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NEW QUESTION 30
Which of the following statements are true:
I. The sum of unexpected losses for individual loans in a portfolio is equal to the total unexpected loss for the portfolio.
II. The sum of unexpected losses for individual loans in a portfolio is less than the total unexpected loss for the portfolio.
III. The sum of unexpected losses forindividual loans in a portfolio is greater than the total unexpected loss for the portfolio.
IV. The unexpected loss for the portfolio is driven by the unexpected losses of the individual loans in the portfolio and the default correlation between these loans.
- A. I, II and III
- B. III and IV
- C. I and II
- D. II and IV
Answer: B
Explanation:
Explanation
Unexpected losses (UEL) for individual loans in a portfolio will always sum to greater than the total unexpected loss for the portfolio (unless all the loans are correlatedin such a way that they default together).
This is akin to the 'diversification effect' in market risk, in other words, not all the obligors would default together. So the UEL for the portfolio will always be less than the sum of the UELs for individual loans.
Therefore statement III is true.This 'diversification effect' will be affected by the default correlations between the obligors, in cases where the probability of various obligors defaulting together is low, the UEL for the portfolio would bemuch less than the UEL for the individual loans. Hence statement IV is true.I and II are false for the reasons explained above.
NEW QUESTION 31
When pricing credit risk for an exposure, which of the following is a better measure than the others:
- A. Mark-to-market
- B. Notional amount
- C. Expected Exposure (EE)
- D. Potential Future Exposure (PFE)
Answer: C
Explanation:
Explanation
Exposure for derivative instruments can vary significantly over the lifetimeof the instrument, depending upon how the market moves. The potential future exposure represents the extremes, not the most likely outcome.
The expected exposure is the most suitable measure for pricing the credit risk. Over time, as multiple transactionsare entered into, the expectation (or the mean) will be realized - though individual transactions may have more or less by way of exposure.
The notional amount may not be relevant, though for loans it may be the most important contributor to the expected exposure. Mark-to-market will represent the exposure at a given point in time, but cannot be predicted nor be used to price the credit risk.
NEW QUESTION 32
In respect of operational risk capital calculations, the Basel II accord recommends a confidence leveland time horizon of:
- A. 99% confidence level over a 1 year time horizon
- B. 99.9% confidence level over a 1 year time horizon
- C. 99% confidence level over a 10 year time horizon
- D. 99.9% confidence level over a 10 day time horizon
Answer: B
Explanation:
Explanation
Choice 'd' represents the Basel II requirement, all other choices are incorrect.
NEW QUESTION 33
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 34
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