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Updated Dec-2021 Pass 8008 Exam - Real Practice Test Questions
NEW QUESTION 113
In respect of operational risk capital calculations, the Basel II accord recommends a confidence level and time horizon of:
- A. 99.9% confidence level over a 10 day time horizon
- B. 99.9% confidence level over a 1 year time horizon
- C. 99% confidence level over a 1 year time horizon
- D. 99% confidence level over a 10 year time horizon
Answer: B
Explanation:
Explanation
Choice 'd' represents the Basel II requirement, all other choices are incorrect.
NEW QUESTION 114
The standalone economic capital estimates for the three uncorrelated business units of a bank are $100, $200 and $150 respectively. What is the combined economic capital for the bank?
- A. 0
- B. 1
- C. 2
- D. 3
Answer: A
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 115
Which of the following event types is hacking damage classified under Basel II operational risk classifications?
- A. Technology risk
- B. External fraud
- C. Damage to physical assets
- D. Information security
Answer: B
Explanation:
Explanation
Choice 'b' is the correct answer. All other answers are incorrect.
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 116
A portfolio has two loans, A and B, each worth $1m. The probability of default of loan A is 10% and that of loan B is 15%. The probability of both loans defaulting together is 1%. Calculate the expected loss on the portfolio.
- A. 0
- B. 1
- C. 2
- D. 3
Answer: A
Explanation:
Explanation
The easiest way to answer this question is to ignore the joint probability of default as that is irrelevant to expected losses. The joint probability of default impacts the volatility of the losses, but not the expected amount. One way to think about it is to think of asset portfolios, where diversification reduces risk (ie standard deviation) but the expected returns are nothing but the average of the expected returns in the portfolio. Just as the expected returns of the portfolio are not affected by the volatility or correlations (these affect standard deviation), in the same way the joint probability of default does not affect the expected losses. Therefore the expected losses for this portfolio are simply $1m x 10% + $1m x 15% = $250,000.
This can also be seen from the lens of a joint probability distribution as follows:
There are four possibilities for this portfolio:
- Only loan A defaults: loss of $1m: 9% probability
- Only loan B defaults: loss of $1m: 14% probability
- Both loan A and B default: loss of $2m: 1% probability
- Neither A nor B default: loss of $0m: 76% probability
Therefore the expected losses on the portfolio are ($1m x 9%) + ($1m x 14%) + ($2m x 1%) + ($0m x 76%) =
$250,000.
(Notes: How is the above table calculated? The totals (10%, 90%, 15% and 85%) are filled in first. The top left cell (both A & B default) is given as 1%. We can now calculate the rest of the cells as the totals are known.)
NEW QUESTION 117
Which of the following is not a parameter to be determined by the risk manager that affects the level of economic credit capital:
- A. Confidence level
- B. Risk horizon
- C. Definition of credit losses
- D. Probability of default
Answer: D
Explanation:
Explanation
Three parameters define economic credit capital: the risk horizon, ie the time horizon over which the risk is being assessed; the confidence level, ie the quintile of the loss distribution; and the definition of credit losses, ie whether mark-to-market losses are considered in addition to default-only losses. The probability of default is not a parameter within the control of the risk manager, but an input into the capital calculation process that he has to estimate. Therefore Choice 'c' is the correct answer.
NEW QUESTION 118
When modeling operational risk using separate distributions for loss frequency and loss severity, which of the following is true?
- A. Loss severity and loss frequency are considered independent
- B. Loss severity and loss frequency are modeled using the same units of measurement
- C. Loss severity and loss frequency distributions are considered as a bivariate model with positive correlation
- D. Loss severity and loss frequency are modeled as conditional probabilities
Answer: A
Explanation:
Explanation
When modeling 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 Choice 'a' is correct, and the others are not valid assumptions underlying the operational loss modeling.
Once each of these distributions has been built, a random number is drawn from each to determine a loss scenario. The process is repeated many times as part of a Monte Carlo simulation to get a the loss distribution.
NEW QUESTION 119
Which of the following methods cannot be used to calculate Liquidity at Risk?
