[Jan-2022] The Best PRM Certification 8008 Professional Exam Questions
Try 100% Updated 8008 Exam Questions [2022]
NEW QUESTION 173
Which of the following statements are true:
I. Credit risk and counterparty risk are synonymous
II. Counterparty risk is the contingent risk from a counterparty's default in derivative transactions III. Counterparty risk is the risk of a loan default or the risk from moneys lent directly IV. The exposure at default is difficult to estimate for credit risk as it depends upon market movements
- A. III and IV
- B. I and II
- C. II
- D. II and III
Answer: C
Explanation:
Explanation
Credit risk is the risk from a borrower defaulting on moneys lent. Counterparty risk, on the other hand, is the risk that a counterparty to a derivative transaction will be unable to pay at the time the transaction is in-the-money.
Credit risk therefore relates more to the banking book, counterparty risk relates more to the trading book.
Credit risk and counterparty risk differ in that for counterparty risk, the amount at risk fluctuates for counterparty risk depending upon the value of the underlying derivative. Counterparty risk generally starts at zero, for most swaps and other derivatives are near zero value at inception. Over time, as the prices of the underlying instruments move, one party ends up owing money to the other. A deterioration in the financial situation of the party owing moneys may lead to a loss to the other party, resulting in counterparty risk.
Counterparty risk can also arise from stock lending operations and repo trades.
Credit risk on the other hand is the traditional risk of default by a borrower, or a bank's customer who has taken a loan or has an overdraft or other credit facility.
Statement I is therefore incorrect as credit risk and counterparty risks are different.
Statement II is correct as counterparty risk is 'contingent' in the sense it arises only if the transaction with the counterparty ends up being in-the-money, and the counterparty defaults.
Statement III is incorrect. The statement describes credit risk.
Statement IV is incorrect, as the exposure is known for moneys lent. Derivative exposures for the future are difficult to estimate, they can even turn from moneys owed to moneys due as the value of the underlying changes.
NEW QUESTION 174
Which of the following best describes Altman's Z-score
- A. A calculation of default probabilities
- B. A numerical computation based upon accounting ratios
- C. A standardized z based upon the normal distribution
- D. A regression of probability of survival against a given set of factors
Answer: B
Explanation:
Explanation
Choice 'c' correctly describes Altman's z-score. All other choices are incorrect.
NEW QUESTION 175
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.
- A. IV only
- B. I, II and IV
- C. II and IV
- D. I, II, III and IV
Answer: D
Explanation:
Explanation
Stress testing is used for all the listed purposes. Therefore Choice 'a' is the correct answer.
NEW QUESTION 176
A long position in a credit sensitive bond can be synthetically replicated using:
- A. a short position in a treasury bond and a long position in a CDS
- B. a long position in a treasury bond and a long position in a CDS
- C. a long position in a treasury bond and a short position in a CDS
- D. a short position in a treasury bond and a short position in a CDS
Answer: C
Explanation:
Explanation
The correct answer is choice 'a'
A long position in a credit sensitive bond is equivalent to earning the risk free rate and the spread on the bond.
The risk free rate can be earned through a long position in a treasury bond, and the spread can be earned in the form of premiums on a CDS, which are received by the protection seller, ie the party short a CDS contract.
Therefore we can get the same results as a long bond position using a combination of a long treasury bond and a short position in a CDS. Choice 'a' is the correct answer.
NEW QUESTION 177
Under the contingent claims approach to measuring credit risk, which of the following factors does NOT affect credit risk:
- A. Leverage in the capital structure
- B. Maturity of the debt
- C. Cash flows of the firm
- D. Volatility of the firm's asset values
Answer: C
Explanation:
Explanation
Under the contingent claims approach, credit risk is modeled as the value of a put option on the value of the firm's assets with a strike equal to the face value of the debt and maturity equal to the maturity of the obligation. The cost of credit risk is determined by the leverage ratio, the volatility of the firm's assets and the maturity of the debt. Cash flows are not a part of the equation. Therefore Choice 'a' is the correct answer.
NEW QUESTION 178
In setting confidence levels for VaR estimates for internal limit setting, it is generally desirable:
- A. that actual losses exceed the VaR estimates with some reasonably observable frequency that is neither too high nor too low
- B. that actual losses exceed the VaR estimates on only the rarest of occasions
- C. that actual losses never exceed the VaR estimates
- D. that actual losses very frequently exceed the VaR estimates
Answer: A
Explanation:
Explanation
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).
