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PRMIA 8011 Credit and Counterparty Manager (CCRM) Certificate Exam is a globally recognized professional certification program designed for individuals who aspire to become experts in credit and counterparty risk management. The CCRM certificate is awarded by the Professional Risk Managers’ International Association (PRMIA), which is a non-profit organization dedicated to promoting best practices in risk management, education and certification.
NEW QUESTION # 75
Which of the following is additive, ie equal to the sum of its components
- A. Incremental VaR
- B. Component VaR
- C. Specific VaR
- D. Conditional VaR
Answer: B
Explanation:
Component VaR measures the proportion of total VaR that can be allocated to each asset in the portfolio. It is based upon the covariance matrix multiplied by the weights, and each row represents the component VaR for the asset in question. Since the total of such a matrix is the total VaR, component VaR is additive. Component VaR is used to assess the contribution of each asset in the portfolio to total risk and has the useful property of being additive so some sense can be made of the contribution of each asset to total risk.
Incremental VaR, conditional VaR and VaR are sub-additive by definition, and therefore not the correct answer.
NEW QUESTION # 76
What would be the consequences of a model of economic risk capital calculation that weighs all loans equally regardless of the credit rating of the counterparty?
I. Create an incentive to lend to the riskiest borrowers
II. Create an incentive to lend to the safest borrowers
III. Overstate economic capital requirements
IV. Understate economic capital requirements
- A. I only
- B. II and III
- C. I and IV
- D. III only
Answer: C
Explanation:
If capital calculations are done in a standard way regardless of risk (as reflected by credit ratings), then it creates a perverse incentive for the lenders' employees to lend to the riskiest borrowers that offer the highest expected returns as there is no incentive to 'save' on economic capital requirements that are equal for both safe and unsafe borrowers. Therefore statement I is correct.
Given that the portfolio of such an institution is likely to then comprise poor quality borrowers, and economic capital would be based upon 'average' expected ratings, it is likely to carry lower economic capital given its exposures. Therefore any such economic risk capital model is likely to understate economic capital requirements. Therefore statement IV is correct.
Statements II and III are incorrect and Choice 'b' is the correct answer.
NEW QUESTION # 77
Which of the following are considered asset based credit enhancements?
I. Collateral
II. Credit default swaps
III. Close out netting arrangements
IV. Cash reserves
- A. II and IV
- B. I and IV
- C. I and III
- D. I, II and IV
Answer: C
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 is third party based. Cash reserves are not credit enhancements (unless held as collateral).
NEW QUESTION # 78
For an investor with a long position in market index futures, which of the following is a primary risk:
- A. Movement in interest rates underlying the futures prices
- B. Risk that expected dividends will differ from realized dividend yields
- C. Basis risk between futures and spot prices
- D. Increase or decrease in the level of the underlying index
Answer: D
Explanation:
This question emphasizes the difference between primary and secondary risks. Primary risks are the risks consciously undertaken, ie the risks whose premium the investor is trying to earn. Secondary risks are risks that accompany the primary risks that the investor will either hedge, or will ignore if they are small. It is important to watch out for secondary risks because they could become significant and offset the returns being sought even if the investor's market view is proved correct.
An investor in market index futures is betting that the index will rise. Index futures prices are largely driven by the spot value of the index, but are also affected by costs of carry. In particular, futures prices will be driven by interest rates, expected dividends, and any other factors that may cause the basis between spot and futures prices to diverge. These risks are secondary risks.
In this question, Choice 'd' represents the primary risk, and Choice 'a', Choice 'b' and Choice 'c' are all secondary risks. Therefore Choice 'd' is the correct answer.
NEW QUESTION # 79
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?
- A. First, Second and Third
- B. Insufficient information to answer the question
- C. First
- D. First and Second
Answer: C
Explanation:
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.
NEW QUESTION # 80
There are two bonds in a portfolio, each with a market value of $50m. The probability of default of the two bonds are 0.03 and 0.08 respectively, over a one year horizon. If the default correlation is 25%, what is the one year expected loss on this portfolio?
