||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||™THEPROFESSIONALRISKMANAGER(PRM)CERTIFICATIONPROGRAMMEPRMSelfStudyGuide–ExamI(ONEOFFIVE)FINANCETHEORY,FINANCIALINSTRUMENTS,FINANCIALMARKETS
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||[]ECRADLETOTHEPINNACLEOFYOURCAREERPREE·mFROMTHee·ahAHigherStandardforRiskProfessionalssanon-profit,member-ledassociationofprofessionals,theProfessionalRiskManagers’InternationalAssociation(PRMIA). CONNECTIONTOALOCALCHAPTERNETWORKOF54,000MEMBERSINOVER180COUNTRIES–Over150meetingseachyearareofferedthroughmorethan65localPRMIAchapters,givingmembersaccesstothebestpracticesoftheglobalriskprofessionandtoalocalnetworkofcolleagues. THEPROFESSIONALRISKMANAGER(PRM)CERTIFICATION–Endorsedbyleadinguniversitiesandbusinesses,thePRMcertificationistheglobalstandardforfinancialriskmanagersandisofferedin140countries. ASSOCIATEPRMCERTIFICATE–Coversthecoreconceptsofriskmanagement,allowingnon-specialiststointerpretriskmanagementinformationandreports,makecriticalassessments,andevaluatetheimplicationsandthelimitationsofsuchresults. THEPRMIAJOBSBOARD–. PRMIAEDUCATION–Offeringclassroominstructionandover500onlineprofessionaldevelopmentcourses,,@.
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||TMPRMSELF-STUDYGUIDE–EXAMIFinanceTheory,FinancialInstruments,FinancialMarketsOVERVIEWTMxamIofthePRMcertificationtestsacandidate’sknowledgeandunderstandingofthefoundationsofEfinancetheory,thefinancialinstrumentsthatprovidetoolsforthemitigationortransferofrisk,,,somequitecomplex,,,thenreviewtheLearningOutcomeStatements,,becomingcomfortablewithyourknowledgeandunderstandingofeachLearningOutcomeStatement,andworkingthroughtheStudyQuestionsandtheTMSampleExamQuestions,(Diagnostics),aswellasworkingasariskofficer,,orwhohascompletedthefirstyearofauniversitydegreeinamathematical-basedqualification(physics,economics,engineering,etc),,,
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||’s“ahigherstandardinriskcertification”-StudyGuide,,!WORDDEFINITIONSInthisguide,,withafewadditionalwords,,;specifically,;toillustrateandexplain,,animpression,;;;;toprovideanunderstandingof;;,account,ordescription;-study,,,orasmuchastenormore,,it’-STUDYGUIDE–EXAMI
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||,iftheexamhas30questionsin90minutes,,decideonthebestansweryoucan(ignoringtheobviouslywrong),,makeabsolutelysurethatyouhaveananswerforeveryquestionattheendoftheexam!,(availableasstandardwithMicrosoftWindows)andoffersbothscientificandstandardfunctionalitywhichistoggledthrougha“View”!STUDYQUESTIONSAfewquestions,withanswers,,
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||:fromtheexpectedutilityapproachandriskaversion,whichweretheforerunnersofthecap-italassetpricingmodel(CAPM),’,: Differentiatebetweencontinuousanddiscretecompounding DifferentiatebetweenthenominalinterestrateandeffectiveyieldCHAPTER1providesageneraloverviewofriskandriskaversion,introducestheutilityfunctionandmean–: ExplaintheconceptsofUtilityandUtilityMaximization Explainthewaysofthedeterminationofutilityfunction ExplaintheconceptofRiskAversion DiscusstheMean-VarianceCriterion DefinetheSharpe,TreynorandInformationRatios DefineJenson’sAlpha,RAROC,RoVaRandRAPM DefinetheSortino,OmegaIndexandKappaRatiosCHAPTER2providesanintroductiontoportfoliomathematics,,-at-risk,: Calculatethereturn,meanreturn,varianceandstandarddeviationofasingleasset Calculatethereturn,meanreturn,varianceandstandarddeviationofaportfolioTM4PRMSELF-STUDYGUIDE–EXAMI
|||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||| Calculatethecorrelationbetweentwoassets Identifyadominatedportfolio Discusstheefficientfrontier Calculatetheminimumvariancehedgeratio Describehowdiversificationreducesrisk Describetheimpactofserialcorrelationonthestandarddeviationofreturns CalculateValueatRiskinaportfolio Calculatetheprobabilitythatoneportfoliowilloutperformanotherportfolio ,,thecapitalmarketline,(ratherthanabsoluterisk): Describeefficientportfoliosthatsatisfythemean-variancecriterion Showtheefficientfrontierfortwoassets Showtheefficientfrontierforamulti-assetportfolio Definetherisk-freeasset DeriveanddescribetheCapitalAllocationLine DescribetheCapitalMarketsLine Definethemarketportfolio Describetheseparationprinciple ListthepredictionsofMean-VariancePortfolioTheoryCHAPTER4providesarigorousdescriptionoftheCAPMmodel,includingbetas,systematicrisk,: DescribetheCapitalAssetPricingModel(CAPM) DescribeBetaasaMeasureofRelativeRisk ListtheassumptionsoftheCAPM Defineriskpremium DerivetheSecurityMarketLine DefineandCalculatetheSharpeRatioandJensen’sAlpha DescribetheSingleIndexModel Describesystematicandspecificrisk DescribetheArbitragePricingTheory(APT)FINANCETHEORY5
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||Capitalstructureisanimportanttheoreticalconceptforriskmanagerssincecapitalisviewedasthelastdefenseagainstextreme,,advantagesandcostsrelatedtodebtfinancing,variousagencycosts,varioustypesofdebtandequity,returnonequitydecomposition,examplesofattractiveandunattractivedebt,: ExplainandShowtheformulafortheValueofaFirm DescribetheAgencycostsofEquity DescribetheAgencycostsofDebt DescribethecharacteristicsofDebtandEquity CharacterizetheimpactofleverageonROEvolatility Characterizetheimpactoftaxesonthedebt/equitydecision ,,andthenturnstothemodelsthatpractitionersuseinvaluation,: Describeyieldtomaturityasaninternalrateofreturn Definespotcurve,spotrateandtermstructure Defineanddescribetheyieldcurve Demonstratetheprocessofbootstrapping Defineno-arbitragepricing Calculateimpliedforwardrates Describenormal,flatandinvertedyieldcurves Describethepureexpectationstheory Describetheliquiditypreferencetheory Describethepreferredhabitattheory Describethemarketsegmentationtheory CompareandcontrasttheHo-Lee,Hull-WhiteandBlack-Derman-Toymodels Compareandcontrastsingle-factorandmulti-factormodels Describemeanreversion Calculatethevalueofnon-callablebondsusingtermstructuremodels Describetheimpactofanembeddedcallonthevalueofabondusingtermstructuremodels Calculateeffectivedurationandconvexitywithinatermstructuremodel DefineOptionAdjustedSpread DiscusstheimplicationsofchoosingonetermstructuremodelovertheothersTM6PRMSELF-STUDYGUIDE–EXAMI
