PRMIA 8010 Exam Practice Test Instant Access

Question 1

Which of the following was not a policy response introduced by Basel 2.5 in response to the global financial crisis:

AComprehensive Risk Model (CRM)

BComprehensive Capital Analysis and Review (CCAR)

CStressed VaR (SVaR)

DIncremental Risk Charge (IRC)

Answer : B

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.

Question 2

Which of the following are valid criticisms of value at risk:

1. There are many risks that a VaR framework cannot model

2. VaR does not consider liquidity risk

3. VaR does not account for historical market movements

4. VaR does not consider the risk of contagion

A1, 2 and 4

B1 and 3

C2 and 4

DAll of the above

Answer : A

Risks such as abrupt changes to a firm's business model caused by legislation, or the introduction of capital controls in foreign countries where a firm in invested, geo-political risks etc are not modelable in the traditional sense. These risks cannot be modeled using VaR. Therefore statement I is correct.

VaR indeed does not consider liquidity risk, it is only concerned with the standard deviation of portfolio returns. Statement II is a valid criticism.

Statement III is not correct, as VaR can consider historical price movements.

Statement IV is correct, as VaR does not consider systemic risk or the risk of contagion.

Question 3

A risk analyst peforming PCA wishes to explain 80% of the variance. The first orthogonal factor has a volatility of 100, and the second 40, and the third 30. Assume there are no other factors. Which of the factors will be included in the final analysis?

AFirst, Second and Third

BFirst and Second

CFirst

DInsufficient information to answer the question

Answer : C

The total variance of the system is 100^2 + 40^2 + 30^2 = 12500 (as variance = volatility squared). The first factor alone has a variance of 10,000, or 80%. Therefore only the first factor will be included in the final analysis, and the rest will be ignored.

Interestingly, this example highlights one of the limitations of PCA. Obviously, the second and third factors are material when considering volatility, though the effect of squaring them to get the variance makes them appear less important than they are.

Question 4

Which of the following formulae correctly describes Component VaR. (p refers to the portfolio, and i is the i-th constituent of the portfolio. MVaR means Marginal VaR, and other symbols have their usual meanings.)

D1 and 2

Answer : D

The first two formulae describe component VaR. The last formula is the formula for Marginal VaR. Therefore I and II is the correct answer.

Component VaR is a VaR decomposition technique that allows the total VaR for a portfolio to be broken down and attributed to the components of a portfolio. The total of the component VaR for each constituent of a portfolio is equal to the VaR for the portfolio. This property is extremely useful as opposed to the standalone VaR for each constituent taken alone as it can be used for allocating trading budgets.

Question 5

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

AMarginal VaR is the value of the expected losses on occasions where the VaR estimate is exceeded.

BMarginal VaR is the contribution of the asset to portfolio VaR in a way that the sum of such calculations for all the assets in the portfolio adds up to the portfolio VaR.

CMarginal VaR is the change in the VaR estimate for the portfolio as a result of including the asset in the portfolio.

DMarginal VaR describes the change in total VaR resulting from a $1 change in the value of the asset in question.

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 6

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

AThe net amount due is immediately receivable or payable

BAll transactions are immediately closed out upon the occurrence of a credit event for either of the counterparties

CAll transactions are netted against each other

DTransactions are separated by transaction type and immediately settled separately at each's replacement value

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 7

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

ARestructuring

BObligation accelerations

CRating downgrade

DFailure to pay

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.

PRMIA 8010 Operational Risk Manager (ORM) Exam Practice Test