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PRMIA 8010 certification program is ideal for individuals who want to enhance their knowledge and expertise in the field of operational risk management. The program covers a broad range of topics, including risk identification, risk assessment, risk mitigation, and risk reporting. It also covers various types of operational risks, such as legal and regulatory risks, technology risks, and people risks.
NEW QUESTION # 105
Under the internal ratings based approach for risk weighted assets, for which of the following parameters must each institution make internal estimates (as opposed to relying upon values determined by a national supervisor):
- A. Effective maturity
- B. Exposure at default
- C. Loss given default
- D. Probability of default
Answer: D
Explanation:
Explanation
Regardless of the approach being followed by a bank (ie, whether foundation IRB or advanced IRB), it must make its own estimates for the probability of default. Banks following the foundation IRB approach may use values set by the supervisor for the other three parameters, though those following the advanced IRB approach may use their own estimates for all four inputs.(This is also the difference between advanced IRB and the foundation IRB approaches.) Therefore Choice 'a' is the correct answer.
Also note the four difference elements that go as inputs to the internal ratings based approach in the choicesprovided.
NEW QUESTION # 106
Which of the following best describes economic capital?
- A. Economic capital is a form of provision for market risk losses should adverse conditions arise
- B. Economic capital is the amount of regulatory capital mandated for financial institutions in the OECD countries
- C. Economic capital is the amount of regulatory capital that minimizes the cost ofcapital for firm
- D. Economic capital reflects the amount of capital required to maintain a firm's target credit rating
Answer: D
Explanation:
Explanation
Economic capitalis often calculated with a view to maintaining the credit ratings for a firm. It 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 levelequal to the confidence required for the desired credit rating. For example, if the probability of default for a AA rating is 0.02%, and the firm desires to hold an AA rating, then economic capital maintained at a confidence level of 99.98% would allow for such a rating. In this case, 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, and would help get the firm its desired credit rating.
Choice 'c' is the correct answer. Economic capital does not target minimizing the cost of capital, nor is it a provision for losses arising from market risk. The concept of economic capital is unrelated to where an institution or firm is based, therefore Choice 'a' is incorrect as well.
NEW QUESTION # 107
For a corporate bond, which of the following statements is true:
I. The credit spread is equal to the default rate times the recovery rate II. The spread widens when the ratings of the corporate experience an upgrade III. Both recovery rates and probabilities of default are related to the business cycle and move in oppositedirections to each other IV. Corporate bond spreads are affected by both the risk of default and the liquidity of the particular issue
- A. I, II and IV
- B. III and IV
- C. IV only
- D. III only
Answer: B
Explanation:
Explanation
The credit spread is equal to thedefault rate times the loss given default, or stated another way, default rate times (1 - recovery rate). It is not equal to the default rate times the recovery rate. Therefore statement I is not correct.
When ratings are upgraded by rating agencies, the spread contracts and not widen. Therefore statement II is not correct.
Both recovery rates and probabilities of default are related to the business cycle, and they move in opposite directions. Economic recessions witness an increase in the default rate anda decrease in the recovery rate, and economic expansions result in a decrease in the default rate and an increase in the recovery rates when default does happen. Therefore statement III is correct.
Bond spreads incorporate both the risk of default, but also considerations of liquidity in the case of corporate bonds. Hence statement IV is correct.
NEW QUESTION # 108
The key difference between 'top down models' and 'bottom up models' foroperational risk assessment is:
- A. Bottom up approaches to operational risk are based upon an analysis of key risk drivers, while top down approaches consider causality in risk scenarios.
- B. Bottom up approaches to operational risk calculate the implied operational risk using available data such as income volatility, capital etc; while top down approaches use causal factors, risk drivers and other factors to get an aggregated estimate of risk.
- C. Top down approaches to operational risk calculate the implied operational risk using available data such as income volatility, capital etc; while bottom up approaches use causal factors, risk drivers and other factors to get an aggregated estimate of risk.
- D. Top down approaches to operational risk are based upon an analysis of key risk drivers, while bottom up approaches consider causality in risk scenarios.
Answer: C
Explanation:
Explanation
Top down approaches rely upon available data such as total capital, income volatility, peer group information etc and attempt to imply the capital attributable to operational risk. They do not consider firm specific scenarios or causal factors. Bottom up approaches on the other hand attempt to determine operational risk capital based upon an identification and quantification of firm specific risks. Bottom up approaches help determine a traditional loss distribution from which capital requirements can be determined at a given level of confidence.
