Explanation A cumulative accuracy plot measures the accuracy of credit ratings assigned by rating agencies by considering the relative rankings of obligors according to the ratings given. Choice 'd' is the correct answer.
Question 37
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?
Correct Answer: C
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.
Question 38
Altman's Z-score does not consider which of the following ratios:
Correct Answer: C
Explanation A computation of Altman's Z-score considers the following ratios: - Working capital to total assets - Retained earnings to total assets - EBIT to total assets - Market cap to debt - Sales to total assets It does not consider Net Income to total assets, therefore Choice 'c' is the correct answer. This makes sense as net income is after interest and taxes, both of which are not relevant for considering the cash flows for debt servicing.
Question 39
The Basel framework does not permit which of the following Units of Measure (UoM) for operational risk modeling: I. UoM based on legal entity II. UoM based on event type III. UoM based on geography IV. UoM based on line of business
Correct Answer: D
Explanation Units of Measure for operational risk are homogenous groupings of risks to allow sensible modeling decisions to be made. For example, some risks may be fat-tailed, for example the risk of regulatory fines. Other risks may have finite tails - for example damage to physical assets risk (DPA) may be limited to the value of the asset in the question. Additionally, risk reporting may need to be done at the line of business, legal entity or regional basis, and in order to be able to do, so the right level of granularity needs to be captured in the risk modeling exercise. The level of granularity applied is called the 'unit of measurement' (UoM), and it is okay to adopt all of the choices listed above as the dimensions that describe theunit of measure. Note that it is entirely possible, even likely, to use legal entity, risk type, region, business and other dimensions simultaneously, though doing so is likely to result in an extremely large number of UoM combinations. That can be addressed by then subsequently grouping the more granular UoMs into larger UoMs, which may ultimately be used for frequency and severity estimation.
Question 40
If the annual default hazard rate for a borrower is 10%, what is the probability that there is no default at the end of 5 years?
Correct Answer: D
Explanation A default hazard rate is the rate of default in a continuous time setting. This question is asking for probability of survival at the end of 5 years. The formula to calculate the probability of survival at the end of t years where the default hazard rate is is e^(- *t) (or in Excel,=exp(-*t). Therefore the correct answer is Choice 'd'. (It may be tempting to infer that if the probability of survival at the end of 1 year is 90% (1 - 10%), then the probability of survival in 5 years would be 90%^5. However this reasoning is not correct for the reason that the given rate is not the discrete rate of default, but the hazard rate which is nothing but the continuously compounded rate of default.)