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||(havingalinearpayoff)andoptions(havinganon-linearpayoff).: Definespotpriceandforwardprice Calculatethevalueofaforwardcontractatexpirationandpriortoexpiration Describetheimpactofintermediatecashflowsonthevalueofaforwardcontract Describetheimpactofstoragecostsonthevalueofaforwardcontract Describetheimpactofconvenienceyieldonthevalueofaforwardcontract Calculatetheforwardpriceofabond,stock,currencyandcommodity DefineandDiscussaForwardRateAgreement(FRA) CalculatethevalueandpriceofFRA ,put–callparity,binomialmodels,–Scholes–,: Discussthefactorinfluencingoptionprice Describeput-callparity Discussthebasicprinciplesofthebinomialoptionmodel Defineanddiscussdelta-hedging Explainrisk-neutralvaluation Calculateanoptionpriceusingaone-stepbinomialmodel Definethesymbolsandlettersofinputsintothebinomialmodel DescribethebasicprinciplesoftheBlack-Scholes-Mertonmodel StatetheBlack-Scholes-Mertonformulaforpricingacalloption CalculateanoptionpriceusingBlack-Scholes-Mertonmodel Identifyanddiscussthegraphicrepresentationsofaputandacall Definedelta,gamma,vega,thetaandrho Defineanddiscussimpliedvolatility Defineavolatilitysmile DefineintrinsicvalueandtimevalueFINANCETHEORY7
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||FINANCIALINSTRUMENTSavingfirmlyestablishedthetheoreticalbasisforvaluationinTheProfessionalRiskManagers’GuideHtoFinanceTheoryanditsApplications,TheProfessionalRiskManagers’,definesthemaintypesofbondsanddescribesthemarketconventionsformajortypesoftreasuries,strips,floaters(floating-ratenotes): Defineanddiscussthevariouscharacteristicsofbondissues ListanddiscusstheMoody’sandS&Pratingsforbonds Definecleanprice,dirtyprice,accruedinterestandbondyield Definebondspread(yieldspread)andbid/askspread Describetheimpactofliquidityonspreads Discussstrips,floatingratenotesandinflation-indexedbondsCHAPTER2analysesthemaintypesofbonds,,dayconventionsandaccruedinterestareprovided,,thusnaturallyleadingthereadertoduration,: Definenominal(notional,face,par,maturity)value,maturity,termtomaturity,coupon,coupon-rate,zero-couponandvanillabond Describeabondasaseriesofcashflows Defineindex-linkedbonds,securitizedbonds,amortizingbonds,callablebonds,putablebondsandconvertiblebonds Definediscountandpremium Calculatethecleananddirtypriceofabond Calculatecurrentyieldandyieldtomaturity Describetherelationshipbetweenyieldandprice Discussthe“pulltopar”ofbondprices CompareandcontrastMacauleyDurationandModifiedDuration DefineDVBP,dollardurationandkeyrateduration Calculatethemodifieddurationofabond DescribetheshortcomingsofMacauleyandModifieddurations CalculatetheDVBPofabond DiscussEffectiveDuration Discussthedurationofafloatingratenote Describetheimpactofanembeddedcallorputonduration Definebasispointvalue(BPV) CalculatethehedgeratioforabondusingBPVTM8PRMSELF-STUDYGUIDE–EXAMI
|||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||| Defineanddiscussconvexity Describetheimpactofanembeddedcallorputonconvexity ,commodity,-to-market,quotation,,: CompareandContrastforwardandfuturescontracts Discusssomeusesofstockindexfutures Defineindexpointandvalueofanindexpoint Describeindexarbitrageandprogramtrading Calculateaminimumvariancehedgeratioforaportfolioofstocks,usingfutures,givenbeta Describesomerisksinindexhedging Discuss“tailingthehedge” Compareandcontrastcurrencyforwardsandfuturescontracts Definecoveredinterestparity Calculateaforwardexchangerate Calculateahedgeratiousingforeignexchangefutures Discusstherelativebasisriskswithcommodityfutures Defineforwardrateagreement(FRA) DiscussFRAs,theirnomenclature,usesandsettlement CalculateT-billandEurodollarfuturesprices ConstructahedgeusingEurodollarorT-billfutures DefinethetickvalueofaEurodollarorT-billfuturescontract Definecheapest-to-deliverandconversionfactor CompareandcontrastT-BondandGiltfuturescontracts DefinethetickvalueofaT-BondandGiltfuturescontract ConstructahedgeusingT-bondfutures CompareandcontraststackandstriphedgesCHAPTER4analysessomeofthemostpopularswapvarieties,: Defineaswap Listthekeycomponentsofaswapagreement Discussequityswaps DiscusscommodityswapsFINANCIALINSTRUMENTS9
|||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||| Definebuyerofinterestrateswaps Discussinterestrateswaps Discusscurrencyswaps Discussbasisswaps Discussvolatilityswaps Decomposeaswapintoitsrespectivecashflows Defineparswap,accrualswap,commodity-linkedinterestrateswap,crackspreadswap,overnightindexswap,powerLIBORswapandextendibleswap Defineswapspreadandswaprate Definethepayerandreceiverinswaps Discussriskofswaps DiscussmainusesofswapsTheremainingchaptersinthebookallapplytheprinciplesofoptionvaluationasintroducedinChapter8oftheProfessionalRiskManagers’: Definepremium,underlying,strike(exercise)price,expirationdate(expiry),in-the-money,at-the-moneyandout-of-the-money Drawtheexpirationpayoffdiagramofaputandacall Compareandcontrasttheriskoflongandshortoptionpositions CompareandcontrastAmerican,EuropeanandBermudanoptions Drawanddiscusstheexpirationpayoffdiagramsofacoveredcall,protectiveput,callspread,putspread,straddle,strangle,collar,butterflyandcondor Describeacalendarspread Discussusesofstraddles,strangles,riskreversals,collars,butterfliesandcondorsCHAPTER6coversoneofthenewerapplicationsofoptions:,theycanbeultimatelydecomposedintooptions,: Contrasttechnicaldefaultandactualdefault Discusstheapplicationsofcreditderivatives Definereferenceentity,creditevent,settlementmechanismanddeliverableobligation Defineanddiscussfundedandunfundedinstruments ListthetypesofcrediteventscontainedinastandardISDAcreditderivativesdocument Defineanddiscusscreditdefaultswaps(CDS)andtheirprospectivecashflowsTM10PRMSELF-STUDYGUIDE–EXAMI