Therefore Choice 'd' is the correct answer.
NEW QUESTION # 109
Loss from a lawsuit from an employee due to physical harm caused while at work is categorized per Basel II as:
- A. Execution delivery and process management
- B. Employment practices and workplace safety
- C. Unsafe working environment
- D. Damage to physical assets
Answer: B
Explanation:
Explanation
Choice 'a' is the correct answer. 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 # 110
Under the credit migration approach to assessing portfolio credit risk, which of the following are needed to generate adistribution of future portfolio values?
- A. The forward yield curve
- B. A specified risk horizon
- C. A rating migration matrix
- D. All of the above
Answer: D
Explanation:
Explanation
The credit migration approach to assessing portfolio credit risk involves obtaining a distribution of future portfolio values from the ratings migration matrix. First, the frequencies in the matrix are used as probabilities, and expected future values of the securities belonging to each rating category are calculated. These are then discounted to the present using the discount rate appropriate to the 'future' rating category. This gives us a forward distribution of the value of each security in the portfolio. These are then combined using the default correlations between the issuers. The default correlation between the issuers is often proxied using asset returns, and recognizing that default occurs when asset values fall below a certain threshold. A distribution for the future value of the portfolio is generated using simulation, and from thisdistribution the Credit VaR can be calculated.
Thus, we need the migration matrix, the risk horizon from which the present values need to be calculated, and the forward yield curve or the discount curve for each rating category for the risk horizon. Thus,Choice 'd' is the correct answer.
NEW QUESTION # 111
A loan portfolio's full notional value is $100, and its value in a worst case scenario at the 99% level of confidence is $65. Expected losses on the portfolio are estimated at 10%. What is the level of economic capital required to cushion unexpected losses?
- A. 0
- B. 1
- C. 2
- D. 3
Answer: B
Explanation:
Explanation
Expected value = $90 ($100 - 10%)
Value at 99% confidence level = $65
Therefore economic capital required at this level of confidence = $90 - $65 = $25.
Choice 'a' is the correct answer, the other choices are not.
(We can also look at it this way as explained in section III.B.6.2.2 of the handbook: Economic capital is designed to absorb unexpected losses, which areequal to total losses at a given confidence level minus expected losses. (Expected losses are to be covered by credit reserves). Total losses are $100-$65=$35, and expected losses are 10%*$100=$10, therefore economic capital should be $35-$10=$25.)
NEW QUESTION # 112
If the default hazard rate for a company is 10%, and the spread on its bondsover the risk free rate is 800 bps, what is the expected recovery rate?
- A. 40.00%
- B. 0.00%
- C. 8.00%
- D. 20.00%
Answer: D
Explanation:
Explanation
The recovery rate, the default hazard rate (also called the average default intensity) and the spread on debt arelinked by the equation Hazard Rate = Spread/(1 - Recovery Rate). Therefore, the recovery rate implicit in the given data is = 1 - 8%/10% = 20%.
NEW QUESTION # 113
Under the contingent claims approach to measuring credit risk, which of the following factors does NOT affect credit risk:
- A. Cash flows of the firm
- B. Maturity of the debt
- C. Volatility of the firm's asset values
- D. Leverage in the capital structure
Answer: A
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 # 114
What would be the correct order of steps to addressing data quality problems in an organization?
- A. Design the future state, perform a gap analysis, analyze the current state and implement the future state
- B. Call in external consultants
- C. Articulate goals, do a 'strategy-fit' analysis and plan for action
- D. Assess the current state, design the future state, determine gaps and the actions required to be implemented to eliminate the gaps
Answer: D
Explanation:
Explanation
The correct answer is choice 'a'
The correct order of steps to addressing data quality problems in an organization would include:
1. Assesing the current state
2. Designing the future state, and
3. Planning and implementation which would include identifying the gaps between the current and the desired future state, and implementation to address the gaps.
Therefore Choice 'a' is the correct answer.
Choice 'c' is incorrect because a gap analysis cannot be performed without understanding the 'as-is' (which results from understanding the current state).
Choice 'b' is non-sensical, and Choice 'd' is a flippant option (though often used in real life situations by management as an easy (and ineffective) way to escape accountability for difficult problems)
NEW QUESTION # 115
Which of the following statements is true
I. If no loss data is available, good quality scenarios can be used to model operational risk II. Scenario data can be mixed with observed loss data for modeling severity and frequency estimates III. Severity estimates should not be created by fitting models to scenario generated loss data points alone IV. Scenario assessments should only be used as modifiers to ILD or ELD severity models.
