Ultimate Guide to Prepare 8008 with Accurate PDF Questions [Nov 21, 2021]
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NEW QUESTION 145
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: A
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 are equal 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 146
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: D
NEW QUESTION 147
There are three bonds in a diversified bond portfolio, whose default probabilities are independent of each other and equal to 1%, 2% and 3% respectively over a 1 year time horizon. Calculate the probability that exactly 1 of the three bonds will default.
- A. 2%
- B. .011%
- C. 0%
- D. 5.8%
Answer: D
Explanation:
Explanation
The probability that only one of the three bonds will default is equal to the sum of the probabilities of the three scenarios where one bond defaults and the other two survive. This probability is given by 1%*(1 - 2%)*(1 -
3%) + (1 - 1%)*2%*(1 - 3%) + (1 - 1%)*(1 - 2%)*3% = 5.7818%. Choice 'c' is the correct answer.
NEW QUESTION 148
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.)
- A. I and II
- B. II
- C. III
- D. I
Answer: A
Explanation:
Explanation
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.
NEW QUESTION 149
The minimum 'multiplication factor' to be applied to VaR calculations for calculating the capital requirements for the trading book per Basel II is equal to:
- A. 0
- B. 1
- C. 2
- D. 3
Answer: D
Explanation:
Explanation
The minimum multiplication factor specified under Basel II is 3. Therefore the correct answer is Choice 'a'.
The exact requirements are laid down below.
Each bank must meet, on a daily basis, a capital requirement expressed as the higher of (i) its previous day's value-at-risk number measured according to the parameters specified in this section and (ii) an average of the daily value-at-risk measures on each of the preceding sixty business days, multiplied by a multiplication factor.
The multiplication factor will be set by individual supervisory authorities on the basis of their assessment of the quality of the bank's risk management system, subject to an absolute minimum of 3. Banks will be required to add to this factor a "plus" directly related to the ex-post performance of the model, thereby introducing a built in positive incentive to maintain the predictive quality of the model. The plus will range from 0 to 1 based on the outcome of so-called "backtesting."
NEW QUESTION 150
For credit risk calculations, correlation between the asset values of two issuers is often proxied with:
- A. Credit migration matrices
- B. Transition probabilities
- C. Default correlations
- D. Equity correlations
Answer: D
Explanation:
Explanation
Asset returns are relevant for credit risk models where a default is related to the value of the assets of the firm falling below the default threshold. When assessing credit risk for portfolios with multiple credit assets, it becomes necessary to know the asset correlations of the different firms. Since this data is rarely available, it is very common to approximate asset correlations using equity prices. Equity correlations are used as proxies for asset correlation, therefore Choice 'c' is the correct answer.
NEW QUESTION 151
Which of the following cannot be used to address the issue of heavy tails when modeling market returns
- A. Student's t-distribution
- B. EWMA
- C. Normal mixtures
- D. EVT
Answer: B
Explanation:
Explanation
Normal mixtures, EVT and the t-distribution are all possible solutions addressing the issue of heavy tails in financial returns.
EWMA and GARCH address volatility clustering, which is the other problem when doing risk calculations.
Therefore Choice 'b' is the correct answer as EWMA is not used to address heavy tails but volatility clustering.
NEW QUESTION 152
Which of the following distributions is generally not used for frequency modeling for operational risk
- A. Binomial
- B. Gamma
- C. Negative binomial
- D. Poisson
Answer: B
Explanation:
Explanation
Frequency modeling is performed using discrete distributions that have a positive integer as a resultant - this allows for the number of events per period of time to be modeled. Of the distributions listed above, Poisson, negative binomial and binomial can be used for modeling frequency distributions. The Poisson and negative binomial distributions are encountered the most in practice.
The gamma distribution is a continuous distribution and cannot be used for frequency modeling.
NEW QUESTION 153
Which of the following are considered counterparty based credit enhancements?
