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NEW QUESTION 42
Once the frequency and severity distributions for loss events have been determined, which of the following is an accurate description of the process to determine a full loss distribution for operational risk?
- A. A firm wide operational risk distribution is generated using Monte Carlo simulations
- B. A firm wide operational risk distribution is generated by adding together the frequency and severity distributions
- C. The frequency distribution alone forms the basis for the loss distribution for operational risk
- D. A firm wide operational risk distribution is set to be equal to the product of the frequency and severity distributions
Answer: A
Explanation:
Explanation
Once the frequency distribution has been determined (for example, using the binomial, Poisson or the negative binomial distributions) and the severity distribution has also been determined (for example, using the lognormal, gamma or other functions), the loss distribution can be produced by a Monte Carlo simulation using successive drawings from each of these two distributions. It is assumed that the severity and frequency are independent of each other. The resulting distribution gives a distribution showing the losses for operational risk, from whichthere Op Risk VaR can be determined using the appropriate percentile.Therefore Choice 'b' is the correct answer.
NEW QUESTION 43
Which of the following statements are true:
I. A high score according to Altman's Z-Score methodology indicates a lower default risk II. A high score according to theProbit or Logit models indicates a higher default risk III. A high score according to Altman's Z-Score methodology indicates a higher default risk IV. A high score according to the Probit or Logit models indicates a lower default risk
- A. I and II
- B. I and IV
- C. II and III
- D. III and IV
Answer: A
Explanation:
Explanation
A high score under the probit and logit models indicates a higher default risk, while under Altman's methodology it indicates a lower default risk. Therefore Choice 'd' is the correct answer.
NEW QUESTION 44
A risk analyst peforming PCA wishes to explain80% of the variance. The first orthogonal factor has a volatility of 100, and the second 40, and the third 30. Assume there are no other factors. Which of the factors will be included in the final analysis?
- A. Insufficient information to answer the question
- B. First, Second and Third
- C. First and Second
- D. First
Answer: D
Explanation:
Explanation
The total variance of the system is 100^2 + 40^2 + 30^2 = 12500 (as variance = volatility squared). The first factor alone has a variance of 10,000, or 80%. Therefore only the first factor will be included in the final analysis, and the rest will be ignored.
Interestingly, this example highlights one of the limitations of PCA. Obviously, the second and third factors are material when considering volatility, though the effect of squaring them to get the variance makes them appear less important than they are.
NEW QUESTION 45
Random recovery rates in respectof credit risk can be modeled using:
- A. the binomial distribution
- B. the omega distribution
- C. the beta distribution
- D. the normal distribution
Answer: C
Explanation:
Explanation
The beta distribution is commonly used to model recovery rates. It is a distribution forvariables whose values lie between 0 & 1, and the parameters of the distribution can be estimated using the mean and standard deviation of the data. Therefore Choice 'a' is correct and the others are wrong.
Refer to the tutorial on distributions for an Excel model of the beta distribution.
NEW QUESTION 46
The probability of default of a security over a 1 year period is 3%. What is the probability that it would have defaulted within 6 months?
- A. 98.49%
- B. 17.32%
- C. 1.51%
- D. 3.00%
Answer: C
Explanation:
Explanation
The question is asking for the probability of default over a 6 month period when the probability of annual default is known. If we let the 6 month probability of defaut be 'd', then the probability of survival at the end of
1 year would be (1 - d)^2. This we know is equal to 1 - 3% = 0.97. Therefore we can calculate 'd' to be equal to 1.51%. Choice 'c' is the correct answer, the others are incorrect.
Note that an exam question may ask for probability of the security having survived after 6 months, in which case the answer might be 1 - 1.51%. Also note that such questions will always require you to use the probability of survival (1 - probability of default) for doing the calculations. That isbecause the probabilities of survival can be multiplied over periods of time, but not probabilities of default as the first default in any period is the 'game-over' event after which neither survival nor defaults mean anything. Therefore you generally always have to get the probability of survival till a point in time, and use that for any other calculations.
NEW QUESTION 47
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