Pass the PRMIA PRM Certification 8010 Questions and answers with ExamsMirror

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.

Monte Carlo VaR computations generally include the following steps:

1. Generate multivariate normal random numbers, based upon thecorrelation matrix of the risk factors

2. Based upon these correlated random numbers, calculate the new level of the risk factor (eg, an index value, or interest rate)

3. Use the new level of the risk factor to revalue each of the underlying assets, and calculate the difference from the initial valuation of the portfolio. This is the portfolio P&L.

4. Use the portfolio P&L to estimate the desired percentile (eg, 99th percentile) to get and estimate of the VaR.

Monte Carlo based VaR calculations rely upon full portfolio revaluations, as opposed to delta/delta-gamma approximations. As a result, they are also computationally more intensive. Because they are not limited by the range of instruments and the properties they can cover, they can capture a wide rangeof distributional assumptions for asset returns. They also tend to provide more robust estimates for the tail, including portions of the tail that lie beyond the VaR cutoff.

Therefore I and III are true, and the other two are not.

Since the business units are uncorrelated, we can get the combined EC as equal to the square root of the sum of the squares of the individual EC estimates.Therefore Choice 'a' is the correct answer. [=SQRT(100^2+200^2+150^2)]

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.

Statement I is correct. Economic capital is the capital available to absorbunexpected losses, and credit ratings are also based upon a certain probability of default. Economic capital is often calculated at a level equal to the confidence required for the desired credit rating. For example, if the probability of default for a AArating is 0.02%, then economic capital maintained at a 99.98% would allow for such a rating. 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.

Loss distributions are the product of the severity and frequency distributions, each of which are estimated separately. The total loss distribution is affected far more by the severity distribution than by the frequency distribution, therefore statement II is correct.

The Loss Distribution Approach (LDA) is one of the ways in which the requirements of the AMA can be satisfied, and not the other way round. Therefore statement III is incorrect.

Statement IV is correct as the total loss distribution is estimated using separate estimatesof loss frequency and distributions.

This is a tricky question in the sense norisk management professional can be expected to know the answer to this one unless they have read Chapter 2 of the PRMIA handbook. So this question appears purely for the sake of something you would need to know purely for the sake of the exam.

PRMIA's handbook classifies governance sructures as reactive, preventative and active. Reactive structures involve monitoring signals after the event leading to corrective actions. Preventative structures are forward looking and anticipate issues before they arise. Active structures include considerations of operational efficiency and not just governance. All other answers are made up phrases and are incorrect.

In reality, corporations employ all structures together without worrying about the boundary between the three, and these distinctions do not exist except in textbooks.

Pre-settlement risk is the risk that one of the counterparties defaults prior to the date for the maturity of the transaction in question. This may be an unrelated default, in fact there may have been no default on that particular contract, but the party may have defaulted on its other obligations, or filed for bankruptcy. To deal with such cases and to protect the interests of both the parties, it is common toprovide for immediate termination of positions and settlement based on the current replacement value of the contracts. Therefore statements I and II are correct.

Statement III is correct as well - the exposure from an OTC derivative contract derives fromits current replacement value, and not the notional. If the current replacement value is negative, then the credit exposure is considered equal to zero.

Statement IV is correct as it is quite common to restate all exposures - those from credit lines, OTC derivatives etc - in loan equivalent terms prior to estimating credit risk.

Ultimately, the objective of the operational risk severity estimation exercise is to calculate the 99.9th percentile loss over a one year horizon; and everything else we do with data, collecting loss information, modeling, curve fitting etc revolves around this objective. If we cannot estimate the 99.9th percentile loss accurately, then not much else matters. Therefore Choice 'a' is the correct answer.

Minimizing the combination of fitting and approximation errors is one of the things we do witha view to better estimating the operational loss distribution. Likewise, empirical loss data generally is range bound because corporations do not require employees to log losses less than an threshold, and high value losses are generally rare. This problemis addressed by extrapolating both large and small losses, something that impacts the performance of our model. Likewise, one of the objectives of scenario analysis is to fill data gaps by generating plausible scenarios. Yet while all these are real issues to address, the primary problem we are trying to solve is estimating the 0.999th quantile.

Exposure for derivative instruments can vary significantly over the lifetimeof the instrument, depending upon how the market moves. The potential future exposure represents the extremes, not the most likely outcome. The expected exposure is the most suitable measure for pricing the credit risk. Over time, as multiple transactionsare 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.

The correct answer is Choice 'c'. The following is a brief description of the major approaches available to model credit risk, and the analysis that underlies them:

1. CreditMetrics: based on the credit migration framework. Considers the probability of migration to other credit ratings and the impact of such migrations on portfolio value.

2. CreditPortfolio View: similar to CreditMetrics, but adds the impact of the business cycle to the evaluation.

3. The contingent claims approach: uses option theory by considering a debt as a put option on the assets of the firm.

4. KMV's EDF (expected default frequency) based approach: relies on EDFs and distance to default as a measure of credit risk.

5. CreditRisk+: Also called the 'actuarial approach', considers default as a binary event that either happens or does not happen. This approach does not consider the loss of value from deterioration in credit quality (unless the deterioration implies default).