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PRMIA 8010 exam is an excellent certification for professionals who want to deepen their understanding of operational risk management and enhance their career prospects in this field. 8010 exam covers a comprehensive range of topics and includes practical case studies to enable candidates to apply their knowledge in real-world situations. Operational Risk Manager (ORM) Exam certification is recognized globally and can help professionals advance their careers in the financial services industry.
NEW QUESTION # 109
For a loan portfolio, unexpected losses are charged against:
- A. Economic credit capital
- B. Credit reserves
- C. Regulatory capital
- D. Economic capital
Answer: A
Explanation:
Explanation
Creditreserves are created in respect of expected losses, which are considered the cost of doing business.
Unexpected losses are borne by economic credit capital, which is a part of economic capital. This question is a bit nuanced - and 'economic capital' wouldgenerally be a good answer as well. However, taking a rather beady eyed view of the terminology and distinguishing between 'economic credit capital' which is a subset of
'economic capital', we can say that 'economic credit capital' is a more appropriateChoice 'a's the question relates to credit losses.
NEW QUESTION # 110
Which of the following statements are correct?
I. A reliance upon conditional probabilities and a-priori views of probabilities is called the 'frequentist' view II. Knightian uncertainty refers to thingsthat might happen but for which probabilities cannot be evaluated III. Risk mitigation and risk elimination are approaches to reacting to identified risks IV. Confidence accounting is a reference to the accounting frauds that were seen in the past decadeas a reflection of failed governance processes
- A. I and IV
- B. II, III and IV
- C. II and III
- D. All of the above
Answer: C
Explanation:
Explanation
In statistics, which is relevant to risk management, a distinction is often drawn between 'frequentists' and
'Bayesians'.Frequentists rely upon data to draw conclusions as to probabilities. Bayesians consider conditional probabilities, ie, take into account what things are already known, and inject sometimes subjective a-priori probabilities into the calculations. StatementI describes Bayesians, and not frequentists. In reality however, the difference is merely academic. Risk managers use whichever technique best applies to the given situation without making it about ideology.
The difference between 'Knightian uncertainty'and 'Risk' is similarly academic. Knightian uncertainty refers to risk that cannot be measured or calculated. 'Risk' on the other hand refers to things for which past data exists and calculations of exposure can be made. To give an example in the contextof the financial world, the risk from a pandemic creating systemic failures from a failure of payment and settlement systems and the like is
'Knightian uncertainty', but the market risk from equity price movements can be modeled (albeit with limitations) and is calculable. Statement II is therefore correct.
Once a risk is identified, it can be mitigated, accepted, avoided or eliminated, or transferred by way of insurance. Therefore statement III is correct.
Confidence accounting is a conceptual idea that suggests that accounting statements make reference to ranges as opposed to point estimates in financial statements. For example, instead of saying that the pension obligation is $xx million, the company should say the pension obligation is in a range of $xxm - $yy m with a certain confidence level. Statement IV is therefore inaccurate.
NEW QUESTION # 111
Which of the following statements are true:
I. The set of UoMs used for frequency and severity modeling should be identical II. UoMs can be grouped together into larger combined UoMs using judgment based on the knowledge of the business III. UoMs can be grouped together into combined UoMs using statistical techniques IV. One may use separate sets of UoMs for frequency and severity modeling
- A. II, III and IV
- B. I, II and III
- C. IV only
- D. All of the above
Answer: A
Explanation:
Explanation
One may use separate UoMs for frequency and severity modeling, for example, a combined UoM may be used for estimating thefrequency of cyber attacks in a scenario, while the severity may be modeled using a more granular line-of-business UoM. Therefore statement I is false, while statement IV is true.Statement II is correct, UoMs can be grouped together into larger units based on the facts relating to the business, controls and the business environment. Similarly, UoMs can be grouped together based on statistical clustering techniques using the 'distance' between the units of measure and combining UoMs that are closer to eachother.
In addition, it is also possible to combine both business knowledge and statistical algorithms to combine UoMs.
NEW QUESTION # 112
Which of the following best describes economic capital?