|||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||| Definereferenceasset Defineanddiscussloan-onlycreditdefaultswaps(LCDS) DefinestructuredfinancesecurityCDS Defineanddiscusspay-as-you-goCDS Defineanddiscusscredit-linkednotes(CLN)andtheirprospectivecashflows Defineanddiscusstotalreturnswaps(TRS)andtheirprospectivecashflows Discusstherisksoftotalreturnswaps Discussthepotentialbalance-sheetimplicationsofdifferenttotalreturnswapstructures Discusstheuseoftotalreturnswapsasafundingvehicle Defineacreditoptioncallandput Defineanddiscusscollateralizeddebtobligations(CDO),collateralizedbondobligation(CBO)andcollateralizedloanobligation(CLO)andtheirprospectivecashflows Definetranch,tranchingandcreditenhancement Defineseniornote,subordinatednote,mezzaninenoteandequitynoteandhowcashflowstoeach Listvariouscreditenhancements DiscusssyntheticCDOsandtheirprospectivecashflows Definereferenceportfolio Definefirst-losspiece Describeunfunded,partiallyfunded,fullyfundedandfullyunfundedsyntheticCDOs Definesuper-seniorswap Discusssomeuses,advantagesandlimitationsofsyntheticCDOs Discusssomegeneralapplicationsofcreditderivatives DiscusssomepossibleunintendedriskswithcreditderivativesCHAPTER7addressescaps,floorsandswaptions,,FloorsandSwaptionsLearningOutcomeStatement Definecap,floor,collar,caplet,floorlet,referencerate,exerciserate,settlementfrequency,startingdateandmaturity Describeacaporfloorasaportfolioofoptions Discussvarioususesofcaps,floorsandcollarsinhedging Defineswaption,receiveroptionandpayeroption Discussthepricingofswaptions Discussthequotationconventionsforcaps,floorsandswaptions DiscusssomeusesofswaptionsinhedgingandwhentheymightbepreferredtocapsandfloorsTMChapter8,ConvertibleBonds,andChapter9,
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||’GuidetoFinancialMarkets,–geographically,bytypeofexchange,byissuers,liquidityandtypeofinstruments–,: CompareandcontrastfinancialexchangesandOTCmarkets Defineinter-dealermarketandinter-dealerbroker Compareandcontrastthesizeofvariousmarkets(bonds,foreignexchange,equities,etc) Discusstheimportanceofmarketliquidity Describearepoandareverserepoandtheirrolesassourcesofliquidity DefineanISDAMasterAgreement Describehowscreen-tradingsystemswork Describeamarket“specialist” Describean“open-outcry”tradingsystem DescribeanECN Describethestepsinpost-tradeprocessing Describestraight-throughprocessing Compareandcontrastretail,wholesaleandprimebrokers Discussissueswith“newmarket”‘risk-free’-termdebtsecurities,–marketsforborrowing/: Describethecharacteristicsoffixedincomeinstruments Defineterm,principal, Describethetypesofdeposits(demand,noticeandfixed-term) Defineareferencerate Describeacreditfacility Discusssyndication Calculatetheinterestpaymentonatermrepo DescribetheEurocurrencymarket,particularlytheEurodollarmarket Define“add-on”interest DefineLIBOR Describedifferenttypesofmoneymarketsecurities Calculatethebond-equivalentyieldofaT-bill DefineacommercialpaperandapromissorynoteTM12PRMSELF-STUDYGUIDE–EXAMI
|||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||| Definebanker’sacceptanceandcertificateofdeposit Definebasispoint DefineastampingfeeThemarketforlonger-termdebtsecuritiesisdiscussedinCHAPTER3,whichclassifiesbondsbyissuer:government,agencies,: Compareandcontrastaretailandaninvestmentbank Definemarket-makingandorigination Describethevariousmarketparticipantsbygroup Compareandcontrastaproprietarytraderandamarket-maker(dealer)andaninter-dealerbroker Definebid-priceandoffer-price Compareandcontrastsovereign,agency,corporateandmunicipalbonds Describeon-the-run,off-the-runandbenchmarksecurities Compareandcontrastgeneralobligationandrevenuebonds Defineasinkingfund Definepropertyclausesandcallprovision Definetypesofforeignbonds(Yankee,Bulldog,Samurai,AlpineandMatador) Comparegrossandnetinterestpayments Compareandcontrasttheprimaryandsecondarymarkets Compareandcontrastapublicofferandaprivateoffer Describetheprocessofunderwritinganewissue Defineunderwriter,leadmanagerandbook-runner Defineafixed-pricere-offermechanism Defineabought-deal DescribethecharacteristicsoftheEurobondmarket Definethedifferentday-countconventions Definedefaultandrecoveryrates Describehowabond’sratingaffectstheyieldspread DescribetheroleofRatingAgenciesCHAPTER4turnstotheforeignexchangemarket–,suchasquotationconventions,typesofbrokers,’: Defineanexchangerate Describetheinterbankmarket Definedecentralized,continuous,openbidanddouble-auctionFINANCIALMARKETS13
|||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||| Definedirectandindirect-termquotations Compareandcontrastdirectdealing,foreignexchangebrokersandelectronicsystems Definethetradingterms“mine”and“yours” Definethetradingterm“bigfigure” Defineacross-rateandacross-trade Calculateacross-rategiventwoexchangerates Describesomeeconomicfactorsthatmightaffectexchangerates Discusscentralbankintervention Discussspotandforwardmarkets Definecurrencyswaprate,forwardpremiumandforwarddiscount Calculatetheforwardpremiumordiscount Definecovered-interestarbitrage/interestrateparity Describeatypicalforeignexchangeoperation Definefront,,,includingtypesoforders,marketparticipants,marginandshorttrades,: Describethecommoncharacteristicsofastock DefineIPO,primaryissue,andsecondaryoffering Discussshareholderrights Definedividendandex-dividendtrading Compareandcontrastordinaryandpreferenceshares Definemarketcapitalization Discussstockindices DefinethedividenddiscountandGordongrowthmodelsofstockvaluation Discussthetypesofstockmarketparticipants Definelistingandfloat Compareandcontrastmatchedmarketandmarketmaker DefineT+1andT+3settlement Defineprivateplacementandseasonednewissue DescribetheprocessofanIPO Describetheprocessofaprivateplacement Describetheroleofexchanges DescribetheroleoftheOTCmarket Definethebid/offerspread Discussmargintrading Discussshort-sellingandborrowingstocks Compareandcontrastsingle-stockandindexoptionsTM14PRMSELF-STUDYGUIDE–EXAMI
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||CHAPTER6introducesthefuturesmarkets;thisincludesacomparisonofthemainexchange-tradedmarkets,optionsonfutures,specificationsofthemostpopularcontracts,theuseoffuturesforhedging,tradeordersforfuturescontracts,mark-to-marketprocedures,: Defineafuturescontacts Discusssomeofthereasonsthatfuturesmarketsexist Defineopen-outcry,contactsize,ticksize,limitup,limitdown,expandedlimit,initialmargin,maintenancemargin,mark-to-market,dailysettlement,deliverymonth,offsettingtransaction,volumeandopeninterest Discusstypesofordersinfuturesmarkets Discusstheimportanceofstandardizationinfuturescontracts Discusstheroleoftheclearinghouse Compareandcontrastphysicaldeliveryandcash-settlement Discusstheprocessofphysicalsettlement Defineanddiscussthevarioustypesoforders Defineflexoption Discusstheexerciseofanoptiononafuturescontract Discussthevariousparticipantsinfuturesmarkets:hedgers,speculators,managedfuturesinvestors Calculateinitialmarginandchangeinmarginduetomarketmovements ,suchasdeliveryandsettlementmethods,–(suchasbackwardationandcontango)aredescribed,: Listfourgeneraltypesofcommodities Contrastbase,strategic,minorandpreciousmetals Contrastgrains,oilseedsandfibers Define“onthespot”and“settlementofdifference” Defineinstore,exstore,FreeonBoard(FOB),FreealongsideShip(FOS),CostInsurance&Freight(CIF)andExchangeforPhysicals(EFP) Discusstheuniquenessofthegoldmarket Definecontango,backwardation,carryingcost(costofcarry)andleaserate Discusstheimpactofshortagesoncommoditypricesandthehistoryofshortsqueezes DefineshortsqueezeanddemandforimmediacyFINANCIALMARKETS15