- A. Monte Carlo simulation
- B. Scenario analysis
- C. Historical simulation
- D. Analytical or parametric approaches
Answer: D
Explanation:
Explanation
Analytical or parametric approaches are not useful at all for liquidity at risk calculations because there are no neat distributions available to parameterize the large number of factors that affect the calculations of liquidity inflows and outflows. Historical simulations, Monte Carlo and scenario analysis (which can complement historical scenarios) are all valid choices
NEW QUESTION 120
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. I, II and III
- C. II and III
- D. II
Answer: D
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 121
Which of the following statements is correct?
- A. Funding liquidity risks present themselves in the form of an adverse market impact on prices from a trade
- B. Market liquidity risk is idiosyncratic while funding liquidity risk is not
- C. Market liquidity risks present themselves in the form of higher bid offer spreads
- D. Dynamic simulations of liquidity needs require an assumption of counterparty risk remaining constant
Answer: C
Explanation:
Explanation
Simulations of liquidity needs can be of various types: historical simulations, where the current positions are subjected to the kind of liquidity shocks experienced in the past; static simulations, where a static view of current positions, counterparty credit position, and the business is considered; and dynamic simulations where all factors are dynamically changed including counterparty credit standing, changes to the current portfolio and behavioural aspects of the business. Choice 'b' is incorrect as dynamic simulations require no such assumptions.
Liquidity risk is often thought of in terms of market liquidity risk and funding liquidity risk. Market liquidity risk relates to the the liquidity for a particular type of asset drying up. For example, during the 2007-2009 crisis a large number of corporate bonds and structured products became extremely illiquid. Market liquidity risk manifests itself in the form of higher bid offer spreads, higher pricde impact, and a reduction in the normal market size (ie, the 'normal' size of a trade for which a dealer quote is valid for). Therefore Choice 'd' is correct. Similarly, Choice 'a' is incorrect as adverse price impact results from market liquidity risk and not funding liquidity risk.
Market liquidity risk applies to the entire market and all its participants. It is not idiosyncratic. Therefore Choice 'c' is incorrect too. Funding liquidity risk on the other hand applies to an individual institution that is under liquidity stress in the sense of not being able to meet its obligations such as margin or collateral calls because of a lack of liquid assets. Thus it is funding liquidity that is idiosyncratic. Market liquidity risk often leads to funding liquidity risks materializing as firms are unable to get to the funds they were relying upon due to assets becoming illiquid.
NEW QUESTION 122
Which of the following statements is true?
I. It is sufficient to ensure that a parent entity has sufficient excess liquidity to cover a liquidity shortfall for a subsidiary.
II. If a parent entity has a shortfall of liquidity, it can always rely upon any excess liquidity that its foreign subsidiaries might have.
III. Wholesale funding sources for a bank refer to stable sources of funding provided by the central bank.
IV. Funding diversification refers to diversification of both funding sources and funding tenors.
- A. IV
- B. I and IV
- C. I and III
- D. III and IV
Answer: A
Explanation:
Explanation
It is not generally sufficient to ensure the adequacy of liquidity across a group - ie it is not appropriate to just add up the sources and needs for liquidity across multiple entities in a group. This is because there can be restrictions on transferring liquidity between entities, particularly when the entities are located across borders.
In cases where transfers of liquidity are permitted, there may be settlement delays in transferring funds from one entity to another. Therefore both statements I and II are incorrect.
Wholesale funding sources refers to the temporary interbank funding sources that need to be rolled over on very short intervals, often as short as overnight. These are not stable sources for long term funding. Statement III is therefore false.
Statement IV is correct as funding diversification refers to diversification of both funding sources and the duration for which the amounts are borrowed, ie tenor diversity.
Statement IV is the only correct statement and therefore Choice 'a' is the correct answer.
NEW QUESTION 123
A bank holds $10m of a corporate debt that it has purchased CDS protection against. What is the impact on the short term liquidity of the bank in the event of a default by the corporate on its bonds?