- A. $5.26m
- B. $11m
- C. $5.5mc
- D. $1.38m
Answer: C
Explanation:
We will need to calculate the joint probability distribution of the portfolio as follows.Probability of the joint default of both A and B = A black line with numbers and symbols Description automatically generated with medium confidence
The marginal probabilities (ie the standalone probabilities of default of the two bonds) are known, and if we can calculate the probability of joint defaults of the two bonds, we can calculate the rest of the entries. We then multiply the probabilities with the expected loss under each scenario and add them up to get the total expected loss.
The calculations are shown below. The expected loss is $5.5m, and therefore the correct answer isChoice 'd'.
A screenshot of a paper Description automatically generated
NEW QUESTION # 81
Which of the following is not a parameter to be determined by the risk manager that affects the level of economic credit capital:
- A. Probability of default
- B. Definition of credit losses
- C. Risk horizon
- D. Confidence level
Answer: A
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 # 82
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 and IV
- D. I, II and IV
Answer: C
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 # 83
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. Leverage in the capital structure
- D. Volatility of the firm's asset values
Answer: A
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 # 84
Which of the following decisions need to be made as part of laying down a system for calculating VaR:
I. The confidence level and horizon
II. Whether portfolio valuation is based upon a delta-gamma approximation or a full revaluation III. Whether the VaR is to be disclosed in the quarterly financial statements IV. Whether a 10 day VaR will be calculated based on 10-day return periods, or for 1-day and scaled to 10 days
- A. II and IV
- B. I and III
- C. I, II and IV
- D. All of the above
Answer: C
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.
The Basel framework requires banks to estimate VaR at the 99% confidence level over a 10 day horizon. Yet this is a decision that needs to be explicitly made and documented. Therefore 'I' is a correct choice.
At various stages of the calculations, portfolio values need to be determined. The valuation can be done using a 'full valuation', where each position is explicitly valued; or the portfolio(s) can be reduced to a handful of risk factors, and risk sensitivities such as delta, gamma, convexity etc be used to value the portfolio. The decision between the two approaches is generally based on computational efficiency, complexity of the portfolio, and the degree of exactness desired. 'II' therefore is one of the decisions that needs to be made.
The decision as to disclosing the VaR in financial filings comes after the VaR has been calculated, and is unrelated to the VaR calculation system a bank needs to set up. 'III' is therefore not a correct answer.
Though the Basel framework requires a 10-day VaR to be calculated, it also allows the calculation of the 1- day VaR and and scaling it to 10 days using the square root of time rule. The bank needs to decide whether it wishes to scale the VaR based on a 1-day VaR number, or compute VaR for a 10 day period to begin with.
'IV' therefore is a decision to be made for setting up the VaR system.
NEW QUESTION # 85
The VaR of a portfolio at the 99% confidence level is $250,000 when mean return is assumed to be zero. If the assumption of zero returns is changed to an assumption of returns of $10,000, what is the revised VaR?
- A. 0
- B. 1
- C. 2
- D. 3
Answer: A
Explanation:
The exact formula for VaR is = -(Z# # + #), where Z # is the z-multiple for the desired confidence level, and # is the mean return. Now Z# is always a negative number, or at least will certainly be provided the desired confidence level is greater than 50%, and # is often assumed to be zero because generally for the short time periods for which market risk VaR is calculated, its value is very close to zero.
Therefore in practice the formula for VaR just becomes -Z##, and since Z is always negative, we normally just multiply the Z factor without the negative sign with the standard deviation to get the VaR.
For this question, there are two ways to get the answer. If we use the formula, we know that -Z##= 250,000 (as #=0), and therefore -Z## - # = 250,000 - 10,000 = $240,000.
The other, easier way to think about this is that if the mean changes, then the distribution's shape stays exactly the same, and the entire distribution shifts to the right by $10,000 as the mean moves up by $10,000.
Therefore the VaR cutoff, which was previously at -250,000 on the graph also moves up by 10k to -240,000, and therefore $240,000 is the correct answer.