- A. All statements are true
- B. I and II
- C. I
- D. III and IV
Answer: B
Explanation:
Explanation
There are multiple ways to incorporate scenario analysis for modeling operational risk capital - and the exact approach used depends upon thequantity of loss data available, and the quality of scenario assessments.
Generally:
- If there is no past loss data available, scenarios are the only practical means to model operational risk loss distributions. Both frequency and severity estimates can be modeled based on scenario data.
- If there is plenty of past data available, scenarios can be used as a modifier for estimates that are based solely on data (for example, consider the MAX of the loss estimates at the desired quantile as provided bythe data, and as indicated by scenarios)
- If high quality scenario data is available, and there is sufficient past data, one could mix scenario assessments with the loss data and fit the combined data set to create the loss distribution. Alternatively, both could be fitted with severity estimates and then the two severities could be parametrically combined.
In short, there is considerable flexibility in how scenarios can be used.
Statement I is therefore correct, and so is statement II as both indicate valid uses of scenarios.
Statement III is not correct because it may be okay to create severity estimates based on scenario data alone.
Statement IV is not correct because while using scenarios as modifiers to other means of estimation is acceptable, that isnot the only use of scenarios.
NEW QUESTION # 116
Which of the following event types is hacking damage classified under Basel II operational risk classifications?
- A. Information security
- B. Technology risk
- C. External fraud
- D. Damage to physical assets
Answer: C
Explanation:
Explanation
Choice 'b' is the correct answer. All other answers are incorrect.
Refer to the detailed loss event type classification underBasel II (see Annex 9 of the accord). You should know the exact names of all loss event types, and examples of each.
NEW QUESTION # 117
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 # 118
Which of the following is not a measure of risk sensitivity of some kind?
- A. PL01
- B. CR01
- C. Delta
- D. Convexity
Answer: A
Explanation:
Explanation
Measures of risk sensitivity include delta, gamma, vega, PV01, convexity and CR01, among others. They allow approximating the change in the value of a portfolio from achange (generally small) in one of the underlying risk factors.
Risk sensitivity measures are derivatives of the value of the portfolio, calculated with respect to the risk factor.
Some risk sensitivity measures are second derivatives, and allow a more precise calculation of the change in the value of the portfolio. Many risk sensitivities are represented by Greek letter, but not all.
Delta () is a measure of the change in portfolio value based on a 1% change in the value of the underlying.
Gamma () is asecond order derivative that improves the calculation as part of a Taylor expansion. CR01 is a measure of the change due to a 1 basis point change in the credit spread. PL01 is not a measure of any kind of risk sensitivity, it does not mean anything.
NEW QUESTION # 119
Which of the following data sources are expected to influence operational risk capital under the AMA:
I. Internal Loss Data (ILD)
II. External Loss Data (ELD)
III. Scenario Data (SD)
IV. Business Environment and Internal Control Factors (BEICF)
- A. I and II
- B. I, II and III only
- C. III only
- D. All of the above
Answer: D
Explanation:
Explanation
All four data sources are expected to be utilized as inputs as appropriate for operational risk calculations under the advanced measurement approach. Of these, the last one, BEICF, is slightly different from the rest as it does not yield data points that becomethe basis of curve fitting or other statistical computions underlying capital calculations. It includes items such as KRIs, risk assessments etc and allow the risk manager to assess the qualitative aspects of loss data.
NEW QUESTION # 120
The generalized Pareto distribution, when used in the context of operational risk, is used to model:
- A. Unexpected losses
- B. Tail events
- C. Expected losses
- D. Average losses
Answer: B
Explanation:
Explanation
Some risk experts have suggested the use of extreme value theory to model tail risk or extreme events for operational risk. The generalized Pareto model or the Peaks-over-Threshold (POT) model are often used to model extreme value distributions, and therefore Choice 'a' is the correct answer.
NEW QUESTION # 121
The sum of the stand alone economic capital of all the business units of a bank is:
- A. less than the economic capital for the firm as a whole
- B. equalto the economic capital for the firm as a whole
- C. more than the economic capital for the firm as a whole
- D. unrelated to the economic capital for the firm as a whole
Answer: C
Explanation:
Explanation
Economic capital is sub-additive, ie, because of the correlation being less than perfect between the risks of thedifferent business units, the total economic capital for the firm will be less than the sum of the EC for the individual business units. Therefore Choice 'b' is the correct answer.