- A. No impact
- B. Cannot be determined without information on recovery rates
- C. A short term increase in available liquidity
- D. An immediate reduction in available liquidity
Answer: C
Explanation:
Explanation
The immediate impact of the default would be to improve the liquidity available in the short term due to the pay out from the CDSs.
It is also important to consider the impact on liquidity from the occurence of a default even in situations where CDS protection may not have been purchased. In such cases, there may be a nearer term payout in the form of the recovery rate. Of course, recovery payments are generally not realized for longer periods of time as court cases linger on, but there is a good likelihood that a payment, albeit lower in total, is likely to be realized sooner than the maturity of the bond in cases where the bond is a longer term bond. At the same time, any interest payments, and the final principal payment, which may have been included in liquidity projections, will not occur.
NEW QUESTION 124
Which of the following are considered counterparty based credit enhancements?
I. Collateral
II. Credit default swaps
III. Close out netting arrangements
IV. Guarantees
- A. II and IV
- B. I, II and IV
- C. I and IV
- D. I and III
Answer: A
Explanation:
Explanation
Credit enhancements come in two varieties: counterparty based, where the exercise of the credit enhancement requires a third party to pay, and this includes guarantees and CDS contracts. Asset based credit enhancements are based upon a physical asset in possession, and these include collateral and balances owed on other trades or transactions, and availed through close out netting arrangements.
Of the listed choices, I and III are asset based credit enhancements, and II and IV are third party based.
NEW QUESTION 125
For a loan portfolio, expected losses are charged against:
- A. Economic credit capital
- B. Credit reserves
- C. Economic capital
- D. Regulatory capital
Answer: B
Explanation:
Explanation
Credit reserves are created in respect of expected losses, which are considered the cost of doing business.
Unexpected losses are borne by economic credit capital, which is a part of economic capital. Therefore Choice
'c' is the correct answer.
NEW QUESTION 126
Which of the following is not one of the 'three pillars' specified in the Basel accord:
- A. National regulation
- B. Minimum capital requirements
- C. Market discipline
- D. Supervisory review
Answer: A
Explanation:
Explanation
The three pillars are minimum capital requirements, supervisory review and market discipline. National regulation is not a pillar described under the accord. Choice 'c' is the correct answer.
NEW QUESTION 127
Which of the following would not be a part of the principal component structure of the term structure of futures prices?
- A. Tilt component
- B. Curvature component
- C. Trend component
- D. Parallel component
Answer: D
Explanation:
Explanation
The trend component refers to parallel shifts in the term structure, the tilt refers to changes in the shape of the term structure at the long and short ends, and the curvature refers to movements in the medium term part. The phrase 'parallel component' has no meaning and is not a part of the principal components in analyzing term structures.
Changes in the term structure can also be analyzed as "level, slope and curvature", so you should be aware of this terminology as well to refer to the principal components of a term structure analysis.
NEW QUESTION 128
Fill in the blank in the following sentence:
Principal component analysis (PCA) is a statistical tool to decompose a ____________ matrix into its principal components and is useful in risk management to reduce dimensions.
- A. Correlation
- B. Covariance
- C. Positive semi-definite
- D. Volatility
Answer: C
Explanation:
Explanation
PCA is a statistical tool that decomposes a positive semi-definite matrix into its principal components. The first few principal components explain nearly all the variation and other components can then be ignored as they are too small in the larger picture. PCA in risk management is applied to a positive semi-definite correlation or covariance matrix to reveal the principal components that cause the variation. By allowing a focus on a few components, PCA reduces dimensionality.
While performing the math of PCA is unlikely to be asked in the PRMIA exam, you should remember that principal components have the additional property of being uncorrelated to each other which makes it useful as it is possible to vary one of the components without having to worry about the effect of that on the other components.
NEW QUESTION 129
Which of the following is NOT true in respect of bilateral close out netting:
- A. Transactions are separated by transaction type and immediately settled separately at each's replacement value
- B. The net amount due is immediately receivable or payable
- C. All transactions are immediately closed out upon the occurrence of a credit event for either of the counterparties
- D. All transactions are netted against each other
Answer: A
Explanation:
Explanation
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.
NEW QUESTION 130
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