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Operational Risk Manager (ORM) Exam Practice Tests 2024 | Pass 8010 with confidence!
PRMIA 8010 (Operational Risk Manager (ORM)) Certification Exam is a globally recognized certification offered by the Professional Risk Managers' International Association (PRMIA). Operational Risk Manager (ORM) Exam certification is designed for professionals who are responsible for managing operational risks within their organizations. Operational risks refer to those risks that arise from the day-to-day operations of an organization, such as human error, system failures, and fraud. The PRMIA 8010 exam covers a wide range of topics related to operational risk management, including risk assessment, risk monitoring and reporting, risk mitigation, and risk culture.
NEW QUESTION # 99
For a corporate issuer, which of the following can be used to calculate market implied default probabilities?
I. CDS spreads
II. Bond prices
III. Credit rating issued by S&P
IV. Altman's scoring model
- A. III and IV
- B. I, II and III
- C. II and III
- D. I and II
Answer: D
Explanation:
Generally, the probability of default is an input into determining the price of a security. However, if we know the market price of a security, we can back out the probability of default that the market is factoring into pricing that security. Market implied default probabilities are the probabilities of default priced into security prices, and can be determined from both bond prices and CDS spreads. Credit ratings issued by a credit agency do not give us 'market implied default probabilities', and neither does an internal scoring model like Altman's as these do not consider actual market prices in any way.
Therefore Choice 'b' is the correct answer and the others are not.
NEW QUESTION # 100
For a given notional amount, which of the following carries the greatest counterparty exposure (assuming the same counterparty credit rating for each):
- A. A one year certificate of deposit
- B. A one year forward foreign exchange contract
- C. A one year interest rate swap
- D. A futures contract on an equity index
Answer: A
Explanation:
Explanation
The exposure at default is the greatest for the certificate of deposit as the entire notional amount is exposed to the risk of default. The other choices represent derivatives for which the current replacement value, which would be far less than notional, would be the credit exposure.
Said another way - if the counterparty were to default, the entire money in the CD would be at risk, whereas for the derivative contracts it would only be the replacement value that would be at risk.
NEW QUESTION # 101
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 set to be equal to the product of the frequency and severity distributions
- B. The frequency distribution alone forms the basis for the loss distribution for operational risk
- C. A firm wide operational risk distribution is generated using Monte Carlo simulations
- D. A firm wide operational risk distribution is generated by adding together the frequency and severity distributions
Answer: C
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 # 102
Which loss event type is the failure to timely deliver collateral classified as under the Basel II framework?
- A. Information security
- B. External fraud
- C. Clients, products and business practices
- D. Execution, Delivery & Process Management
Answer: D
Explanation:
Explanation
Refer to the detailed loss event type classification under Basel II (see Annex 9 of the accord). You should know the exact names of all loss event types, and examples of each.
NEW QUESTION # 103
Which of the following are valid approaches to leveraging external loss data for modeling operational risks:
I. Both internal and external losses can be fitted with distributions,and a weighted average approach using these distributions is relied upon for capital calculations.
II. External loss data is used to inform scenario modeling.
III. External loss data is combined with internal loss data points, and distributions fitted to the combined data set.
IV. External loss data is used to replace internal loss data points to create a higher quality data set to fit distributions.
- A. I and III
- B. I, II and III
- C. II and IV
- D. All of the above
Answer: B
Explanation:
Explanation
Internal loss data isgenerally the highest quality as it is relevant, and is 'real' as it has occurred to the organization. External loss data suffers from a significant limitation that the risk profiles of the banks to which the data relates is generally not known due to anonymization, and may likely may not be applicable to the bank performing the calculations. Therefore, replacing external loss data with external loss data is not a good idea. Statement IV is therefore incorrect.
All other approach described are valid approaches for the risk analyst to consider and implement. Therefore statements I, II and III are correct and IV is not.
NEW QUESTION # 104
For a hypotherical UoM, the number of losses in two non-overlapping datasets is 24 and 32 respectively. The Pareto tail parameters for the two datasets calculated using the maximum likelihood estimation method are 2 and 3. What is an estimate of the tail parameter of the combined dataset?