|||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||| Discusstheconvenienceyieldtheory Statethearbitrageequationforcommoditypricing Discussthedecompositionofriskfactorsincommodities Discusstheimportanceofnon-normalityofcommoditypricedistributionsFinally,CHAPTER8examinesoneofthemostrapidlydevelopingmarketsforrisk–,electricity,,includingmarketsforgreenhousegasemis-sions,–: Discussthesizeofmarketsforenergy Discussthevariousenergyfuturesmarkets Listthemajorenergyfuturescontracts Describevariousoptionsonenergy Discussusingfuturesmarketstohedgeenergyrisk Constructanenergyhedgeusingfuturescontracts Discussphysicaldeliveryinenergymarkets DefinebasiscontractsinOTCenergymarkets DiscusstheroleoftheSingaporeMarket DiscusstheroleoftheEuropeanMarket DiscusstheroleoftheNorthAmericanOTCenergymarket DiscusstheroleofNordPool DiscusstherolethatPlattsplaysintheenergymarket DiscusstheCoalmarket Discusstheweatherderivativesmarket Discusstheemergenceofgreentrading DefineHeatingDegreeDay(HDD)andCoolingDegreeDay(CDD) DiscusstheissuesoffutureenergytradingTM16PRMSELF-STUDYGUIDE—EXAMI
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||STUDYQUESTIONSFINANCETHEORYMean-VarianceAnalysisQ:Whendoesdiversifyinganinvestmentfromasingleassetintoaportfolioshowmoremerit?Consideringtwoassets,providedtheyarenotperfectlycorrelated,(&Lvarianceofthebasketofassets).Inmorequantitativeterms,,-relatedassets,whengoldwasahoardingtool,wasagooddefensivemeasure:whenthepoliticalsituationwentbad,mostassetsdepreciatedwhilescaredinvestorstooktheirsavingsintogold,:WhatwouldmakeaknowledgeableinvestorchooseaCAPM-suboptimalportfolio?Apartfromidiosyncraticpreferences(ethicalinvestingorothers),,,:AssumeyouliveinaCAPMworldandtheexpectedreturnonthemarketportfoliois9%,whiletherisk-freerateis3%.,theexpectedreturnonAis:a)%b)%c)%d)%CAPMsaysthattheexpectedreturnistherisk-freerateplusbetatimesthemarketpremium(whichisthedifferencebetweenthemarketexpectedreturnandtherisk-freerate,here6%):3+*6=:c).STUDYQUESTIONS—FINANCETHEORY17
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||EfficientFrontiers,CapitalQ:Whatwouldhappenifaninvestor’spreferencecurvewerenottangenttoMarketLine,Betathecapitalmarketline?Aninvestor’spreferencecurveisthe(convex),hewillmovehispreferencesuntilhetouchestheline,andwillthenmovealongthelinetoanother,,,;hewouldgetintolowerpreferencecurves,paralleltothefirstone,,-Scholes-MertonModelQ:HowcriticalisittoapplytheBlack-ScholesframeworktoEuropean-typeoptionsonly?Intheory,itisnotatall,asexercisinganAmericantypeorBermudan-typeoptionbeforematurityisrenouncingthevolatilityvalueoftheoption(subjecttothepresenceofdividends).Aholderofsuchoptionshouldthenonlyhedgehisposition,,thedifferencematters,,uncertaindividends,-cisecansubstantiallyincreasethevalueofderivativesovertheirEuropeanequivalentincertaincircumstances().ThebasicapproachtovaluationhoweverdoesnotchangefromtheBlack-Scholesframework,butitisimportanttosolvethepartialdifferentialequation(PDE)inanumericalframeworkwhichallowstheeffectsofearlyexercisetobemodelled,“closedformsolution.”TheBinomialOptionModelQ:Whichofthefollowingistrue:a)Non-Markovianinterestrateprocessesareusuallyrepresentedbyrecombiningtreesb)Markovianinterestrateprocessesareusuallyrepresentedbyrecombiningtreesc)Non-Markovianinterestrateprocessesareusuallyrepresentedbytrinomialtreesd),andusuallyare,representedbyarecombiningtree:b).TM18PRMSELF-STUDYGUIDE—EXAMI
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||Put-CallParityQ:Whatshouldaninvestordotohedgeapositionincludingalongcallandashortputatthesamestrikeprice?,justshort(sell):WhatshouldanoperatordoifJPY/USD=120,forward6M=114,6MinterestforUSDandJPYare4%and1%respectively?Theforwardpricesuggestedbythemarketis:120*
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||a))CHF1000c)CHF106d)(floatingrateindex),forthefirstyear,3%on1000CHFpayableintwoinstallments,andthesameforthesecondyear:,b)andc)(ascominglaterthantoday),:a).FloatingRateNotesQ:AcompanyissuesanFRNatpar,.,,howwouldthiseffectthepriceofthisFRN?,.,sothewillpaylessforthisFRNanditwilltradeatapricebelowpar(100).FuturesandForwardsQ:Agasmarketmaker(MM)hasagreedtodelivergasatUSD3/
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||OptionsQ:Inalongoptionstraddlestrategy,whereonebuysaputandacallsimultaneouslyatthesamestrike,thefollowingistrue:a)Deltawillbezero,regardlessofthelevelofthespotpriceb)Gammawillbethehighestatthemoneyandapproachingmaturityc)Deltawillbenearto1atthemoneyandapproachingmaturityd):put:strategy:Thelongoptionstrategywillresultinthedottingcurveabove,(theslope)willnotbezero,itcouldtendto–(thecurviness)willtendtoinfinitewhenapproachingmaturityandifat-the-money,whenthecurvegetsintothebottomoftheV-shape:b).TermStructureBasicsQ:Acustomerwantsatailoredsix-monthswapwithconstantvolumes,butrequeststhefixedpriceforthelasttwomonthstobesetatUSD20/
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||HybridInstrumentsQ:Whichofthefollowingis/aretrueconcerningpreferredstocks?a)Theyaresomehowsimilartosubordinateddebt,but,unlikebondholders,preferredshareholderscouldnotforceacompanyintobankruptcyifpreferredcoupons(dividends)werenotpaidontimeb)Manypreferredsharesprovideforcumulativepreferreddividendpaymentshavingpriorityoverordinarydividendsc)Fromanissuer’staxperspective,preferredstocksareamoreexpensivesourceoffinancingthanbondsd)AlloftheaboveTherearegenerallytwokindsofpreferenceshares,,thisdividendforegonemustberepaidifthecompanyrecovers,,,inwhichremunerationisvariable,,ifnodividendispaid,)isrelevantfortaxpurposesonly,aspreferredsharesdividendsarenotalwaystax-deductible,contrarilytobondcoupons:d).ConvertibleBondsQ:Aconvertiblebondisissuedat100%withaUSD10,,howmuchcon-versionpremiumistheinvestorpayingfortheconversionright?EachbondcostsUSD10,,sotheinvestorispayingaconversionpremiumof(50–40)/40equalto25%.SwapsQ:%,%.
