.
NEW QUESTION # 138
Which of the following credit risk models considers debt as including a put option on the firm's assets toassess credit risk?
- A. The contingent claims approach
- B. The actuarial approach
- C. CreditPortfolio View
- D. The CreditMetrics approach
Answer: A
Explanation:
Explanation
The correct answer is Choice 'c'. The following is a brief description of the major approaches available to model credit risk, and the analysis that underlies them:
1. CreditMetrics: based on the credit migration framework. Considers the probability of migration to other credit ratings and the impact of such migrations on portfolio value.
2. CreditPortfolio View: similar to CreditMetrics, but adds the impact of the business cycle to the evaluation.
3. The contingent claims approach: uses option theory by considering a debt as a put option on the assets of the firm.
4. KMV's EDF (expected default frequency) based approach: relies on EDFs and distance to default as a measure of credit risk.
5. CreditRisk+: Also called the 'actuarial approach', considers default as a binary event that either happens or does not happen. This approach does not consider the loss of value from deterioration in credit quality (unless the deterioration implies default).
NEW QUESTION # 139
A cumulative accuracy plot:
- A. measures rating accuracy
- B. measures the accuracy of credit risk estimates
- C. measures accuracy of default probabilities observed empirically
- D. is a measure of the correctness of VaR calculations
Answer: A
Explanation:
Explanation
A cumulative accuracy plot measures the accuracy of credit ratings assigned by rating agencies by considering the relative rankings of obligors according to the ratings given. Choice 'd' is the correct answer.
NEW QUESTION # 140
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. II and III
- B. All of the above
- C. I, III and IV
- 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 GEVdistribution.
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 # 141
Which of the following is not a credit event under ISDA definitions?
- A. Obligation accelerations
- B. Rating downgrade
- C. Restructuring
- D. Failure to pay
Answer: B
Explanation:
Explanation
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 eventusually 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.
NEW QUESTION # 142
Which of the following is NOT an approach used to allocate economic capital to underlying business units:
- A. Stand alone economic capital contributions
- B. Incremental economic capital contributions
- C. Marginal economic capital contributions
- D. Fixed ratio economic capital contributions
Answer: D
Explanation:
Explanation
Other than Choice 'c', all others represent valid approaches to allocate economic capital to underlying business units. There is no such thing as 'fixed ratioeconomic capital contribution'
NEW QUESTION # 143
Pick underlying risk factors for a position in an equity index option:
I. Spot value for the index
II. Risk free interest rate
III. Volatility of the underlying
IV. Strike price for the option
- A. II and II
- B. All of the above
- C. I and IV
- D. I, II and III
Answer: D
Explanation:
Explanation
The index option is affected by the spot value for the underlying index, as also the risk free interest rate, or the zero rate for the duration of the option. It is also affected by the volatility of the underlying.The 'strike price' is set and is fixed at the time the option is purchased, and therefore is not a risk factor.
Therefore other than IV, all other choices are valid risk factors that underlie an equity index option.
Other instruments may have other risk factors - for example, a long forex position will have the spot exchange rate as the only risk factor.
NEW QUESTION # 144
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PRMIA 8010: Operational Risk Manager (ORM) Exam is recognized globally and is an excellent choice to take your risk management career to new heights. After passing the exam, you will have the knowledge and expertise necessary to identify and mitigate operational risks that could potentially harm a company. 8010 exam is an excellent way to show potential employers that you are serious about developing and maintaining a successful career in operational risk management.
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