- A. Economic capital is the amount of regulatory capital that minimizes the cost ofcapital for firm
- B. Economic capital is a form of provision for market risk losses should adverse conditions arise
- C. Economic capital reflects the amount of capital required to maintain a firm's target credit rating
- D. Economic capital is the amount of regulatory capital mandated for financial institutions in the OECD countries
Answer: C
Explanation:
Explanation
Economic capitalis often calculated with a view to maintaining the credit ratings for a firm. It is the capital available to absorb unexpected losses, and credit ratings are also based upon a certain probability of default.
Economic capital is often calculated at a levelequal to the confidence required for the desired credit rating. For example, if the probability of default for a AA rating is 0.02%, and the firm desires to hold an AA rating, then economic capital maintained at a confidence level of 99.98% would allow for such a rating. In this case, 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, and would help get the firm its desired credit rating.
Choice 'c' is the correct answer. Economic capital does not target minimizing the cost of capital, nor is it a provision for losses arising from market risk. The concept of economic capital is unrelated to where an institution or firm is based, therefore Choice 'a' is incorrect as well.
NEW QUESTION # 113
Which of the following is the most important problem to solve for fitting a severity distribution for operational risk capital:
- A. The fit obtained should reduce the combination of the fitting and approximation errors to a minimum
- B. The risk functional's minimization should lead to a good estimate of the 0.999 quantile
- C. Determine plausible scenarios to fill the data gaps inthe internal and external loss data
- D. Empirical loss data needs to be extended to the ranges below the reporting threshold and above large value losses
Answer: B
Explanation:
Explanation
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.
NEW QUESTION # 114
According to the Basel II framework, subordinated term debt that was originally issued 4 years ago with amaturity of 6 years is considered a part of:
- A. None of the above
- B. Tier 3 capital
- C. Tier 1 capital
- D. Tier 2 capital
Answer: D
Explanation:
Explanation
According to the Basel II framework, Tier 1 capital, also called core capital or basic equity, includes equity capital and disclosed reserves.
Tier 2 capital, also called supplementary capital, includes undisclosed reserves, revaluation reserves, general provisions/general loan-loss reserves, hybrid debt capital instruments and subordinated term debt issued originally for 5 years or longer.
Tier 3 capital, or short term subordinated debt, is intended only to cover market risk but only at the discretion of their national authority. This only includes short term subordinated debt originally issued for 2 or more years.
An interesting thing to note is the difference between 'subordinated term debt' under Tier 2 and the 'short term subordinated debt' under Tier 3. The distinction is based upon the years to maturity at the time the debt was issued. The remaining time to maturity is not relevant. For the subordinated term debt included under Tier 2, the amount that can be counted towards capital is reduced by 20% for every year when the debt is due within 5 years. This takes care of the time to maturity problem for Tier 2subordinated debt. For Tier 3 short term subordinated debt, this is not an issue because debt will only qualify for Tier 3 if it has a lock-in clause stipulating that the debt is not required to be repaid if the effect of such repayment is to take the bank below minimum capital requirements.
NEW QUESTION # 115
Under the standardized approach to calculating operational risk capital, how many business lines are a bank's activities divided into per Basel II?
- A. 0
- B. 1
- C. 2
- D. 3
Answer: C
Explanation:
Explanation
In the Standardized Approach, banks' activities are divided into eight business lines: corporate finance, trading
& sales, retail banking, commercial banking, payment & settlement, agency services, asset management, and retail brokerage. Therefore Choice 'c' is the correct answer.
NEW QUESTION # 116
Which of the following statements are true:
I. Capital adequacy implies the ability of a firm to remain a going concern II. Regulatory capital and economic capital are identical as they target the same objectives III. The role of economic capital is to provide a buffer against expected losses IV. Conservative estimates of economic capital are based upon a confidence level of 100%
- A. I
- B. I, III and IV
- C. I and III
- D. III
Answer: A
Explanation:
Explanation
Statement I is true - capital adequacy indeed is a reference to the ability of the firm to stay a 'going concern'.
