8010 Exam Dumps - PRMIA PRM Certification Questions and Answers

The greatest model risk when calculating operational risk capital comes fromincorrect assumptions about correlations between different operational risks for which standalone risk calculations have been made. Generally, the correlation can be expected to be positive, and would therefore vary between 0 and 1. These two values determine the 'bounds' between which the total operational risk capital would lie, and these bounds are generally quite far apart. Therefore the total value of the operational risk capital is very sensitive to the value chosen for the correlation, and this is the source of the biggest model risk under the AMA.

The correct answer is choice 'a'

A long position in a credit sensitive bond is equivalent to earning the risk free rate and the spread on the bond. The risk freerate can be earned through a long position in a treasury bond, and the spread can be earned in the form of premiums on a CDS, which are received by the protection seller, ie the party short a CDS contract. Therefore we can get the same results as a long bond position using a combination of a long treasury bond and a short position in a CDS. Choice 'a' is the correct answer.

The Basel II framework allows the use of the basic indicator approach, thestandardized approach and the advanced measurement approaches for operational risk. There is no approach called the 'internal measurement approach' permitted for operational risk. Choice 'a' is therefore the correct answer.

An interesting property that distinguishes the three most used distributions for modeling event frequency is that for a given mean, their variances differ. The ratio of variance to mean (the variance-mean ratio, calculated as variance/mean) can then be used to decide the kind of distribution to use. Both the variance and the mean can be estimated from available data points from the internal or external loss databases, or the scenario exercise.

The variance-mean ratio reflects how dispersed a distribution is. (In the PRMIA handbook, the variance to mean ratio has been described as the "Q-Factor".)

The Poisson distribution has its mean equal to its variance, and therefore the variance to mean ratio is 1. For the negative binomial distribution, this ratio is always greater than 1, which means there is greater dispersion compared to the mean - or more intervals with low counts as well as more intervals with high counts. For the binomial distribution, the variance to mean ratio is less than one, which means it is less dispersed than the Poisson distribution with values closer to the mean.

In a situation where operational risk events are seen as clustering together, ordependent, the variance will be higher and it would be more appropriate to use the negative binomial distribution.

All the factors listed above contributed to systemic failure. Liquidity risk was not on the radar of regulators, and was a second priority for risk managers, and most of the focus was oncapital adequacy as liquidity was thought to be an unlikely problem. Liquidity, regardless of capital adequacy, was the primary cause of failure of a number of institutions during the crisis.

Similarly, stress tests proved to be much milder than the shocks that were actually experienced, and the strategy of 'originate and distribute' implied that the mortgage and other debt originators had no interest in any due diligence as they intended to package and sell the debt to other investors.

Therefore Choice 'd' is the correct answer.

Performance measurement at a very basic level involves comparing the return earned to the capital invested to earn that return. Risk adjusted performance measures (RAPMs) come in various varieties - and the key difference between RAPMs and traditional measures such as return on equity, return on assets etc is that RAPMs account for the risk undertaken. They may do so by either adjusting the return, or the capital, or both. They are classified as RAROCs (risk adjusted return on capital), RORACs (return on risk adjusted capital) and RARORACs (risk adjusted return on risk adjusted capital).

According to ISDA standard definitions, the legal claim for OTCderivatives is the current replacement value of the contract. Therefore Choice 'c' is the correct answer. None of the other choices are correct.

Loss provisioning is intended to cover expected losses. Economic capital is expected to cover unexpected losses. No capital or provisions are set aside for losses in excess of unexpected losses, which will ultimately be borne by equity.

Choice 'd' is the correct answer.

The easiest way to answer this question is to ignore the joint probability of default as thatis irrelevant to expected losses. The joint probability of default impacts the volatility of the losses, but not the expected amount. One way to think about it is to think of asset portfolios, where diversification reduces risk (ie standard deviation) butthe expected returns are nothing but the average of the expected returns in the portfolio. Just as the expected returns of the portfolio are not affected by the volatility or correlations (these affect standard deviation), in the same way the joint probability of default does not affect the expected losses. Therefore the expected losses for this portfolio are simply $1m x 10% + $1m x 15% = $250,000.

This can also be seen from the lens of a joint probability distribution as follows:

There are four possibilities for this portfolio:

- Only loan A defaults: loss of $1m: 9% probability

- Only loan B defaults: loss of $1m: 14% probability

- Both loan A and B default: loss of $2m: 1% probability

- Neither A nor B default: loss of $0m: 76% probability

Therefore the expected losses on the portfolio are ($1m x 9%) + ($1m x 14%) + ($2m x 1%) + ($0m x 76%) = $250,000.

(Notes: How is the above table calculated? The totals (10%, 90%, 15% and 85%) are filled in first. The top left cell (both A & B default) is given as 1%. We can now calculate the rest of the cells as the totals are known.)

Basel II proposes three approaches to compute operational risk capital - the basic indicator approach(BIA), the standardized approach (SIA) and the advanced measurement approach (AMA). There is no operational risk approach called the factor based approach.