NEW QUESTION 179
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: C
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 180
Which of the following statements are true with respect to stress testing:
I. Stress testing results in a dollar estimate of losses
II. The results of stress testing can replace VaR as a measure of risk as they are better grounded in reality III. Stress testing provides an estimate of losses at a desired level of confidence IV. Stress testing based on factor shocks can allow modeling extreme events that have not occurred in the past
- A. I, II and IV
- B. II, III and IV
- C. I and IV
- D. II and III
Answer: C
Explanation:
Explanation
Any stress test is conducted with a view to produce a dollar estimate of losses, therefore statement I is correct.
However, these numbers do not come with any probabilities or confidence levels, unlike VaR, and statement III is incorrect. Stress testing can complement VaR, but not replace it, therefore statement II is not correct.
Statement IV is correct as stress tests can be based on both actual historical events, or simulated factor shocks (eg, a factor, such as interest rates, moves by say 10-z).
Therefore Choice 'a' is correct.
NEW QUESTION 181
Consider a portfolio with a large number of uncorrelated assets, each carrying an equal weight in the portfolio.
Which of the following statements accurately describes the volatility of the portfolio?
- A. The volatility of the portfolio will be close to zero
- B. The volatility of the portfolio will be equal to the weighted average of the volatility of the assets in the portfolio
- C. The volatility of the portfolio is the same as that of the market
- D. The volatility of the portfolio will be equal to the square root of the sum of the variances of the assets in the portfolio weighted by the square of their weights
Answer: D
Explanation:
Explanation
When assets are uncorrelated, variances are additive. But volatility (which is standard deviation) is not. In the given situation, the total variance of the portfolio will be equal to the the square root of the sum of the variances of the assets in the portfolio weighted by the square of their weights. Its volatility will be the square root of this variance. Thus Choice 'c' is the correct answer.
(This is because V(cA + dB) = c^2 V(A) + d^2 V(B) - refer tutorial on combining variances.) Choice 'd' is incorrect as it describes the calculation of variance, not volatility. Also, the presence of a large number of uncorrelated assets does not create a portfolio with volatility equal to zero or that of the market. The other choices are therefore incorrect.
NEW QUESTION 182
Which of the following statements is true:
I. Confidence levels for economic capital calculations are driven by desired credit ratings II. Loss distributions for operational risk are affected more by the severity distribution than the frequency distribution III. The Advanced Measurement Approach (AMA) referred to in the Basel II standard is a type of a Loss Distribution Approach (LDA) IV. The loss distribution for operational risk under the LDA (Loss Distribution Approach) is estimated by separately estimating the frequency and severity distributions.
- A. III and IV
- B. I, III and IV
- C. I and II
- D. I, II and IV
Answer: D
Explanation:
Explanation
Statement I is correct. Economic capital is the capital available to absorb unexpected losses, and credit ratings are also based upon a certain probability of default. Economic capital is often calculated at a level equal to the confidence required for the desired credit rating. For example, if the probability of default for a AA rating is
0.02%, then economic capital maintained at a 99.98% would allow for such a rating. Economic capital set at a
99.8% level can be thought of as the level of losses that would not be exceeded with a 99.8% probability.
Loss distributions are the product of the severity and frequency distributions, each of which are estimated separately. The total loss distribution is affected far more by the severity distribution than by the frequency distribution, therefore statement II is correct.
The Loss Distribution Approach (LDA) is one of the ways in which the requirements of the AMA can be satisfied, and not the other way round. Therefore statement III is incorrect.
Statement IV is correct as the total loss distribution is estimated using separate estimates of loss frequency and distributions.
NEW QUESTION 183
Under the KMV Moody's approach to credit risk measurement, how is the distance to default converted to expected default frequencies?
- A. Using Monte Carlo simulations
- B. Using migration matrices
- C. Using a proprietary database based on historical information
- D. Using a normal distribution
Answer: C
Explanation:
Explanation
KMV Moody's uses a proprietary database to convert the distance to default to expected default probabilities.
NEW QUESTION 184
Which of the following was not a policy response introduced by Basel 2.5 in response to the global financial crisis:
- A. Comprehensive Risk Model (CRM)
- B. Comprehensive Capital Analysis and Review (CCAR)
- C. Incremental Risk Charge (IRC)
- D. Stressed VaR (SVaR)
Answer: B
Explanation:
Explanation
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.