I. Collateral
II. Credit default swaps
III. Close out netting arrangements
IV. Guarantees
- A. I, II and IV
- B. I and IV
- C. I and III
- D. II and IV
Answer: D
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 154
Which of the following statements is true:
- A. Total expected losses are equal to the sum of individual underlying exposures while total unexpected losses are greater than the sum of unexpected losses on underlying exposures
- B. Both total expected losses and total unexpected losses are less than the sum of expected and unexpected losses on underlying exposures respectively
- C. Total expected losses are greater than the sum of individual underlying exposures while total unexpected losses are less than the sum of unexpected losses on underlying exposures
- D. Total expected losses are equal to the sum of expected losses in the individual underlying exposures while total unexpected losses are less than the sum of unexpected losses on underlying exposures
Answer: D
Explanation:
Explanation
Total expected losses which are average and anticipated are equal to the sum of expected losses in the underlying exposures. Total unexpected losses, which are the excess of worst case losses at a certain confidence level over the expected losses, benefit from the diversification effect and are lower than the sum of unexpected losses of the underlying exposures. Therefore Choice 'c' is the correct answer. The other choices are incorrect.
NEW QUESTION 155
Which of the following is a valid approach to determining the magnitude of a shock for a given risk factor as part of a historical stress testing exercise?
I. Determine the maximum peak-to-trough change in the risk factor over the defined period of the historical event II. Determine the minimum peak-to-trough change in the risk factor over the defined period of the historical event III. Determine the total change in the risk factor between the start date and the finish date of the event regardless of peaks and troughs in between IV. Determine the maximum single day change in the risk factor and multiply by the number of days covered by the stress event
- A. I, II and IV
- B. I and III
- C. II and IV
- D. IV only
Answer: B
Explanation:
Explanation
Stress events rarely play out in a well defined period of time, and looking back it is always difficult to put exact start and end dates on historical stress events. Even after that is done, the question arises as to what magnitude of a change in a particular risk factor (for example interest rates, spreads, or exchange rates) are reasonable to consider for the purposes of the stress test.
Statements I and III correctly identify the two approaches that are acceptable and used in practice - the risk manager can either take the maximum adverse move - from peak to trough - in the risk factor, or alternatively he or she could consider the change in the risk factor from the start of the event to the end as defined for the purposes of the stress test. Between the two, the approach mentioned in statement III is considered slightly superior as it produces more believable shocks.
Statement II is incorrect because we never want to consider the minimum, and statement IV is not correct as it is likely to generate a shock of a magnitude that is not plausible. Therefore Choice 'b' is the correct answer.
NEW QUESTION 156
If two bonds with identical credit ratings, coupon and maturity but from different issuers trade at different spreads to treasury rates, which of the following is a possible explanation:
I. The bonds differ in liquidity
II. Events have happened that have changed investor perceptions but these are not yet reflected in the ratings III. The bonds carry different market risk IV. The bonds differ in their convexity
- A. I, II and IV
- B. I and II
- C. II and IV
- D. III and IV
Answer: B
Explanation:
Explanation
When two bonds that appear identical in every respect trade at different prices, the difference is often due to differences in liquidity between the two bonds (the less liquid bond will be cheaper and yield higher), and also due to the fact that ratings from the major rating agencies do not generally react to day to day changes in the market. The market's perception of the differences in the two credits will cause a divergence in the prices. This has been an extremely visible phenomenon during the credit crisis of 2007-2009, where fixed income security prices have changed sharply for many securities without any changes in external credit ratings.
Bonds carrying 'different market risk' is meaningless, and so is the difference in convexity (because the calculated convexity would be identical for similar bonds).
Therefore Choice 'c' is the correct answer.
NEW QUESTION 157
Which of the following best describes the concept of marginal VaR of an asset in a portfolio:
- A. Marginal VaR describes the change in total VaR resulting from a $1 change in the value of the asset in question.
- B. Marginal 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.
- C. Marginal VaR is the value of the expected losses on occasions where the VaR estimate is exceeded.
- D. Marginal VaR is the change in the VaR estimate for the portfolio as a result of including the asset in the portfolio.
Answer: A
Explanation:
Explanation
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.
