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Download Operational Risk Manager (ORM) Exam Exam Dumps
NEW QUESTION 51
Under the contingent claims approach to measuring credit risk, which of the following factors does NOT affect credit risk:
- A. Maturity of the debt
- B. Cash flows of the firm
- C. Volatility of the firm's asset values
- D. Leverage in the capital structure
Answer: B
Explanation:
Explanation
Under the contingent claims approach, credit risk is modeled as the value of a put option on the value of the firm's assets with a strike equal to the face value of the debt and maturity equal to the maturity of the obligation. The cost of credit risk is determined by the leverage ratio, the volatility of the firm's assets and the maturity of the debt. Cash flows are not a part of the equation. Therefore Choice 'a' is the correct answer.
NEW QUESTION 52
Which of the following steps are required for computing the aggregate distribution for a UoM for operational risk once loss frequency and severity curves have been estimated:
I. Simulate number of losses based on the frequency distribution
II. Simulate the dollar value of the losses from the severity distribution III. Simulate random number from the copula used to model dependence between the UoMs IV. Compute dependent losses from aggregate distribution curves
- A. III and IV
- B. I and II
- C. All of the above
- D. None of the above
Answer: B
Explanation:
Explanation
A recap would be in order here: calculating operational risk capital is a multi-step process.
First, we fit curves to estimate the parameters to our chosen distribution types for frequency (eg, Poisson), and severity (eg, lognormal). Note that these curves are fitted at the UoM level - which is the lowest level of granularity at which modeling is carried out. Since there are many UoMs, there are are many frequency and severity distributions. However what we are interested in is the loss distribution for the entire bank from which the 99.9th percentile loss can be calculated. From the multiple frequency and severity distributions we have calculated, this becomes a two step process:
- Step 1: Calculate the aggregate loss distribution for each UoM. Each loss distribution is based upon and underlying frequency and severity distribution.
- Step 2: Combine the multiple loss distributions after considering the dependence between the different UoMs. The 'dependence' recognizes that the various UoMs are not completely independent, ie the loss distributions are not additive, and that there is a sortof diversification benefit in the sense that not all types of losses can occur at once and the joint probabilities of the different losses make the sum less than the sum of the parts.
Step 1 requires simulating a number, say n, of the number of losses that occur in a given year from a frequency distribution. Then n losses are picked from the severity distribution, and the total loss for the year is a summation of these losses. This becomes one data point. This process of simulating the number of losses andthen identifying that number of losses is carried out a large number of times to get the aggregate loss distribution for a UoM.
Step 2 requires taking the different loss distributions from Step 1 and combining them considering the dependence between the events. The correlations between the losses are described by a 'copula', and combined together mathematically to get a single loss distribution for the entire bank. This allows the 99.9th percentile loss to be calculated.
NEW QUESTION 53
The Options Theoretic approach to calculating economic capital considers the value of capital as being equivalent to a call option with a strike price equal to:
- A. The notional value ofthe debt
- B. The value of the firm
- C. The market value of the debt
- D. The value of the assets
Answer: A
Explanation:
Explanation
The Options Theoretic approach to calculating economic capital is a top-down approach that considers the value of capital as being equivalent to a calloption with a strike price equal to the notional value of the debt - ie, the shareholders have a call option on the assets of the firm which they can acquire by paying the debt holders a value equal to their notional claim (ie the face value of the debt).Therefore Choice 'a' is the correct answer and the other choices are incorrect.
NEW QUESTION 54
Which of the following statements are true:
I. Heavy tailed parametricdistributions are a good choice for severity modeling in operational risk.
II. Heavy tailed body-tail distributions are a good choice for severity modeling in operational risk.
III. Log-likelihood is a means to estimate parameters for a distribution.
IV. Body-tail distributions allow modeling small losses differently from large ones.
- A. All of the above
- B. I and IV
- C. II, III and IV
- D. II and III
Answer: A
Explanation:
Explanation
When modeling for operational risk, we are generally concerned with tail losses - this isbecause the horizon for operational risk is 1 year at the 99.9th percentile. Since the 99.9th percentile is in the tail region, we would like to ensure that the tails are modeled as accurately as possible. Operational risk distributions are modeled usingheavy tailed distributions.
Heavy tailed parametric distributions such as log-normal, pareto and others are therefore a good choice for modeling risk severity, therefore statement I is correct.
Body-tail distributions are combinations of parametric distributions, with different types of distributions being used to model the body and the tail - this provides flexibility because small and medium losses upto a threshold can be modeled using one distribution, and losses beyond the threshold can be modeled usinga different distribution that is a better estimate of the tail. Statement II is therefore correct.
A log-likelihood function simplifies the optimization of a regular likelihood function. We generally maximize (or minimize the risk functional) a likelihoodfunction with a view to estimating the parameters of the underlying distribution. If the likelihood function is complex, it may sometimes make it mathematically easier to optimize the log of the function - as that changes exponents and multiplications toadditions, while behaving in the same way as the underlying function. Therefore statement III is correct, log-likelihood is a means to estimate parameters for a distribution.
Statement IV is correct as body-tail distributions allow modeling different partsof the distribution differently from each other.
NEW QUESTION 55
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. Tier 3 capital
- B. None of the above
- C. Tier 2 capital
- D. Tier 1 capital
Answer: C
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 56
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