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||%%,“price”is“LIBORplus55.”Caps,FloorsandSwaptionsQ:ACapconsistsofthreecapletsthatexpireinthreemonths,%%forpaymentinthreemonthstime,whatistheapproximatevalueofthefirstcapletatexercise?TheLIBORrateontheloanisfixedtodayandpayableinthreemonthstime,thisrateis6%%onthesamenotional,,hewouldpay(6%/4)*USD10mbutwiththecapheeffectivelypays(5%/4)*USD10msothecapletmustpayoutUSD25,:
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||MARKETSMoneyMarkets/FXMarketsQ:Twootherwiseidenticalinstrumentsarequotedindifferentcurrencies,
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||MarketsforCommoditiesQ:Whatcouldbeanexplanationforthemarketforoilbeinginbackwardation?Backwardationinacommoditiesmarketmeansthatthespotpriceofthecommodityishigherthanthepriceforforwarddelivery,(forinstanceasuddencoldsnapinwinterdrivingupshorttermheatingoilprices)andcanalsooccurwhenthisincreaseinshorttermdemandoccursinamarketwhichneedstimetorespondtoincreaseddemandbyincreasedsupply, seasonalityofprices,intra-day,withintheyear,etc.,hencepricestendtofollowsinusoids(sinewaves,orregularup-and-downcycles),ratherthanstraightlines,beforetheerrortermsareadded presenceofshocks(powerdisruptionsandothers),breakingtrendlineserrorterms,,arelargerthaninfinancialmarkets errorterms,,—MARKETS25
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||PRMSelf-StudyResourcesomeetthedemandfromPRMcandidatesfordistancelearningopportunities,,inpartnershipwithTheICMACentre,UniversityofReading,offersacompletepersonallearningtrainingpackageforthePRMexamsI,II,IIIandIVfeaturingleadingfacultymemberslikeCarolAlexander,JacquesPezier,SalihNeftci,MooradChoudhry,JohnBoard,,: Studio-recordedlecturesonDVD AdobeCaptivatedemonstrationsofExcelworkbooks ,theePRMCoachisequippedwithconceptsandpractices,including: Exhaustivetheoreticalmaterialsupplementedwithcontemporarycasestudies Learnerfriendlycoursescompletewithformulae,definitions,concisesummaries,andinteractivesimulations State-of-the-artsimulatedlearningenvironment Solvedexamples,practiceexercisesandquizzes Mockexamsfromaproprietarydatabase Timedtestsinexamformat Personalizedresultsforselfassessment Glossary,FAQs,tipscenterandpocketreference Valuablereferenceextracts Onlineaccesswith24x7customersupportEPRMDIAGNOSTICEXAMSePRMDiagnosticExamsaremockexamsdesignedinaccordancewithPRMIA’sexamstructureandfeature:TM SimulationoftheactualPRMExam State-of-the-artlearningenvironment Timedtestsinexamformat Personalizedresultsforself-assessment @.
TheProfessionalRiskManagers’InternationalAssociation··support@
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||THEPROFESSIONALRISKMANAGER(PRM™)CERTIFICATIONPROGRAMMEPRMSelfStudyGuide–ExamII(TWOOFFIVE)MATHEMATICALFOUNDATIONSOFRISKMEASUREMENT
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||[]ECRADLETOTHEPINNACLEOFYOURCAREERPREE·mFROMTHee·ahAHigherStandardforRiskProfessionalssanon-profit,member-ledassociationofprofessionals,theProfessionalRiskManagers’InternationalAssociation(PRMIA). CONNECTIONTOALOCALCHAPTERNETWORKOF54,000MEMBERSINOVER180COUNTRIES–Over150meetingseachyearareofferedthroughmorethan65localPRMIAchapters,givingmembersaccesstothebestpracticesoftheglobalriskprofessionandtoalocalnetworkofcolleagues. THEPROFESSIONALRISKMANAGER(PRM)CERTIFICATION–Endorsedbyleadinguniversitiesandbusinesses,thePRMcertificationistheglobalstandardforfinancialriskmanagersandisofferedin140countries. ASSOCIATEPRMCERTIFICATE–Coversthecoreconceptsofriskmanagement,allowingnon-specialiststointerpretriskmanagementinformationandreports,makecriticalassessments,andevaluatetheimplicationsandthelimitationsofsuchresults. THEPRMIAJOBSBOARD–. PRMIAEDUCATION–Offeringclassroominstructionandover500onlineprofessionaldevelopmentcourses,,@.