NEW QUESTION 158
Under the contingent claims approach to measuring credit risk, which of the following factors does NOT affect credit risk:
- A. Volatility of the firm's asset values
- B. Maturity of the debt
- C. Leverage in the capital structure
- D. Cash flows of the firm
Answer: D
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 159
The loss severity distribution for operational risk loss events is generally modeled by which of the following distributions:
I. the lognormal distribution
II. The gamma density function
III. Generalized hyperbolic distributions
IV. Lognormal mixtures
- A. I and III
- B. II and III
- C. I, II and III
- D. I, II, III and IV
Answer: D
Explanation:
Explanation
All of the distributions referred to in the question can be used to model the loss severity distribution for op risk. Therefore Choice 'c' is the correct answer.
NEW QUESTION 160
An investor enters into a 5-year total return swap with Bank A, with the investor paying a fixed rate of 6% annually on a notional value of $100m to the bank and receiving the returns of the S&P500 index with an identical notional value. The swap is reset monthly, ie the payments are exchanged monthly. On Jan 1 of the fourth year, after settling the last month's payments, the bank enters bankruptcy. What is the legal claim that the hedge fund has against the bank in the bankruptcy court?
- A. $6m
- B. $0, as all payments on the swap are current
- C. The replacement value of the swap
- D. $100m
Answer: C
Explanation:
Explanation
According to ISDA standard definitions, the legal claim for OTC derivatives is the current replacement value of the contract. Therefore Choice 'c' is the correct answer. None of the other choices are correct.
NEW QUESTION 161
Which of the following decisions need to be made as part of laying down a system for calculating VaR:
I. How returns are calculated, eg absoluted returns, log returns or relative/percentage returns II. Whether VaR is calculated based on historical simulation, Monte Carlo, or is computed parametrically III. Whether binary/digital options are included in the portfolio positions IV. How volatility is estimated
- A. I and III
- B. II and IV
- C. All of the above
- D. I, II and IV
Answer: D
Explanation:
Explanation
While conceptually VaR is a fairly straightforward concept, a number of decisions need to be made to select between the different choices available for the exact mechanism to be used for the calculations.
There is more than one way to calculate returns. Absolute returns may be relevant for risk factors where the size of the movement is unrelated to its current value. For other risk factors, the returns might scale with the size of the existing value of the risk factor, eg equity prices. The right return definition needs to be adopted for each risk factor, therefore 'I' is a correct choice.
The risk analyst has a Choice 'b'etween parametric VaR, Monte Carlo, and historical simulation based VaR. 'II' therefore is one of the decisions that needs to be made (though historical simulation is the choice most often made).
The decision as to what to include in a portfolio is not a decision that is affected by choices made for VaR calculations. 'III' is therefore not a correct answer.
There are multiple ways to calculate volatility - including decisions on how long back in time to go for the data, and whether volatility clustering needs to be accounted for using EWMA or GARCH. Therefore 'IV' is a correct answer.
NEW QUESTION 162
In estimating credit exposure for a line of credit, it is usual to consider:
- A. the present value of the line of credit at the agreed rate of lending.
- B. only the value of credit exposure currently existing against the credit line as the exposure at default.
- C. the full value of the credit line to be the exposure at default as the borrower has an informational advantage that will lead them to borrow fully against the credit line at the time of default.
- D. a fixed fraction of the line of credit to be the exposure at default even though the currently drawn amount is quite different from such a fraction.
Answer: D
Explanation:
Explanation
Choice 'a' is the correct answer. Exposures such as those to a line of credit of which only a part (or none) may be drawn at the time of assessment present a difficulty when attempting to quantify credit risk. It is not correct to take the entire amount of the line as the exposure at default, and likewise the current exposure is likely to be too aggressively low a number to consider.
While the borrower has an information advantage in that he would be aware of the deterioration in credit standing before the bank and would probably draw cash prior to default, it is unlikely that the entire amount of the line of credit would be drawn in all cases. In some cases, none may be drawn. In other cases, the bank would become aware of the situation and curtail or cancel access to the credit line in a timely fashion.
Therefore a fixed proportion of existing credit lines is considered a reasonable approximation of the exposure at default against credit lines.
NEW QUESTION 163
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