PRMIA 8011 Cert Guide PDF 100% Cover Real Exam Questions
Pass 8011 Exam - Real Questions and Answers
NEW QUESTION # 124
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. II, III and IV
- B. II and III
- C. I, II and IV
- D. I and IV
Answer: D
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 # 125
An assumption regarding the absence of ratings momentum is referred to as:
- A. Markov property
- B. Time invariance
- C. Herstatt risk
- D. Ratings stability
Answer: A
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 # 126
long bond position is hedged using a short position in the futures market. If the hedge performs as expected, then which of the following statements is most accurate:
- A. the investor will be able to avoid losses
- B. None of the above
- C. the investor will be able to avoid losses but will also forgo the gains on his positions
- D. the investor will be able to avoid losses and will also be able to keep the gains on his positions
Answer: C
Explanation:
If the hedge performs as expected, then any P&L on the long bond position will be offset by identical losses (or gains) on the hedge.
Since hedges are never perfect, and some residual risk such as basis risk, the inability to enter into an unrounded number of futures contracts will remain. However, the bulk of the risk would be mitigated, and the investor will be able to avoid any losses but will also forgo any gains. Therefore choice b is the correct answer and the rest are incorrect.
NEW QUESTION # 127
If a borrower has a default probability of 12% over one year, what is the probability of default over a month?
- A. 12.00%
- B. 2.00%
- C. 1.06%
- D. 1.00%
Answer: C
Explanation:
Let the probability of default over a month be p. Therefore the probability of survival at the end of 12 months would be (1 - p)^12. Since the one year probability of default is 12%, we know that the probability of survival is 88%. Putting (1 - p)^12 = 88% and solving for p, we get p = 1.06%. Therefore Choice 'd' is the correct answer.
NEW QUESTION # 128
When doing stress tests based on historical scenarios, if no appropriate historical scenarios exist for a security, it is most INAPPROPRIATE to:
- A. Estimate a shock factor based on other instruments that might be considered as proxies for such a security
- B. Estimate a shock factor based upon extrapolation
- C. Leave the position unshocked
- D. Estimate a shock factor based upon interpolation
Answer: C
Explanation:
Where a historical shock factor does not exist for a security, for example because the security is new or was only thinly traded earlier, or because a particular emerging market was immature at the time of the historical scenario being considered, it is inappropriate to leave the position unshocked. By and large, the general rule to be followed when carrying out stress testing is to leave no position unshocked. Therefore Choice 'b' is the correct answer.
Choice 'd', Choice 'a' and Choice 'c' all represent valid approaches to estimating a shock factor in such cases.
NEW QUESTION # 129
All else remaining the same, an increase in the joint probability of default between two obligors causes the default correlation between the two to:
- A. Increase
- B. Cannot be determined from the given information
- C. Decrease
- D. Stay the same
Answer: A
Explanation:
The default correlation between two obligors goes up if the joint probability of default between them increases. This is intuitive. Also consider the formula for the default correlation between two obligors Default correlation = [P(1,2) - P1 * P2] / #P1*(1-P1)*P2*(1-P2); where P(1,2) is the joint probability of default between the two and P1 and P2 are their individual probabilities of default. Obviously, an increase in P (1,2) will cause the default correlation to increase.
NEW QUESTION # 130
According to the implied capital model, operational risk capital is estimated as:
- A. Total capital based on the capital asset pricing model
- B. Total capital less market risk capital less credit risk capital
- C. Capital implied from known risk premiums and the firm's earnings
- D. Operational risk capital held by similar firms, appropriately scaled
Answer: B
Explanation:
Operational risk capital estimated using the implied capital model is merely the capital that is not attributable to market or credit risk. Therefore Choice 'b' is the correct answer. All other responses are incorrect.
NEW QUESTION # 131
When pricing credit risk for an exposure, which of the following is a better measure than the others:
- A. Mark-to-market
- B. Potential Future Exposure (PFE)
- C. Notional amount
- D. Expected Exposure (EE)
Answer: D
Explanation:
Exposure for derivative instruments can vary significantly over the lifetime of the instrument, depending upon how the market moves. The potential future exposure represents the extremes, notthe most likely outcome.
The expected exposure is the most suitable measure for pricing the credit risk. Over time, as multiple transactions are entered into, the expectation (or the mean) will be realized - though individual transactions may have more or less by way of exposure.
The notional amount may not be relevant, though for loans it may be the most important contributor to the expected exposure. Mark-to-market will represent the exposure at a given point in time, but cannot be predicted nor be used to price the credit risk.
NEW QUESTION # 132
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. Trend component
- C. Parallel component
- D. Curvature component
Answer: C
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 # 133
A zero coupon corporate bond maturing in an year has a probability of default of 5% and yields12%. The recovery rate is zero. What is the risk free rate?
- A. 6.40%
- B. 5.00%
- C. 7.00%
- D. 5.26%
Answer: A
Explanation:
The probability of default would make the expected value of the future cash flows from both the corporate bond and the risk free bond identical. If p be the probability of default, the cash flows from the risky corporate bond would be
= (cash flows in the event of default x probability of default) + (cash flows without default x (1 - probability of default))
=> 5%*0 + (1 - 5%)*(1 + 12%) = (1 + Rf).
therefore Rf = 6.4%
(In reality investors would demand a 'credit risk premium' over and above the expected default loss rate. They are unlikely to be happy with just being compensated with exactly the expected default loss rate plus the risk- fre rate because the expected default loss rate itself is uncertain. They would demand some premium over and above what the default rate alone might mathematically imply above the risk free rate. In this question, this credit risk premium is ignored.)