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||TMPRMSELF-STUDYGUIDE–EXAMIIMathematicalFoundationsofRiskMeasurementOVERVIEWTMxamIIofthePRMcertificationtestsacandidate’,,,,thenreviewtheLearningOutcomeStatements,,becomingcomfortablewithyourknowledgeandunderstandingofeachLearningOutcomeStatement,andworkingthroughtheStudyQuestionsandtheSampleExamTMQuestions,(Diagnostics),aswellasworkingasariskofficer,,orwhohascompletedthefirstyearofauniversitydegreeinamathematical-basedqualification(physics,economics,engineering,etc),,,
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||’s“ahigherstan-dardinriskcertification”-StudyGuide,,!WORDDEFINITIONSInthisguide,weusetheCommandWordsthattheCFAInstituteuses,andafewadditionalwords,,;specifically,;toillustrateandexplain,,animpression,;;;;toprovideanunderstandingof;;,account,ordescription;-study,,,orasmuchastenormore,,it’-STUDYGUIDE–EXAMII
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||,iftheexamhas30questionsin90minutes,,decideonthebestansweryoucan(ignoringtheobviouslywrong),,makeabsolutelysurethatyouhaveananswerforeveryquestionattheendoftheexam!,(availableasstandardwithMicrosoftWindows)andoffersbothscientificandstandardfunctionalitywhichistoggledthrougha“View”-ingoutduringtheexamthattheexamvenuecalculatorisnotthesameasthatwithwhichyouarefamiliarisnotarecommendedstrategy!STUDYQUESTIONSAfewquestions,withanswers,,
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||-at-risk(VaR),riskmanagersrequireknowledgeofprobabilitydistri-butions,,middleofficeriskmanagersmustunderstandtheMarketVaR,’sresponsibilityhasexpandedtoincludetheindependentvalidationoftrader’smodels,,,thehallmarkofagoodriskmanagerisnotjusthavingthestatisticalskillsrequiredforriskassessment–,wedorecognizethatmanystudentswillnothavedegreesinmathematics,,,:thesymbolsusedandthebasicrulesofarithmetic,equationsandinequalities,: DescribeRulesofalgebraicoperations ListtheOrderofalgebraicoperations CharacterizeSequences CharacterizeSeries CharacterizeExponents CharacterizeLogarithms CharacterizeExponentialfunctionandNaturalLogarithms SolveLinearequalitiesandinequalitiesinoneunknown DemonstratetheEliminationmethod DemonstratetheSubstitutionmethod CharacterizeFunctionsandGraphs Demonstratecontinuouscompounding DifferentiatebetweendiscretecompoundingandcontinuouscompoundingTM4PRMSELF-STUDYGUIDE–EXAMII
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||CHAPTER2introducesthedescriptivestatisticsthatarecommonlyusedtosummarisethehistoricalcharacteristicsoffinancialdata:thesamplemomentsofreturnsdistributions,‘downside’riskstatistics,andmeasuresofcovariation(): DescribevariousformsofData DiscussGraphicalrepresentationofdata ExplaintheconceptofTheMomentsofaDistribution Define,DiscussandCalculatetheMeasuresofLocationorCentralTendency Define,DiscussandCalculatetheMeasuresofDispersion CalculateHistoricalVolatilityfromReturnsData Define,DiscussandCalculateSkewness Define,DiscussandCalculateKurtosis DescribeBivariateData DiscussCovarianceandCovarianceMatrix DiscussCorrelationCoefficientandCorrelationMatrix CalculatethevolatilityofaportfolioCHAPTER3focusesondifferentiationandintegration,: DifferentiatebetweenDifferentialCalculusandIntegralCalculus Explaintheconceptofdifferentiation Demonstratetheapplicationoftherulesofdifferentiationtopolynomial,exponentialandlogarithmicfunctions Calculatethemodifieddurationofabond DiscussTaylorApproximations Demonstratetheconceptofconvexity Demonstratetheconceptofdeltaandgamma DemonstratePartialDifferentiation DemonstrateTotalDifferentiation DiscusstheFundamentalTheoremofAnalysis ListtheIndefiniteIntegral(s)offunction(s) ListtheRulesofIntegration DiscussOptimisationofUnivariateandMultivariatefunctions DemonstrateConstrainedOptimisationusingLagrangeMultipliersMATHEMATICALFOUNDATIONSOFRISKMEASUREMENT5
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||CHAPTER4coversmatrixoperations,specialtypesofmatricesandthelawsofmatrixalgebra,theCholeskydecompositionofamatrix,:manipulatingcovariancematrices;calculatingthevarianceofthereturnstoaportfolioofassets;hedgingavanillaoptionposition;: DemonstratebasicoperationsofMatrixAlgebra SolvetwoLinearSimultaneousEquationsusingMatrixAlgebra DemonstratePortfolioConstruction DemonstrateHedgingofaVanillaOptionPosition DescribeQuadraticForms DiscusstheVarianceofPortfolioReturnsasaQuadraticForm DefinePositiveDefiniteness DemonstrateCholeskyDecomposition DemonstrateEigenvaluesandEigenvectors ,alongwiththeirexpectationandvarianceandvariousconceptsrelatingtojointdistributions,suchascovarianceandcorrelation,: Explaintheconceptofprobability Describethedifferentapproachestodefiningandmeasuringprobability Demonstratetherulesofprobability Definethediscreteandcontinuousrandomvariable Describetheprobabilitydistributionsofarandomvariable DescribeProbabilitydensityfunctionsandhistograms DescribetheAlgebraofRandomvariables DefinetheExpectedValueandVarianceofadiscreterandomvariable DescribetheAlgebraofContinuousRandomVariables DemonstrateJointProbabilityDistributions Discusscovarianceandcorrelation DiscusstheBinomialDistribution DemonstratethePoissonDistribution DescribetheUniformContinuousDistribution DiscusstheNormalDistribution DiscusstheLognormalProbabilityDistributionanditsuseinderivativepricing DiscusstheStudent’stDistribution DiscusstheBivariateNormalJointDistributionTM6PRMSELF-STUDYGUIDE–EXAMII
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||CHAPTER6coversthesimpleandmultipleregressionmodels,,forinstance,: DefineRegressionAnalysisandthedifferenttypesofregression DemonstrateSimpleLinearRegression DemonstrateMultipleLinearRegression DiscusstheevaluationoftheRegressionModel DescribeConfidenceIntervals DescribeHypothesisTesting DemonstrateSignificanceTestsfortheRegressionParameters DemonstrateSignificanceTestforR2 DescribeTypeIandTypeIIErrors DemonstratetheconceptofPrediction DescribetheOLSAssumptionsandmainbreakdownsofthem DescribeRandomWalksandMeanReversion DescribeMaximumLikelihoodEstimationCHAPTER7looksatsolvingimplicitequations(-Scholesformulaforimpliedvolatility),latticemethods,‘Greeks’: DemonstratetheBisectionmethodforsolvingNon-differentialEquations DemonstratetheNewton-RaphsonmethodforsolvingNon-differentialEquations DescribetheapplicationofGoalSeekequationsolverinExcel DemonstrateUnconstrainedNumericalOptimisation DemonstrateConstrainedNumericalOptimisation DemonstrateBinomialLatticesforvaluingoptions DemonstrateFiniteDifferenceMethodsforvaluingoptions DemonstrateSimulationusingExcelMATHEMATICALFOUNDATIONSOFRISKMEASUREMENT7