The other choices are intended to confuse by multiplying the z-factor for the 99% confidence level with
10,000 etc.
NEW QUESTION # 86
Identify the correct sequence of events as it unfolded in the credit crisis beginning 2007:
I. Mortgage defaults increased
II. Collapse in prices of unrelated assets as banks tried to create liquidity III. Banks refused to lend or transact with each other IV. Asset prices for CDOs collapsed
- A. III, IV, I and II
- B. I, III, IV and II
- C. IV, I, II and III
- D. I, IV, III and II
Answer: D
Explanation:
According to a paper by the BCBS, here is an excellent summary of what happened. Based on this, Choice 'c' is the correct answer.
"At the outset of the crisis, mortgage default shocks played a part in the deterioration of market prices of collateralised debt obligations (CDOs). Simultaneously, these shocks revealed deficiencies in the models used to manage and price these products. The complexity and resulting lack of transparency led to uncertainty about the value of the underlying investment. Market participants then drastically scaled down their activity in the origination and distribution markets and liquidity disappeared. The standstill in the securitisation markets forced banks to warehouse loans that were intended to be sold in the secondary markets. Given a lack of transparency of the ultimate ownership of troubled investments, funding liquidity concerns were triggered within the banking sector as banks refused to provide sufficient funds to each other. This in turn led to the hoarding of liquidity, exacerbating further the funding pressures within the banking sector. The initial difficulties in subprime mortgages also fed through to a broader range of market instruments since the drying up of market and funding liquidity forced market participants to liquidate those positions which they could trade in order to scale back risk. An increase in risk aversion also led to a general flight to quality, an example of which was the high withdrawals by households from money market funds."
NEW QUESTION # 87
Which of the following statements are true:
I. Stress tests should consider simultaneous pressures in funding and asset markets, and the impact of a reduction in liquidity II. Judging the effectiveness of risk mitigation techniques is not a part of stress testing III. A reverse stress test is useful for discovering hidden vulnerabilities and inconsistencies in hedging strategies IV. Reputational risk, which is explicitly excluded from the definition of operational risk under Basel II, should still be considered as part of stress tests.
- A. II and IV
- B. I, III and IV
- C. I and III
- D. All of the above
Answer: B
Explanation:
All the statements in this question are directly based on the principles for effective stress testing as laid down in the BCBS document on stress testing issued in May 2009. Statement 1 is correct and is an almost verbatim reproduction of principle 10 as laid down in that document. Statement II is incorrect as it is contrary to principle 11 laid down in the same document. Statement III is correct as discovering hidden vulnerabilities and inconsistencies in hedging strategies is one of the objectives of reverse stress tests. Similarly, even though reputational risk is not really covered under any risk category under Basel II (as it is not a part of either market, credit or operational risk), principle 14of this paper requires the mitigation of spill-over effects on market confidence of reputational risk when thinking about stress tests.
Thus statements I, III and IV are correct and statement II is incorrect.
NEW QUESTION # 88
According to Basel II's definition of operational loss event types, losses due to acts by third parties intended to defraud, misappropriate property or circumvent the law are classified as:
- A. Internal fraud
- B. Execution delivery and system failure
- C. External fraud
- D. Third party fraud
Answer: C
Explanation:
Choice 'c' 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 # 89
Which of the following distribution assumptions will produce the lowest probability of exceeding an extreme value, assuming identical means and variances?
- A. a normal distribution
- B. a normal mixture distribution
- C. a distribution with kurtosis = 5
- D. t-distribution
Answer: A
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 # 90
The probability of default of a security over a 1 year period is 3%. What is the probability that it would not have defaulted at the end of four years from now?
- A. 88.53%
- B. 88.00%
- C. 11.47%
- D. 12.00%
Answer: A
Explanation:
The probability that the security would not default in the next 4 years is equal to the probability of survival raised to the power four. In other words, =(1 - 3%)^4 = 88.53%. Choice 'b' is the correct answer.
NEW QUESTION # 91
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