(Going concern is an accounting term that means the ability of the firm to continue in business without the stress of liquidation.) Statement II is not true because even though the stated objective of regulatory capital requirements is similar to the purposes for which economic capital is calculated, regulatory capital calculations are based upon a large number of ad-hoc estimates and parameters that are 'hard-coded' into regulation, while economic capital is generally calculated for internal purposes and uses an institution's own estimates and models. They are rarely identical.
Statement II is not true as the purpose of economic capital is to provide a buffer against unexpected losses.
Expected losses are covered by the P&L (or credit reserves), and not capital.
Statement IV is incorrect as even though economic capital may be calculated at very high confidence levels, that is never 100% which would require running a 'risk-free' business, which would mean there are no profits either. The level of confidence is set at a level which is an acceptable balance between the interests of the equity providers and the debt holders.
NEW QUESTION # 117
Under the KMV Moody's approach to calculating expectingdefault frequencies (EDF), firms' default on obligations is likely when:
- A. expected asset values one year hence are below total liabilities
- B. asset values reach a level below totalliabilities
- C. asset values reach a level between short term debt and total liabilities
- D. asset values reach a level below short term debt
Answer: C
Explanation:
Explanation
An observed fact that the KMV approach relies upon is that firms do not default when their liabilities exceed assets, but when asset values are somewhere between short term liabilities and the total liabilities. In fact, the
'default point' in the KMV methodology is defined as the short term debt plus half of the long term debt. The difference between expected value of the assets in one year and this 'default point', when expressed in terms of standard deviation of the asset values, is called the 'distance-to-default'.
Therefore Choice 'd' is the correct answer. The other choices are incorrect.
NEW QUESTION # 118
If F be the face value of a firm's debt, V the value of its assets and E the market value of equity, then according to the option pricing approach a default on debt occurs when:
- A. F - E < V
- B. F > V
- C. V < E
- D. F < V
Answer: B
Explanation:
Explanation
According to the option pricing approach developed by Merton, the shareholders of a firm have a put on the assets of the firm where the strike price is equal to the face value of the firm's debt. This is just a more complicated way of saying that the debt holders are entitled to all the assets of the firm if these assets are insufficient to pay off the debts, and because of limited liability of the shareholders of a corporation this part payment will fully extinguish thedebt.
A firm will default on its debt if the value of the assets falls below the face value of the debt. Therefore Choice
'a' is the correct answer. All other choices are incorrect.
(There are two ways to consider this sort of optionality, and I have mentioned only one for this question:
1. The equity holders can sell the assets of the firm to the debt holders at a price equal to the face value of the debt, ie a put. (ie they can extinguish their liability to the debt holders in full by handing them the assets of the firm, effectively selling them the assets at the value of the debt)
2. The equity holders have a long position in a call option where they can keep the assets of the firm by paying a price equal to the face value of the debt (ie, they can pay off the debt holders and keep the assets) For this question, perspective 1 applies but you should be aware of the second one too as a question may reference that view point.)
NEW QUESTION # 119
According to the implied capital model, operational risk capital is estimated as:
- A. Capitalimplied from known risk premiums and the firm's earnings
- B. Total capital based on the capital asset pricing model
- C. Total capital less market risk capital less credit risk capital
- D. Operational risk capital held by similar firms, appropriately scaled
Answer: C
Explanation:
Explanation
Operational risk capital estimated using the implied capital model is merely the capital that is not attributable to market or credit risk. Therefore Choice 'b' is the correct answer. All other responses are incorrect.
NEW QUESTION # 120
The 99% 10-day VaR for a bank is $200mm. The average VaR for the past 60 days is $250mm, and the bank specific regulatory multiplier is 3. What is the bank's basic VaR based market risk capital charge?
- A. $250mm
- B. $750mm
- C. $200mm
- D. $600mm
Answer: B
Explanation:
Explanation
The current Basel rules for the basic VaR based charge formarket risk capital set market risk capital requirements as the maximum of the following two amounts:
1. 99%/10-day VaR,
2. Regulatory Multiplier x Average 99%/10-day VaR of the past 60 days
The 'regulatory multiplier' is a number between 3 and 4 (inclusive) calculated based on the number of 1% VaR exceedances in the previous 250 days, as determined by backtesting.