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||STUDYQUESTIONSCALCULUSRateofChangeQ:Findthederivativeofy=2xusingrateofchangeapproach:Δy=f+(Δxx)-f()x=2Δ(x)+-2xΔy=Δ2xΔy/Δx=2nthelimitd/ydx=22Area/VolumeQ:Calculatetheareaunderthecurvey–xfortherangezerotoone₁₁₁32xxArea–ydx–xd==ʃʃ—[]⅓3₀₀₀2OptimizationQ:Whatisthemaximumoftheexpression5x+2x+4ysubjecttotheconstraintthat2x+y=2?02Inthisexampleƒ(x,y)=5x+2x+4yandg(x,y)=2x+y–(Notethereorganisationthatisneededsothattheconstraintisintheform2g(x,y)=0.)TheLagrangianisthenL(x,y,λ)=5x+2x+4y–λ(2x+y–2): L L L—=5+4x–2λ—=4–λ—=2x+y–;; x x xSettingeachtozerogives5+4x–2λ=04–λ=02x+y–20==,y=λ=ƒ(,)=:Findalinearpolynomialp(x)thatisatangent-lineapproximationforthe2x–4functionƒ(x)=eatthepointx=)–)+))+==mx+-4,atthepointx=3,isworth22,.7180(2*3-4),isslopingat2e=14.:778*thisdiscardsb)andc).Thed)line,atthepoint3,is443.:5toohigh,onlya)-check,–=573.:9a).TM8PRMSELF-STUDYGUIDE–EXAMII
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||₂2xIntegrationQ:Evaluatethedefiniteintegral:xedxʃ₀a))))(usingthechain24x2ee1xrule)2xesotheintegralI=—whichonputtinginthelimitsI=₂[2—-—2]=,soanswerb).12MatrixAlgebraQ:Determinetheinversematrixof:()-11-1a)b)c)d)(00)()()().,),)(asc)failsonfirstlinefirstcolumn,d)secondlinefirstcolumn):b).PositiveDefinitenessQ:Underwhatcircumstancesisthe2x2realsymmetricmatrix,A,positivedefinite?abA=()cdInorderforAtobepositivedefinite,:Showthatthefollowingvectorsv1,andv2areeigenvectorsofA–whataretheeigenvalues?1131v1=,v2=,A=(-2)(1)(22)1A*v1==v1,eigenvalue=1(-2)4A*v2==4*v2,eigenvalue=4(4)v1 k*–CALCULUS9
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||CholeskyFactorizationQ:PerformtheCholeskyfactorisationonthefollowingcorrelationmatrix:₂n₁₁n₁₁n₁₂1ρn₁₁0n₁₁n₁₂₂₂=*=(ρ1)(n₁₂n₂)₂(0)()n₂₂n₁₁n₁₂n₁₂+n₂₂Byequatingelementsofthematrixandeliminatingterms,weget:1ρ101ρ=2½½2*()()()ρρ)01(1–ρ(1–ρ)RandomVariablesQ:WhatcanwesayaboutthesumX+YoftwoindependentnormalrandomvariablesXandY:a))Itisalwaysnormalc)Itischi-squaredd)Itischi-squaredifXandYbothhavemean0Onecanrefutec)andd)bytakinganormaldistributionwithazerostandarddeviation(itisjustanumber):addthistoanormaldistribution,-variancedistributionswithdifferentmeans,willgiveanormaldistribution(with0variance,too),discard-inga).Amoreelegantresolutionistorememberthestatisticscourse,torecallthatisthesumoftwonormalindependentdistributionsisitselfanormaldistribution,andgoimmediatelytoanswerb).DistributionsandDensitiesQ:==1Øq()={.50q=2a).6857b).4727c).8921d).4821Weassumeinthequestionthatthedistributionisdiscrete–sowecalculateasimplemeanequalto0*+*+*2==((.125))*.025+(()*.025+(()*.05STD=SQRT()=.08291Soanswerc).TM10PRMSELF-STUDYGUIDE–EXAMII
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||MomentsQ:WhatistheformulafortheskewnessofarandomvariableXthathasmeanµandstandarddeviationσ?2434E([x–σ])E([x–µ])E([x–µ])E([x–µ])a)b)c)d)2434µσσE([x–σ])Thesolutiond),a)lookslikevariancebutisdividedbythemeansquared,b)isthe4thmoment(kurtosis):sotheskewnessisanswerc).CovarianceandCorrelationQ:Acovariancematrixforarandomvector:Matricesa)Isstrictlypositivedefinite,ifitexistb)Isnon-singular,ifitexistc)Alwaysexistsd),andtofindoutthattheonlyrelevantfactisthataco-variance,asthenameindicates,).PrincipalComponentAnalysisQ:WhyisPCAusefulforriskmanagement?PCAallowsthehedgingtobecarriedoutwithareducednumberofhedgeinstrumentsasitallowsthe“normal”:Howcanarandomnumbergeneratingfunctionbeusedtogeneratesamplesfromanormaldistribution?Byusingasumofalargenumberofindependentrandomnumbersfromauniformdistributionsuchasisgeneratedbyarandomnumberfunction,,soournormalrandomvariableisthesumoftwelverandomnumbersminusthemean(6).STUDYQUESTIONS—CALCULUS11
LinearRegressionQ:Iftheregressioncoefficientbintheequationy=a+bXislessthanone,2withsamplesize=n,thentheRis:a)Equaltosqrt(b)b)Equaltotheregressionsumofsquares/totalsumofsquaresc)Totalsumofsquares/nd)(Totalsumofsquares*n)/(regressionsumofsquare*(n-1))theregressionsumofsquaresESS2==,(d).RthetotalsumofsquaresTSSBasicStatisticalTestsQ:Whichofthefollowingwouldnotbeatypicalstatementsubjecttohypothesistesting?a)TraderAgeneratespositivealphab)BondCtradesatapositivespreadtoBondQc)StockXisagoodinvestmentd)VolatilityofCurrencyNislowerthanCurrencyFc),c)couldberephrasedtosaythatStockXhasahigherreturnandlowervolatilitythanStockZ,-STUDYGUIDE–EXAMII
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||PRMSelf-StudyResourcesomeetthedemandfromPRMcandidatesfordistancelearningopportunities,,inpartnershipwithTheICMACentre,UniversityofReading,offersacompletepersonallearningtrainingpackageforthePRMexamsI,II,IIIandIVfeaturingleadingfacultymemberslikeCarolAlexander,JacquesPezier,SalihNeftci,MooradChoudhry,JohnBoard,,: Studio-recordedlecturesonDVD AdobeCaptivatedemonstrationsofExcelworkbooks ,theePRMCoachisequippedwithconceptsandpractices,including: Exhaustivetheoreticalmaterialsupplementedwithcontemporarycasestudies Learnerfriendlycoursescompletewithformulae,definitions,concisesummaries,andinteractivesimulations State-of-the-artsimulatedlearningenvironment Solvedexamples,practiceexercisesandquizzes Mockexamsfromaproprietarydatabase Timedtestsinexamformat Personalizedresultsforselfassessment Glossary,FAQs,tipscenterandpocketreference Valuablereferenceextracts Onlineaccesswith24x7customersupportEPRMDIAGNOSTICEXAMSePRMDiagnosticExamsaremockexamsdesignedinaccordancewithPRMIA’sexamstructureandfeature:TM SimulationoftheactualPRMExam State-of-the-artlearningenvironment Timedtestsinexamformat Personalizedresultsforself-assessment @.
TheProfessionalRiskManagers’InternationalAssociation··support@
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||™THEPROFESSIONALRISKMANAGER(PRM)CERTIFICATIONPROGRAMMEPRMSelfStudyGuide–ExamIII(THREEOFFIVE)RISKMANAGEMENTPRACTICES·MARKETRISKCREDITRISK·OPERATIONALRISK
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||[]ECRADLETOTHEPINNACLEOFYOURCAREERPREE·mFROMTHee·ahAHigherStandardforRiskProfessionalssanon-profit,member-ledassociationofprofessionals,theProfessionalRiskManagers’InternationalAssociation(PRMIA). CONNECTIONTOALOCALCHAPTERNETWORKOF54,000MEMBERSINOVER180COUNTRIES–Over150meetingseachyearareofferedthroughmorethan65localPRMIAchapters,givingmembersaccesstothebestpracticesoftheglobalriskprofessionandtoalocalnetworkofcolleagues. THEPROFESSIONALRISKMANAGER(PRM)CERTIFICATION–Endorsedbyleadinguniversitiesandbusinesses,thePRMcertificationistheglobalstandardforfinancialriskmanagersandisofferedin140countries. ASSOCIATEPRMCERTIFICATE–Coversthecoreconceptsofriskmanagement,allowingnon-specialiststointerpretriskmanagementinformationandreports,makecriticalassessments,andevaluatetheimplicationsandthelimitationsofsuchresults. THEPRMIAJOBSBOARD–. PRMIAEDUCATION–Offeringclassroominstructionandover500onlineprofessionaldevelopmentcourses,,@.
