Which of the following formulae describes CVA (Credit Valuation Adjustment)? All acronyms have their usual meanings (LGD=Loss Given Default, ENE=Expected Negative Exposure, EE=Expected Exposure, PD=Probability of Default, EPE=Expected Positive Exposure, PFE=Potential Future Exposure)

• A.LGD * ENE * PD
• B.LGD * EPE * PD
• C.LGD * EE * PD
• D.LGD * PFE * PD

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Which of the following statements is NOT true in relation to the recent financial crisis of 2007-08?

• A.An intention to diversify from their core activities led all market participants to the same activities, which though appearing diversified at the bank's level, created a concentration risk at the systemic level
• B.The existence of central counterparties could have limited the damage caused by the financial crisis
• C.Central banks had data on the interconnections between institutions, but poor understanding and analysis meant this data was never analyzed
• D.Counterparty risk was difficult togauge as it was impossible to know who the counterparty's counterparties were

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There are two bonds in a portfolio, each with a market value of $50m. The probability of default of the two bonds are 0.03 and 0.08 respectively, over a one year horizon. If the probability of the two bonds defaulting simultaneously is 1.4%, what is the default correlation between the two?

• A.0%
• B.100%
• C.40%
• D.25%

Correct Answer: D

Explanation
Probability of the joint default of both A and B =

We know all the numbers except default correlation, and we can solve for it.
DefaultCorrelation*SQRT(0.03*(1 - 0.03)*0.08*(1 - 0.08)) + 0.03*0.08 = 0.014.
Solving, we get default correlation = 25%

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Which of the following situations are not suitable for applying parametric VaR:
I. Where the portfolio's valuation is linearlydependent upon risk factors II. Where the portfolio consists of non-linear products such as options and large moves are involved III. Where the returns of risk factors are known to be not normally distributed

• A.I and II
• B.II and III
• C.I and III
• D.All of the above

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Which of the following statements is true:

• A.Both total expected losses and total unexpected losses are less than the sum ofexpected and unexpected losses on underlying exposures respectively
• B.Total expected losses are equal to the sum of individual underlying exposures while total unexpected losses are greater than the sum of unexpected losses on underlying exposures
• C.Total expected losses are equal to the sum of expected losses in the individual underlying exposures while total unexpected losses are less than the sum of unexpected losses on underlying exposures
• D.Total expected losses are greater than the sum of individual underlying exposures while total unexpected losses are less than the sum of unexpected losses on underlying exposures

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