- A. 0
- B. 2.23
- C. Cannot be determined
- D. 2.57
Answer: D
Explanation:
Explanation
For a number of processes, including many in finance, while a distribution such as the normal distribution is a good approximation of the distribution near the modal value of the variable, thesame normal distribution may not be a good estimate of the tails. For this reason, the Pareto distribution is one of the distributions that is often used to model the tails of another distribution. Generally, if you have a set of observations, and you discard all observations below a threshold, you are left with what are called 'exceedances'. The threshold needs to be reasonably far out in the tail. If from each value of the exceedances you subtract the threshold value, the resulting dataset is estimated bythe generalized Pareto distribution.
The Pareto distribution has a 'shape parameter'. The average of two Pareto distributions with tail parameters 1 and 2 ( is a Greek character, pronounced as 'sai' (saa-eee)), is the weighted average of 1 and 2 with weights proportional to the number of observations in the datasets underlying the distributions.
NEW QUESTION # 105
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 and Second
- C. First
- D. First, Second and Third
Answer: C
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 # 106
In estimating credit exposure for a line of credit, it is usual to consider:
- A. a fixed fraction of the line of credit to be the exposure at default even though the currently drawn amount is quite different from such a fraction.
- B. only the value of credit exposure currently existing against the credit line as the exposure at default.
- C. the full value of the credit line to be the exposure at default as the borrower has an informational advantage that will lead them to borrow fully against the credit line at the time of default.
- D. the present value of the line of credit at the agreed rate of lending.
Answer: A
Explanation:
Explanation
Choice'a' is the correct answer. Exposures such as those to a line of credit of which only a part (or none) may be drawn at the time of assessment present a difficulty when attempting to quantify credit risk. It is not correct to take the entire amount of the line as the exposure at default, and likewise the current exposure is likely to be too aggressively low a number to consider.
While the borrower has an information advantage in that he would be aware of the deterioration in credit standing before the bank and would probably draw cash prior to default, it is unlikely that the entire amount of the line of credit would be drawn in all cases. In some cases, none may be drawn. In other cases, the bank would become aware of the situation and curtail or cancel access to the credit line in a timely fashion.
Therefore a fixed proportion of existing credit lines is considered a reasonable approximation of the exposure at default against credit lines.
NEW QUESTION # 107
Under the standardized approach to determining operational risk capital, operations risk capital is equal to:
- A. a fixed percentage of the latest gross income of the bank
- B. a fixed percentage (different for each business line) of the gross income of the eight specified business lines, averaged over three years
- C. 15% of the average gross income (considering only the positive years) of the past three years
- D. a varying percentage, determined by the national regulator, of the gross revenue of each of the bank's business lines
Answer: B
Explanation:
Explanation
Choice 'd' is the correct answer, as laid down in the Basel II document. The other choices are incorrect.
NEW QUESTION # 108
Under the KMV Moody's approach to credit risk measurement, how is the distance to default converted to expected default frequencies?
- A. Using a proprietary database based on historical information
- B. Using migration matrices
- C. Using a normal distribution
- D. Using Monte Carlo simulations
Answer: A
Explanation:
Explanation
KMV Moody's uses a proprietary database to convert the distance to default to expected default probabilities.
NEW QUESTION # 109
The probability of default of a security over a 1 year period is 3%. What is the probability that it would not have defaulted at theend of four years from now?
- A. 12.00%
- B. 88.00%
- C. 11.47%
- D. 88.53%
Answer: D
Explanation:
Explanation
The probability that the security would not default in the next 4 years is equal to the probability of survival raised to the power four. In other words, =(1 -3%)^4 = 88.53%. Choice 'b' is the correct answer.
NEW QUESTION # 110
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 III
- B. I and II
- C. II and III
- D. All of the above
Answer: C
Explanation:
Explanation
Parametric VaR relies upon reducing a portfolio's positions to risk factors, and estimating the first order changes in portfolio values from each of the risk factors. This is called the delta approximation approach.
Riskfactors include stock index values, or the PV01 for interest rate products, or volatility for options. This approach can be quite accurate and computationally efficient if the portfolio comprises products whose value behaves linearly to changes in risk factors. This includes long and short positions in equities, commodities and the like.