NEW QUESTION 185
The Altman credit risk score considers:
- A. A historical database of the firms that have survived
- B. A historical database of the firms that have defaulted
- C. A combination of accounting measures and market values
- D. A quadratic approximation of the credit risk based on underlying risk factors
Answer: C
Explanation:
Explanation
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
Nearly all the numbers above are accounting measures derived straight from the balance sheet or the income statement. Market capitalization is a market driven number. Therefore Choice 'c' is the correct answer as the Altman credit risk score considers both accounting and market based measures.
Altman's score, though computationally straightforward and intuitively easy to understand, was introduced in the late sixties and has been very accurate in predicting corporate bankruptcies, which is why it continues to be used extensively.
NEW QUESTION 186
When building a operational loss distribution by combining a loss frequency distribution and a loss severity distribution, it is assumed that:
I. The severity of losses is conditional upon the number of loss events II. The frequency of losses is independent from the severity of the losses III. Both the frequency and severity of loss events are dependent upon the state of internal controls in the bank
- A. I and II
- B. II
- C. I, II and III
- D. II and III
Answer: B
Explanation:
Explanation
When a operational loss frequency distribution (which, for example, may be based upon a Poisson distribution) and a loss severity distribution (for example, based upon a lognormal distribution), it is assumed that the frequency of losses and the severity of the losses are completely independent and do not impact each other. Therefore statement II is correct, and the others are not valid assumptions underlying the operational loss distribution.
NEW QUESTION 187
When modeling severity of operational risk losses using extreme value theory (EVT), practitioners often use which of the following distributions to model loss severity:
I. The 'Peaks-over-threshold' (POT) model
II. Generalized Pareto distributions
III. Lognormal mixtures
IV. Generalized hyperbolic distributions
- A. I, II, III and IV
- B. I and II
- C. I, II and III
- D. II and III
Answer: B
Explanation:
Explanation
The peaks-over-threshold model is used when losses over a given threshold are recorded, as is often the case when using data based on external public sources where only large loss events tend to find a place. The generalized Pareto distribution is also used when attempting to model loss severity using EVT. Lognormal mixtures and generalized hyperbolic distributions are not used as extreme value distributions.
Choice 'd' is the correct answer.
NEW QUESTION 188
The degree distribution of the nodes of the financial network is:
- A. normally distributed
- B. non-linear
- C. long tailed
- D. best approximated by a beta distribution
Answer: C
Explanation:
Explanation
The 'degree' of a node in a network measures the number of links to other nodes. For the financial network, each market participant can be thought of as a node. The 'degree distribution' can be thought of as the histogram of the number of links for each node.
The financial network has a degree distribution with rather long tails - and therefore Choice 'd' is the correct answer. The other choices are incorrect. Long tailed networks have the property that they are robust when affected by random disturbances, but susceptible to targeted attacks, for example on key hubs.
NEW QUESTION 189
Changes in which of the following do not affect the expected default frequencies (EDF) under the KMV Moody's approach to credit risk?
- A. Changes in the risk free rate
- B. Changes in asset volatility
- C. Changes in the firm's market capitalization
- D. Changes in the debt level
Answer: A
Explanation:
Explanation
EDFs are derived from the distance to default. The distance to default is the number of standard deviations that expected asset values are away from the default point, which itself is defined as short term debt plus half of the long term debt. Therefore debt levels affect the EDF. Similarly, asset values are estimated using equity prices.
Therefore market capitalization affects EDF calculations. Asset volatilities are the standard deviation that form a place in the denominator in the distance to default calculations. Therefore asset volatility affects EDF too.
The risk free rate is not directly factored in any of these calculations (except of course, one could argue that the level of interest rates may impact equity values or the discounted values of future cash flows, but that is a second order effect). Therefore Choice 'b' is the correct answer.
NEW QUESTION 190
Which of the following risks were not covered in detail in most stress tests prior to the current crisis:
I. The behavior of complex structured products under stressed liquidity conditions II. Pipeline or securitization risk III. Basis risk in relation to hedging strategies IV. Counterparty credit risk
V. Contingent risks
VI. Funding liquidity risk
- A. I, II, III, IV and VI
- B. All of the above
- C. II, III and V
- D. I, IV and VI
Answer: B
Explanation:
Explanation
The BCBS publication 'Principles for sound stress testing practices and supervision' (May 2009) identifies all of the above as risks that were covered in insufficient detail in most stress tests prior to the current crisis.
Therefore Choice 'd' is the correct answer.
For the PRM exam, you should have read this document. You should also be familiar with all the above risk types as being contributors to the crisis, and know what each of these mean.