- If the number of exceedances is <= 4, then the regulatory multiplier is 3.
- If the number of exceedances is between 5 and 9, then the multiplier = 3 + 0.2*(N-4), where N is the number of exceedances.
- If the number of exceedances is >=10, then the multiplier is 4.
So you can see that in most normal situations the risk capital requirement will be dictated by the multiplier and the prior 60-dayaverage VaR, because the product of these two will almost often be greater than the current
99% VaR.
The correct answer therefore is = max(200mm, 3*250mm) = $750mm.
Interestingly, also note that a 99% VaR should statistically be exceeded 1%*250 days = 2.5times, which means if the bank's VaR model is performing as it should, it will still need to use a reg multiplier of 3.
NEW QUESTION # 121
The standalone economic capital estimates for the three uncorrelated business units of a bank are $100, $200 and $150 respectively. Whatis the combined economic capital for the bank?
- A. 0
- B. 1
- C. 2
- D. 3
Answer: A
Explanation:
Explanation
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)]
NEW QUESTION # 122
Which of the following statements are true:
I.Top down approaches help focus management attention on the frequency and severity of loss events, while bottom up approaches do not.
II. Top down approaches rely upon high level data while bottom up approaches need firm specific risk data to estimate risk.
III. Scenario analysis can help capture both qualitative and quantitative dimensions of operational risk.
- A. III only
- B. I only
- C. II only
- D. II and III
Answer: D
Explanation:
Explanation
Top down approaches do not consider event frequency and severity, on the otherhand they focus on high level available data such as total capital, income volatility, peer group information on risk capital etc. Bottom up approaches focus on severity and frequency distributions for events. Statement I is therefore not correct.
Top downapproaches do indeed rely upon high level aggregate data and tend to infer operational risk capital requirements from these. Bottom up approaches look at more detailed firm specific information. Statement II is correct.
Scenario analysis requires estimating losses from risk scenarios, and allows incorporating the judgment and views of managers in addition to any data that might be available from internal or external loss databases.
Statement III is correct. Therefore Choice 'b' is the correct answer.
NEW QUESTION # 123
Which of the following statements are correct:
I. A training set is a set of data used to create a model, while a control set is a set of data is used to prove that the model actually works II. Cleansing, aggregating or ensuring data integrity is a task for the IT department, and is not a risk manager's responsibility III. Lack of information on the quality of underlying securities and assets was a major cause of the collapse in the CDO markets during the credit crisis that started in 2007 IV. The problem of lack of historical data can be addressed reasonably satisfactorily by using analytical approaches
- A. I, III and IV
- B. II and IV
- C. I and III
- D. All of the above
Answer: C
Explanation:
Explanation
Statement I is correct. Data is often divided into two sets - a 'training set' that is used to create and fine-tune the model while the 'control set' is used to prove that the model works on sample data. Back testing is then perfomed using actual data that becomes available over time, or may already be available as historical data.
Statement II is incorrect. A risk manager often spends a great deal of time in managing data,and ensuring that the data being used is accurate enough for the purpose it is being used for. A risk manager can expect to spend a good part of his or her team's time in cleansing data. While he or she can try to get the IT processes and systems to produce correct data in the first place so it requires minimal subsequent cleansing or validation, this task is likely to remain a key part of a risk manager's role for quite some time in the future given the challenges nearly all organizations face in managingrisk data.
Statement III is correct. There was not enough granular data available on the underlying components of some of the derivative debt securities whose markets dried up during the crisis that began in 2007. This was because investors became increasingly unsure of what the value of these securities, such as CDOs was, leading to market seizure and firesale prices.
Statement IV is not correct. There is no easy solution to the lack of enough historical data, which is used to create as well as test models, and construct stress scenarios. Analytical approaches are not a good enough substitute for real market data. During the recent crisis, many instruments had rather short histories and there was not enough data available, and risk managers and portfolio managers relied upon analytical approaches to value and price them. Many of the assumptions that underpinned these approaches were untested in the real world and turned out to be incorrect.
Therefore Choice 'c' is the correct answer and the rest are incorrect.
NEW QUESTION # 124
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