Pass the PRMIA PRM Certification 8008 Questions and answers with ExamsMirror

Normal mixtures have higher peaks, and therefore higher kurtosis than a normal distribution with an equivalent mean and variance. Therefore statement I is correct.

The term 'normal mixture' literally means that - the distribution is derived by summing two or more normal distributions. Statement II is correct. One interesting thing to note about normal mixtures is that their mean and variances are just the weighted averages of the means and variances of their underlying component normal distributions. But their kurtosis is higher than that of either of the components. They are more peaked, and have fatter tails, a property that makes them useful in finance.

Unfortunately there is no analytical formula for calculating VaR based on normal mixtures. However, we can back solve for VaR (using Excel's Solver, for example), given we know the density functions for the underlying normal distributions. Statement III is not correct.

The Earnings Volatility approach to calculating economic capital is a top down approach that considers economic capital as being the capital required to make for the worst case fall in earnings, and calculates EC as equal to the worst case decrease in earnings capitalized at the rate of return expected of the firm. The worst case decrease in earnings, or the earnings-at-risk can only be stated at a given confidence level, and is equal to the Expected Earnings less Earnings under the worst case scenario.

Current replacement values are a very poor measure of the credit exposure from a derivative contract, because the future value of these instruments is unpredictable, ie is stochastic, and the range of values it can take increases the further ahead in the future we look. Therefore it is common for credit exposures for derivatives to be measured using forward looking exposure profiles, which are distributions of the expected value of the derivative at the time horizon for which credit risk is being measured. To be conservative, a high enough quintile of this distribution is taken as the 'loan equivalent value' of the derivative as the exposure. Choice 'c' is the correct answer.

The notional value of derivative contracts generally tends to be quite high and unrelated to their economic value or the counterparty exposure. Therefore notional value is irrelevant.

In an interest rate swap, the parties agree to exchanging interest rate payments, with one party being a fixed interest rate payer and the other paying floating rates. The party receiving fixed rates and paying floating can be considered to be long a fixed rate bond and short a floating rate note. Therefore an IRS can be modeled as a combination of a fixed coupon bond and a floating rate note. Choice 'b' is the correct answer.

An error rate of 10 basis points means the number of errors expected in a day will be 15 (recall that 100 basis points = 1%). Therefore the total number of errors expected in a year will be 15 x 250 = 3750. Choice 'a' is the correct answer.

Marginal VaR of a component of a portfolio is the change in the portfolio VaR from a $1 change in the value of the component. It helps a risk analyst who may be trying to identify the best way to influence VaR by changing the components of the portfolio. Marginal VaR is also important for calculating component VaR (for VaR disaggregation), as component VaR is equal to the marginal VaR multiplied by the value of the component in the portfolio.

Marginal VaR is by definition the derivative of the portfolio value with respect to the component i. This is reflected in Choice 'a' above. Using the definitions and relationships between correlation, covariance, beta and volatility of the portfolio and/or the component, we can show that the other two choices are also equivalent to Choice 'a'.

Therefore all the choices present are correct.

The term 'group risk' has been defined in the FSA document 08/24 on stress testing as the risk that a firm may be adversely affected by an occurrence (financial or non-financial) in another group entity or an occurrence that affects ther group as a whole. These risks may occur through:

- reputational contagion,

- financial contagion,

- leveraging,

- double or multiple gearing,

- concentrations and large exposures (particularly intra-group).

Thus, the insurance sector may be considered a group, and a firm may suffer just because another group firm has had losses or reputational issues.

The FSA statement goes on to identify some elements of group risk as follows:

- intra-group exposures (credit or operational exposures through outsourcing or service arrangements, as well as more standard business exposures);

- concentration risks (from credit, market or insurance risks which could put a strain on capital resources across entities simultaneously);

- contagion (reputational damage, operational or financial pressures); and

- complex group structures (with dependencies, complex split of responsibilities and accountabilities).

Therefore Choice 'a' is the correct answer and the rest of the choices are incorrect.

It is not generally sufficient to ensure the adequacy of liquidity across a group - ie it is not appropriate to just add up the sources and needs for liquidity across multiple entities in a group. This is because there can be restrictions on transferring liquidity between entities, particularly when the entities are located across borders. In cases where transfers of liquidity are permitted, there may be settlement delays in transferring funds from one entity to another. Therefore both statements I and II are incorrect.

Wholesale funding sources refers to the temporary interbank funding sources that need to be rolled over on very short intervals, often as short as overnight. These are not stable sources for long term funding. Statement III is therefore false.

Statement IV is correct as funding diversification refers to diversification of both funding sources and the duration for which the amounts are borrowed, ie tenor diversity.

Statement IV is the only correct statement and therefore Choice 'a' is the correct answer.

Choice 'a' is the correct answer. According to the Basel II document, banks using the Basic Indicator Approach must hold capital for operational risk equal to the average over the previous three years of a fixed percentage (denoted alpha, and currently 15%) of positive annual gross income. Figures for any year in which annual gross income is negative or zero should be excluded from both the numerator and denominator when calculating the average.

The point that this question is trying to emphasize is the independence of the risk management function. The risk function should be segregated from the risk taking functions as to maintain independence and objectivity.

Choice 'd', Choice 'c' and Choice 'a' run contrary to this requirement of independence, and are therefore not correct. The risk function should report directly to senior levels, for example directly to the audit committee, and not be a part of the risk taking functions.