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PRMIA Credit and Counterparty Manager (CCRM) Certificate Exam Sample Questions (Q265-Q270):
NEW QUESTION # 265
Which of the following statements are true in relation to the current state of the financial network?
I. Interconnectivity between countries has reduced while that between institutions in the same country has increased significantly II. The degrees of separation between institutions has gone up III. The average path length connecting any two given institutions has shrunk IV. Knife-edge dynamics imply that systemic risk arises from the financial system flipping from risk sharing to risk spreading
- A. I and II
- B. III and IV
- C. I and IV
- D. II and III
Answer: B
Explanation:
Over the past decade or so, systemic risk has been increased by vastly increasing network complexities resulting from greater interconnectivity between institutions as well as countries. Therefore statement I is incorrect.
Statement II is incorrect and statement III is correct because the average path length between institutions, or their degree of separation where they are not directly dealing with each other but through other counterparties to which they are exposed (analogous to 6 degrees of separation, or the 'small world' property), has shrunk and not increased.
Statement IV correctly describes knife edge dynamics, which is another way of waying that the financial network displays a tipping point property.
NEW QUESTION # 266
Which of the following statements is correct?
- A. Market liquidity risks present themselves in the form of higher bid offer spreads
- B. Dynamic simulations of liquidity needs require an assumption of counterparty risk remaining constant
- C. Market liquidity risk is idiosyncratic while funding liquidity risk is not
- D. Funding liquidity risks present themselves in the form of an adverse market impact on prices from a trade
Answer: A
Explanation:
Simulations of liquidity needs can be of various types: historical simulations, where the current positions are subjected to the kind of liquidity shocks experienced in the past; static simulations, where a static view of current positions, counterparty credit position, and the business is considered; and dynamic simulations where all factors are dynamically changed including counterparty credit standing, changes to the current portfolio and behavioural aspects of the business. Choice 'b' is incorrect as dynamic simulations require no such assumptions.
Liquidity risk is often thought of in terms of market liquidity risk and funding liquidity risk. Market liquidity risk relates to the the liquidity for a particular type of asset drying up. For example, during the 2007-2009 crisis a large number of corporate bonds and structured products became extremely illiquid. Market liquidity risk manifests itself in the form of higher bid offer spreads, higher pricde impact, and a reduction in the normal market size (ie, the 'normal' size of a trade for which a dealer quote is valid for). Therefore Choice 'd' is correct. Similarly, Choice 'a' is incorrect as adverse price impact results from market liquidity risk and not funding liquidity risk.
Market liquidity risk applies to the entire market and all its participants. It is not idiosyncratic. Therefore Choice 'c' is incorrect too. Funding liquidity risk on the other hand applies to an individual institution that is under liquidity stress in the sense of not being able to meet its obligations such as margin or collateral calls because of a lack of liquid assets. Thus it is funding liquidity that is idiosyncratic. Market liquidity risk often leads to funding liquidity risks materializing as firms are unable to get to the funds they were relying upon due to assets becoming illiquid.
NEW QUESTION # 267
The VaR of a portfolio at the 99% confidence level is $250,000 when mean return is assumed to be zero. If the assumption of zero returns is changed to an assumption of returns of $10,000, what is the revised VaR?
Answer: A
Explanation:
The exact formula for VaR is = -(Z# # + #), where Z # is the z-multiple for the desired confidence level, and # is the mean return. Now Z# is always a negative number, or at least will certainly be provided the desired confidence level is greater than 50%, and # is often assumed to be zero because generally for the short time periods for which market risk VaR is calculated, its value is very close to zero.
Therefore in practice the formula for VaR just becomes -Z##, and since Z is always negative, we normally just multiply the Z factor without the negative sign with the standard deviation to get the VaR.
For this question, there are two ways to get the answer. If we use the formula, we know that -Z##= 250,000 (as #=0), and therefore -Z## - # = 250,000 - 10,000 = $240,000.
The other, easier way to think about this is that if the mean changes, then the distribution's shape stays exactly the same, and the entire distribution shifts to the right by $10,000 as the mean moves up by $10,000.
Therefore the VaR cutoff, which was previously at -250,000 on the graph also moves up by 10k to -240,000, and therefore $240,000 is the correct answer.
The other choices are intended to confuse by multiplying the z-factor for the 99% confidence level with
10,000 etc.
NEW QUESTION # 268
Which of the following is true in relation to Principal Component Analysis (PCA)?
I. An n x n positive definite square matrix will have n-1 eigenvectors
II. The eigenvalues for a correlation matrix can be derived from the corresponding values for the covariance matrix III. Principal components are uncorrelated to each other IV. PCA is useful as it allows 100% of the variation in a complex system to be explained by the first three principal components
- A. III and IV
- B. III
- C. I and III
- D. I, II and IV
Answer: B
Explanation:
An n x n positive definite square matrix will have n eigenvectors, and not n - 1. Therefore statement I is incorrect.
A correlation and covariance matrix are related to each other through the matrix of standard deviations. If the covariance matrix is represented by V, the correlation matrix by C and D is the diagonal matrix of standard deviations, then V = DCD. However, there is no simple relationship between the eigenvalues of the two matrices, and it is not possible to derive the eigenvalues for one given the eigenvalues for the other. Therefore statement II is false.
Principal components are uncorrelated to each other. That is correct, and in fact PCA is useful because of this being so. Statement III is therefore true.
PCA does not explain 100% of the variation in a system with just three components - statement IV is false.
(Remember though that most (though not 100%) of the variation in a system of term structures is explained by the first three components - trend, tilt and curvature).
Thus Choice 'd' is the correct answer.
NEW QUESTION # 269
Which of the following should be included when calculating the Gross Income indicator used to calculate operational risk capital under the basic indicator and standardized approaches under Basel II?
- A. Operating expenses
- B. Net non-interest income
- C. Fees paid to outsourcing service proviers
- D. Insurance income
Answer: B
Explanation:
Gross income is defined by Basel II (see para 650 of the Basel standard) as net interest income plusnet non- interest income. It is intended that this measure should: (i) be gross of any provisions (e.g. for unpaid interest); (ii) be gross of operating expenses, including fees paid to outsourcing service providers; (iii) exclude realised profits/losses from the sale of securities in the banking book; and (iv) exclude extraordinary or irregular items as well as income derived from insurance.
What this means is that gross income is calculated without deducting any provisions or operating expenses from net interest plus non-interest income; and does not include any realised profits or losses from the sale of securities in the banking book, and also does not include any extraordinary or irregular item or insurance income.
Therefore operating expenses are to be not to be deducted for the purposes of calculating gross income, and neither are any provisions. Profits and losses from the sale of banking book securities are not considered part of gross income, and so isn't any income from insurance or extraordinary items.
Of the listed choices, only net non-interest income needs to be included for gross income calculations, and the others are to be excluded. Therefore Choice 'd' is the correct answer. Try to remember the components of gross income from the definition above because in the exam the question may be phrased differently.
NEW QUESTION # 270
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