However, where non-linear products such as options are involved and large moves in the risk factors are anticipated, a delta approximation based valuation may not give accurate results, and the VaR may be misstated. Therefore in such situations parametric VaR is not advised (unless it is extended to include second and third level sensitivities which can bring its own share of problems).
Parametric VaR also assumes that the returns of risk factors are normally distributed - an assumption that is violated in times of market stress. So if it is known that the risk factor returns are not normally distributed, it is not advisable to use parametric VaR.
NEW QUESTION # 111
Under the CreditPortfolio View approach to credit risk modeling, which of the following best describes the conditional transition matrix:
- A. The conditional transition matrix is the unconditional transition matrix adjusted for probabilities of defaults
- B. The conditional transition matrix is the unconditional transition matrix adjusted for the state of the economy and other macro economic factors being modeled
- C. The conditional transition matrix is the transition matrix adjusted for the distribution of the firms' asset returns
- D. The conditional transition matrix is the transition matrix adjusted for the risk horizon being different from that of the transition matrix
Answer: B
Explanation:
Explanation
Under theCreditPortfolio View approach, the credit rating transition matrix is adjusted for the state of the economy in a way as to increase the probability of defaults when the economy is not doing well, and vice versa. Therefore Choice 'a' is the correct answer.The other choices represent nonsensical options.
NEW QUESTION # 112
Which of the following statements is true
I. If no loss data is available, good quality scenarios can be used to model operational risk II. Scenario data can be mixed with observed loss data for modeling severity and frequency estimates III. Severity estimates should not be created by fitting models to scenario generated loss data points alone IV. Scenario assessments should only be used as modifiers to ILD or ELD severity models.
- A. III and IV
- B. All statements are true
- C. I
- D. I and II
Answer: D
Explanation:
Explanation
There are multiple ways to incorporate scenario analysis for modeling operational risk capital - and the exact approach used depends upon thequantity of loss data available, and the quality of scenario assessments.
Generally:
- If there is no past loss data available, scenarios are the only practical means to model operational risk loss distributions. Both frequency and severity estimates can be modeled based on scenario data.
- If there is plenty of past data available, scenarios can be used as a modifier for estimates that are based solely on data (for example, consider the MAX of the loss estimates at the desired quantile as provided bythe data, and as indicated by scenarios)
- If high quality scenario data is available, and there is sufficient past data, one could mix scenario assessments with the loss data and fit the combined data set to create the loss distribution. Alternatively, both could be fitted with severity estimates and then the two severities could be parametrically combined.
In short, there is considerable flexibility in how scenarios can be used.
Statement I is therefore correct, and so is statement II as both indicate valid uses of scenarios.
Statement III is not correct because it may be okay to create severity estimates based on scenario data alone.
Statement IV is not correct because while using scenarios as modifiers to other means of estimation is acceptable, that isnot the only use of scenarios.
NEW QUESTION # 113
Which of the following statements are true?
I. Retail Risk Based Pricing involves using borrower specific data to arrive at both credit adjudication and pricing decisions II. An integrated 'Risk Information Management Environment' includes two elements - people and processes III. A Logical Data Model (LDM) lays down the relationships between data elements that an organization stores IV. Reference Data and Metadata refer to the same thing
- A. I, II and III
- B. I and III
- C. II and IV
- D. All of the above
Answer: B
Explanation:
Explanation
Statement I is correct. Retail Risk Based Pricing (RRBP) involves the use of borrower specific data (such as FICO scores, average balances etc) to arrive at credit decisions. These 'retail' credit decisions may include decisions on whether to grant a line of credit, a mortgage, issue a credit card, or any of the various other retail activities abank may be dealing with. At the same time, this data can also be used to price the product, in addition to providing a yes or no credit decision so that risky borrowers are charged more than less risky borrowers.
Statement II is not correct, because an integrated Risk Information Management Environment includes three elements - people, processes and technology (and not just people and processes).
Statement III is correct. An LDM is a blue print of an organization's data, and describes the relationships between the various data elements.
Statement IV is not correct because reference data and metadata are not the same thing. Reference data refers to relatively static data, such as customer name (while actual transactions may not be so static). Metadata refers to data about data, and is stored in a data dictionary.
