Pass the PRMIA PRM Certification 8011 Questions and answers with ExamsMirror

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.

Choice 'a' is the correct answer. The other choices represent non-sensical statements.

Historical Simulation VaR is conceptually very straightforward: actual prices as seen during the observation period (1 year, 2 years, or other) become the 'scenarios' forming the basis of the valuation of the portfolio. For each scenario, full revaluation is performed, and a P&L data set becomes available from which the desired loss quantile can be extracted.

Historical simulation is based upon actually seen prices over a selected historical period, therefore no distributional assumptions are required. The data is what the data is, and is the distribution. Statement I is therefore not correct.

It uses full revaluation for each historical scenario, therefore statement II is correct.

Since the prices are taken from actual historical observations, a correlation matrix is not required at all. Statement III is therefore incorrect (it would be true for Monte Carlo and parametric Var).

Historical simulation VaR suffers from the limitation that if enough representative data points are no available during the historical observation period from which the scenarios are drawn, the results would be inaccurate. This is likely to be the case for new products. Therefore Statement IV is incorrect.

Statement I is true. According to the statement CP08/24: Stress and scenario testing (December 2008) issued by the FSA in the UK, an underlying objective of reverse stress tests is to ensure that a firm can survive long enough after risks have crystallized for one of the following to occur:

- the market decides that its lack of confidence is unfounded and recommences transacting with the firm;

- the firm down-sizes and re-structures its business;

- the firm is taken over, or its business is transferred in an orderly manner; or

- public authorities take the firm over, or wind down its business in an orderly manner.

Statement II and III are true. The same statement clarifies the intention of the reverse stress testing requirement, which is to encourage firms to: explore more fully the vulnerabilities of theirbusiness model (including ‘tail risks’); make decisions that better integrate business and capital planning; and improve their contingency planning.

Statement IV is incorrect. Since the question is asking for the statement which is NOT an objective for reverse stress tests, Choice 'b' is the correct answer. The same statement clarifies that the introduction of a reverse-stress test requirement should not be interpreted as indicating that the FSA is pursuing a ‘zero-failure’ policy. In the FSA's view, such a policy is neither possible, nor desirable.

If the confidence levels for a VaR estimate are set too high, there may never be any exceedences, ie actual losses will never exceed VaR estimates. For limit setting, we want actual losses to exceed the VaR estimates enough number of times as during the year so that the limits are considered seriously. If the VaR estimate is exceeded too many times, or never, then it is unlikely to be considered seriously. Therefore Choice 'd' is the correct answer.

The other answers are incorrect as they either require the VaR to be too high (ie zero or rare excess loss situations) or too low (ie there will be too many cases of excess loss situations to be taken seriously).

The z value at the 95% confidence level is 1.64. Since the variance is 0.16, the annual volatility is 40%. Therefore the daily volatility is 40% x √10/250 = 8%. The VaR therefore is 8% x 1.64 x $240m = $31,488,000

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.

A mathematical equation with numbers and symbols Description automatically generated

Other answers describe other VaR related concepts such as incremental VaR, Component VaR and Conditional VaR.

When modeling operational loss frequency distribution (which, for example, may be based upon a Poisson distribution) and a loss severity distribution (for example, based upon a lognormal distribution), it is assumed that the frequency of losses and the severity of the losses are completely independent and do not impact each other. Therefore Choice 'a' is correct, and the others are not valid assumptions underlying the operational loss modeling.

Once each of these distributions has been built, a random number is drawn from each to determine a loss scenario. The process is repeated many times as part of a Monte Carlo simulation to get a the loss distribution.

When returns are non-normal and have fat tails, an assumption of normality in returns leads to underestimation of VaR at high confidence levels. At the same time, at lower confidence levels the normal distribution may give higher VaR estimates. Therefore Choice 'a' is correct. The other choices are incorrect.

Also refer to the tutorial about VaR and heavy tails.

Note that events of default under the ISDA MA are caused by one of the parties that is considered 'at fault'. In contrast, "termination events" are events for which no one is at fault, for example changes in legislation, illegality etc that still justify termination of the transactions under the contract.

The ISDA MA describes the following 8 types of events of default:

1. failure of pay or deliver

2. breach of agreement

credit support default

4. misrepresentation

5. default under specified transaction

6. cross default

7. bankruptcy

8. merger without assumption

All of the options presented in the question are events of default.