In practice, correlations are difficult to estimate reliably, and banks often use estimates and corroborate their capital calculations with reference to a number of data points.
NEW QUESTION # 122
Which of the following carry greater counterparty risk: a forward contract on a 10 year note, or a commercial paper carrying a AA credit rating with identicalmaturity and notional?
- A. Credit risk can not be compared in these terms
- B. They both carry the same credit risk
- C. The forward contract has greater credit risk as its future gains are unknown
- D. The commercial paper has greater credit risk as the entire notional is outstanding
Answer: D
Explanation:
Explanation
The commercial paper has greater credit risk as the entire notional is outstanding. On the forward contract, only the replacement value of the contract, which normally would be a mere fraction of the notional, would be at risk.
Therefore Choice 'd' is the correct answer.
NEW QUESTION # 123
Which of the following is a measure of the level of capital that an institution needs to hold in order to maintain a desired credit rating?
- A. Regulatory capital
- B. Shareholders' equity
- C. Book value
- D. Economic capital
Answer: D
Explanation:
Explanation
Economic capital is a measure of the level of capital needed to maintain adesired credit rating. Regulatory capital is the amount of capital required to be held by regulation, and this may be quite different from economic capital. Book value is an accounting measure reflecting the assets minus liabilities as measured per accounting rules, this is often expressed per share. Shareholders' equity is a narrow term which is the amount of capital attributable to the shareholders and includes paid up capital and reserves but not long term debt or other non-equity funding.
Therefore Choice 'b' is the correct answer.
NEW QUESTION # 124
Which of the following represents a riskier exposure for a bank: A LIBOR based loan, or an Overnight Indexed Swap? Which of the two rates is expected to be higher?
Assume the same counterparty and the same notional.
- A. A LIBOR based loan; LIBOR rate will be higher
- B. Overnight Index Swap; LIBOR rate will be higher
- C. A LIBOR based loan; OIS rate will be higher
- D. Overnight Index Swap; OIS rate will be higher
Answer: A
Explanation:
Explanation
A LIBOR based loan requires cash to move from the lenderto the borrower in the amount of the notional. The Overnight Index Swap requires only the exchange of interest payments, and therefore represents less risk.
Therefore the LIBOR based loan is a riskier exposure.
The LIBOR is generally higher than the OIS. In fact, the difference between the two, the LIBOR-OIS spread, is a standard measure of the risk premium in the market that goes up when the risk of default by counterparty banks is considered high. This is because when the market perceives the risk of default to be high, the participants need a risk premium to take on the default risk which is considerably lesser with the OIS.
NEW QUESTION # 125
What does a middle office do for a trading desk?
- A. Operations
- B. Transaction data entry
- C. Reconciliations
- D. Risk analysis
Answer: D
Explanation:
Explanation
The 'middle office' is a term used for the risk management function, thereforeChoice 'd' is the correct answers.
The other functions describe what the 'back office' does (IT, accounting). The 'front office' includes the traders.
NEW QUESTION # 126
As the persistence parameter under EWMA is lowered, which of the following would be true:
- A. High variance from the recent past will persist for longer
- B. The model will react faster to market shocks
- C. The model will react slower to market shocks
- D. The model will give lower weight to recent returns
Answer: B
Explanation:
Explanation
The persistence parameter, , is the coefficient of the prior day's variance in EWMA calculations. A higher value of the persistence parameter tends to 'persist' the prior value of variance for longer. Consider an extreme example - if the persistence parameter is equal to 1, the variance under EWMA will never change in response to returns.
1 - is the coefficient of recent market returns. As is lowered, 1 - increases,giving a greater weight to recent market returns or shocks. Therefore, as is lowered, the model will react faster to market shocks and give higher weights to recent returns, and at the same time reduce the weight on prior variance which will tend to persist for a shorter period.
NEW QUESTION # 127
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PRMIA 8010: Operational Risk Manager (ORM) Exam covers a wide range of topics, including the fundamental principles of operational risk management, the identification and assessment of operational risks, risk measurement and reporting, and risk governance and control. 8010 exam is divided into four sections, and candidates are required to demonstrate their proficiency in each area to pass the exam successfully.
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