Therefore Choice 'b' is the correct answer and the rest are incorrect.
NEW QUESTION # 114
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
- A. III only
- B. I and IV
- C. II only
- D. None of the above
Answer: D
Explanation:
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.
NEW QUESTION # 115
CreditRisk+, the actuarial model for calculating portfolio credit risk, is based upon:
- A. the log-normal distribution
- B. the Poisson distribution
- C. the exponential distribution
- D. the normal distribution
Answer: B
NEW QUESTION # 116
For a FX forward contract, what would be the worst time for a counterparty to default (in terms of the maximum likely credit exposure)
- A. Right after inception
- B. Roughlythree-quarters of the way towards maturity
- C. Indeterminate from the given information
- D. At maturity
Answer: D
Explanation:
Explanation
With the passage of time, the range of possible values the FX contract can take increases. Therefore the maximumvalue of the contract, which is when the credit risk would be maximum, would be at maturity. (Note that this is different than an interest rate swap whose value at maturity approaches zero.) Therefore Choice 'a' is the correct answer and the others are incorrect.
NEW QUESTION # 117
Which of the following statements is true:
I. When averaging quantiles of two Pareto distributions, the quantiles of theaveraged models are equal to the geometric average of the quantiles of the original models based upon the number of data items in each original model.
II. When modeling severity distributions, we can only use distributions which have fewer parameters thanthe number of datapoints we are modeling from.
III. If an internal loss data based model covers the same risks as a scenario based model, they can can be combined using the weighted average of their parameters.
IV If an internal loss model and a scenario based model address different risks, the models can be combined by taking their sums.
- A. III and IV
- B. I and II
- C. II and III
- D. All statements are true
Answer: D
Explanation:
Explanation
Statement I is true, the quantiles of the averaged models are equal to the geometric average of the quantiles of the original models.
Statement II is correct, the number of data points from which model parameters are estimated must be greater than the number of parameters. So if a distribution, say Poisson, has one parameter, we need at least two data points to estimate the parameter. Other complex distributions may have multiple parameters for shape, scale and other things, and the minimum number of observations required will be greater than the number of parameters.
Statement III istrue, if the ILD data and scenarios cover the same risk, they are essentially different perspectives on the same risk, and therefore should be combined as weighted averages.
But if they cover completely different risks, the models will need to be added together, not averaged - which is why Statement IV is true.
NEW QUESTION # 118
Random recovery rates in respectof credit risk can be modeled using:
- A. the omega distribution
- B. the beta distribution
- C. the binomial distribution
- D. the normal distribution
Answer: B
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 # 119
The frequency distribution for operational risk loss events can be modeled by which of the following distributions:
I. The binomial distribution
II. The Poisson distribution
III. The negative binomial distribution
IV. The omega distribution
- A. I and III
- B. I, II, III and IV
- C. I, II and III
- D. I, III and IV
Answer: C
Explanation:
Explanation
The binomial, Poisson and the negative binomialdistributions can all be used to model the loss event frequency distribution. The omega distribution is not used for this purpose, therefore Choice 'a' is the correct answer.
Also note that the negative binomial distribution provides the best model fit because it has more parameters than the binomial or the Poisson. However, in practice the Poisson distribution is most often used due to reasons of practicality and the fact that the key model risk in such situations does not arise from the choice of an incorrect underlying distribution.
NEW QUESTION # 120
Pick underlying risk factors for a position in an equity index option:
I. Spot value for the index
II. Risk free interest rate
III. Volatility of the underlying
IV. Strike price for the option
- A. I, II and III
- B. I and IV
- C. II and II
- D. All of the above
Answer: A
Explanation:
Explanation
The index option is affected by the spot value for the underlying index, as also the risk free interest rate, or the zero rate for the duration of the option. It is also affected by the volatility of the underlying.The 'strike price' is set and is fixed at the time the option is purchased, and therefore is not a risk factor.
Therefore other than IV, all other choices are valid risk factors that underlie an equity index option.
Other instruments may have other risk factors - for example, a long forex position will have the spot exchange rate as the only risk factor.
NEW QUESTION # 121
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