NEW QUESTION 191
The Basel framework does not permit which of the following Units of Measure (UoM) for operational risk modeling:
I. UoM based on legal entity
II. UoM based on event type
III. UoM based on geography
IV. UoM based on line of business
- A. III only
- B. II only
- C. None of the above
- D. I and IV
Answer: C
Explanation:
Explanation
Units of Measure for operational risk are homogenous groupings of risks to allow sensible modeling decisions to be made. For example, some risks may be fat-tailed, for example the risk of regulatory fines. Other risks may have finite tails - for example damage to physical assets risk (DPA) may be limited to the value of the asset in the question.
Additionally, risk reporting may need to be done at the line of business, legal entity or regional basis, and in order to be able to do, so the right level of granularity needs to be captured in the risk modeling exercise. The level of granularity applied is called the 'unit of measurement' (UoM), and it is okay to adopt all of the choices listed above as the dimensions that describe the unit of measure.
Note that it is entirely possible, even likely, to use legal entity, risk type, region, business and other dimensions simultaneously, though doing so is likely to result in an extremely large number of UoM combinations. That can be addressed by then subsequently grouping the more granular UoMs into larger UoMs, which may ultimately be used for frequency and severity estimation.
NEW QUESTION 192
According to the Basel II standard, which of the following conditions must be satisfied before a bank can use
'mark-to-model' for securities in its trading book?
I. Marking-to-market is not possible
II. Market inputs for the model should be sourced in line with market prices III. The model should have been created by the front office IV. The model should be subject to periodic review to determine the accuracy of its performance
- A. I, II, III and IV
- B. III and IV
- C. I, II and IV
- D. II and III
Answer: C
Explanation:
Explanation
According to Basel II, where marking-to-market is not possible, banks may mark-to-model, where this can be demonstrated to be prudent. Marking-to-model is defined as any valuation which has to be benchmarked, extrapolated or otherwise calculated from a market input. When marking to model, an extra degree of conservatism is appropriate. Supervisory authorities will consider the following in assessing whether a mark-to-model valuation is prudent:
* Senior management should be aware of the elements of the trading book which are subject to mark to model and should understand the materiality of the uncertainty this creates in the reporting of the risk/performance of the business.
* Market inputs should be sourced, to the extent possible, in line with market prices. The appropriateness of the market inputs for the particular position being valued should be reviewed regularly.
* Where available, generally accepted valuation methodologies for particular products should be used as far as possible.
* Where the model is developed by the institution itself, it should be based on appropriate assumptions, which have been assessed and challenged by suitably qualified parties independent of the development process. The model should be developed or approved independently of the front office. It should be independently tested.
This includes validating the mathematics, the assumptions and the software implementation.
* There should be formal change control procedures in place and a secure copy of the model should be held and periodically used to check valuations.
* Risk management should be aware of the weaknesses of the models used and how best to reflect those in the valuation output.
* The model should be subject to periodic review to determine the accuracy of its performance (e.g. assessing continued appropriateness of the assumptions, analysis of P&L versus risk factors, comparison of actual close out values to model outputs).
* Valuation adjustments should be made as appropriate, for example, to cover the uncertainty of the model valuation.
The model should be created independent of the front office, and not by it. Therefore statement III does not represent an appropriate choice. Choice 'a' is the correct answer.
NEW QUESTION 193
When performing portfolio stress tests using hypothetical scenarios, which of the following is not generally a challenge for the risk manager?
- A. Building a consistent set of hypothetical shocks to individual risk factors
- B. Considering back office capacity to deal with increased transaction volumes
- C. Evaluating interrelationships between counterparties when considering liquidity risks
- D. Building a positive semi-definite covariance matrix
Answer: B
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 194
Which of the following objectives are targeted by rating agencies when assigning ratings:
I. Ratings accuracy
II. Ratings stability
III. High accuracy ratio (AR)
IV. Ranked ratings
- A. I and II
- B. III and IV
- C. I, II and III
- D. II and III
Answer: A
Explanation:
Explanation
Rating agencies target both accuracy and stability when they assign ratings. These two objectives can sometimes conflict, so a balance needs to be struck between the two. Rating agencies do not target any particular 'accuracy ratio' or rankings. Therefore Choice 'c' is the correct answer.
NEW QUESTION 195
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. $250m
- C. Cannot be determined without the confidence level being specified
Answer: B
Explanation:
Explanation
The 10-day VaR is = $25m x SQRT(10) = $79.06m. Choice 'b' is the correct answer.
NEW QUESTION 196
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