NEW QUESTION # 134
Which loss event type is the failure to timely deliver collateral classified as under the Basel II framework?
- A. Clients, products and business practices
- B. Information security
- C. Execution, Delivery & Process Management
- D. External fraud
Answer: C
Explanation:
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 # 135
If the cumulative default probabilities of default for years 1 and 2 for a portfolio of credit risky assets is 5% and 15% respectively, what is the marginal probability of default in year 2 alone?
- A. 10.53%
- B. 10.00%
- C. 15.79%
- D. 11.76%
Answer: A
Explanation:
One way to think about this question is this: we are provided with two pieces of information: if the portfolio is worth $100 to start with, it will be worth $95 at the end of year 1 and $85 at the end of year 2. What it is asking for is the probability of default in year 2, for the debts that have survived year 1. This probability is $10
/$95 = 10.53%. Choice 'b' is the correct answer.
Note that marginal probabilities of default are the probabilities for default for a given period, conditional on survival till the end of the previous period. Cumulative probabilities of default are probabilities of default by a point in time, regardless of when the default occurs. If the marginal probabilities of default for periods 1, 2... n are p1, p2...pn, then cumulative probability of default can be calculated as Cn = 1 - (1 - p1)(1-p2)...(1-pn). For this question, we can calculate the probability of default for year 2 as [1 - (1 - 5%)(1 - 10.53%)] = 15%.
NEW QUESTION # 136
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 and III
- B. II and III
- C. I and II
- D. I, II, III and IV
Answer: C
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 # 137
If the duration of a bond yielding 10% is 6 years, the volatility of the underlying interest rates 5% per annum, what is the 10-day VaR at 99% confidence of a bond position comprising just this bond with a value of
$10m? Assume there are 250 days in a year.
- A. 0
- B. 1
- C. 2
- D. 3
Answer: C
NEW QUESTION # 138
Which of the following distribution assumptions will produce the lowest probability of exceeding an extreme value, assuming identical means and variances?
- A. t-distribution
- B. a distribution with kurtosis = 5
- C. a normal distribution
- D. a normal mixture distribution
Answer: C
Explanation:
An 'extreme value' will be a value that will lie in the tails. We need to determine the distribution that will have the least weight in the tails so that the probability of exceeding this tail value is minimum across the given choices.
The t-distribution, a distribution with kurtosis > 3 and a normal mixture distribution are all distributions with tails fatter than that for a normal distribution. A normal distribution will have the 'thinnest' tails among the choices and therefore the lowest probability of exceeding a given tail event value.
A note about the t-distribution: Leptokurtic distributions (those that have kurtosis>3, ie kurtosis greater than that for a normal distribution) generally appear to have higher peaks on their PDF graphs. The t-distribution is flatter, and actually appears lower than a normal distribution, which may make one think that it has a lower kurtosis and therefore should have thinner tails than a normal distribution. But that is not so, and the "visual" inspection test fails for inferring the kurtosis from just looking a the shape of the distribution. The kurtosis of a t-distribution is given by the formula {3 + 6/(d - 4)}, where d is the degrees of freedom and d > 4. Therefore the kurtosis of a t-distribution is always greater than 3 as "6/(d-4)" will always be a positive number being added to 3. Therefore there is no conflict between a t-distribution having fatter tails than a normal distribution as it has a higher kurtosis, even though it appears 'lower' on a graph when superimposed with a normal distribution.
NEW QUESTION # 139
Which of the following is not a consideration in determining the liquidity needs of a firm (as opposed to determining the time horizon for liquidity risk)?
- A. The firm's business model
- B. Speed with which new equity can be issued to the owners
- C. Collateral
- D. Off balance sheet items
Answer: B
Explanation:
Managing liquidity requires understanding and providing for two things: the amount of liquidity needed to pay for all current obligations (in both normal and stressed scenarios), and determining the time horizon over which this liquidity should be available. The first is essentially a function of the business of the firm, and the assets and liabilities resulting from operations. The second considers other factors such as the speed with which new cash can be borrowed (eg, from the repo markets), the consequences are of running out of liquidity (eg, maybe only an overdrawn fee as opposed to bankruptcy), etc. In other words, liquidity risk management answers two questions: how much, and for how long.
This question asks for identifying the factors that affect the 'how much' part. Choice 'd', Choice 'c' and Choice
'b' do affect the determination of the liquidity needs of the firm. Choice 'a' does not affect the liquidity needs, but the 'how long' part. Choice 'a' is therefore the correct answer.
NEW QUESTION # 140
Random recovery rates in respect of credit risk can be modeled using:
- A. the binomial distribution
- B. the normal distribution
- C. the beta distribution
- D. the omega distribution
Answer: C
Explanation:
The beta distribution is commonly used to model recovery rates. It is a distribution for variables whose values lie between 0 & 1, and the parameters of the distribution can be estimated using the mean and standard deviation of the data. Therefore Choice 'a' is correct and the others are wrong.
Refer to the tutorial on distributions for an Excel model of the beta distribution.
NEW QUESTION # 141
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