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||TMPRMSELF-STUDYGUIDE–EXAMIIIRiskManagementPractices,MarketRisk,CreditRisk,OperationalRiskOVERVIEWTMxamIIIofthePRMcertificationtestsacandidate’,whichaddressmarketrisk,,,thenreviewtheLearningOutcomeStatements,,becomingcomfortablewithyourknowledgeandunderstandingofeachLearningOutcomeStatement,andworkingthroughtheStudyQuestionsandtheSampleExamTMQuestions,(Diagnostics),aswellasworkingasariskofficer,,orwhohascompletedthefirstyearofauniversitydegreeinamathematical-basedqualification(physics,economics,engineering,etc),,,’s“ahigherstandardinriskcertification”-StudyGuide,,!1
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||WORDDEFINITIONSInthisguide,weusetheCommandWordsthattheCFAInstituteuses,andafewadditionalwords,,;specifically,;toillustrateandexplain,,animpression,;;;;toprovideanunderstandingof;;,account,ordescription;-study,,,orasmuchastenormore,,it’-STUDYGUIDE—EXAMIII
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||,iftheexamhas30questionsin90minutes,,decideonthebestansweryoucan(ignoringtheobviouslywrong),,makeabsolutelysurethatyouhaveananswerforeveryquestionattheendoftheexam!,(availableasstandardwithMicrosoftWindows)andoffersbothscientificandstandardfunctionalitywhichistoggledthrougha“View”-ingoutduringtheexamthattheexamvenuecalculatorisnotthesameasthatwithwhichyouarefamiliarisnotarecommendedstrategy!STUDYQUESTIONSAfewquestions,withanswers,,
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||RISKMANAGEMENTPRACTICEShepracticeofriskmanagementisevolvingatarapidpace,,,,upgradetheirmodelsandsystems,traintheirstaff,reviewtheirremunerationsystems,,, DescribetheRoleofCapitalinaFinancialInstitution DefineandDescribethedifferenttypesofcapital DemonstrateEconomicCapital DescribethedifferentapproachestocalculatingEconomicCapital DescribeRegulatoryCapital ExplaintheBaselNorms ExplaintheDerivationofRegulatoryCapital ExplainCapitalAllocation DemonstratetheRiskContributionMethodologiesforEconomicCapitalAllocation ExplainRiskAdjustedPerformanceMeasurement(RAPM) DemonstrateRiskAdjustedReturnOnCapital(RAROC)TM4PRMSELF-STUDYGUIDE—EXAMIII
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||MARKETRISKCHAPTER2introducesthetopicofmarketriskasitispracticedbybankers,(identification,assessment,monitoringandcon-trol/mitigation),: DefineMarketRisk Explaintheimportanceofmarketrisk DifferentiateMarketRiskfromotherrisks DescribetheMarketRiskManagementTasks DescribetheorganizationofMarketRiskManagement ExplainMarketRiskManagementinFundManagement ExplainMarketRiskManagementinBanking ExplainMarketRiskManagementinNon-financialfirmsThesedaysoneofthemajortasksofriskmanagersistomeasuretheriskusingvalue-at-risk(VaR): DefineValue-at-RiskVaR DiscussInternalModelsforMarketRiskCapital DemonstrateAnalyticalVaRModel ExplainMonteCarloSimulationVaRmodel DemonstrateHistoricalSimulationVaRmodel DescribeRiskFactorMapping DemonstrateMappingSpotPositions DemonstrateMappingEquityPositions DemonstrateMappingZero-CouponBonds DescribeMappingForward/FuturesPositions DemonstrateMappingComplexPositions DemonstrateMappingOptions:DeltaandDelta-GammaApproaches DescribeBacktestingofVaRmodels : DiscusstheissuesrelatedtothethreeVaRmodels DemonstrateStandardDistributionalAssumptions DemonstrateVolatilityClusteringModels DemonstrateimpactofVolatilityClusteringonVaRMARKETRISK5
|||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||| DiscussGARCHmodel DemonstrateVaRwiththeStudent’stdistribution ExplainVaRwithExtremeValueTheory DemonstrateVaRwithNormalMixtures Describetherulesfordisaggregatingrisk DemonstrateIncrementalVaR(IVaR) DemonstrateComponentVaR(CVaR) DemonstratePrincipalComponentAnalysis(PCA) ExplainVaRwithPCAThemainchallengeforriskmanagersistomodeltheempiricalcharacteristicsobservedinthemarket,,,therewillneverbeaperfectVaRmodel,: DefineStressTesting Describethehistoricalandconceptualcontextofstresstesting ExplainHistoricalScenariosApproaches DemonstrateHypotheticalScenariosApproaches DemonstrateAlgorithmicApproaches DescribeExtremeValueTheoryasaStress-TestingMethodTM6PRMSELF-STUDYGUIDE—EXAMIII
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||,includingtheuseofcollateral,: Describetheresponsibilitiesofacreditriskmanager DescribetheReviewofStrategicCreditPositions DescribeCreditLimitsandProvisions ExplainCreditExposureMeasurementIssues DemonstrateCreditRiskReporting DescribeStressandScenarioAnalysis DescribeProvisioning DescribeDocumentation DescribeCreditProtection DescribeAnnualtasksofthecreditofficerFoundationsforcreditriskmodellingarelaidinCHAPTER7,whichexplainsthethreebasiccomponentsofacreditloss:theexposure,,whichcanbedefinedasrandomprocesses,: DefineDefaultRisk DefineExposure,DefaultandRecoveryProcesses ExplaintheCreditLossDistribution ExplainExpectedandUnexpectedLoss DescribeRecoveryRates ,assessmentoftheexposureamountcanpresentchallengesforothercreditsensitiveinstrumentssuchasderivatives,: DefinePre-settlementRisk DefineSettlementRisk DemonstrateExposureProfilesofStandardDebtObligations DemonstrateExposureProfilesofDerivatives ExplainMitigationofExposuresCREDITRISK7
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||,: DefineandDiscussDefaultProbabilitiesandTermStructuresofDefaultRates DefineCreditRatings DemonstrateMeasurementofRatingAccuracy DescribetheMethodologyofCreditRatingfollowedbyRatingAgencies DemonstrateTransitionMatrices,DefaultProbabilitiesandCreditMigrationasdonebyRatingAgencies ExplainCreditScoring DiscusstheEstimationoftheProbabilityofDefault DemonstrateMarket-ImpliedDefaultProbabilities ExplainCreditRatingandCreditSpreadsCHAPTER10tacklesoneofthemostcrucialissuesforcreditriskmodelling:-mentofcreditrisk,,includingthecreditmigrationapproach,thecontingentclaimorstructuralapproach,: DefineDefault DescribenewapproachestoCreditRiskModelling ExplainCreditVaR DefineCreditMigration DescribetheCreditMetricsFramework DemonstrateCreditVaRforasingleBond/Loan DemonstratetheEstimationofDefaultandRatingChangesCorrelations DescribetheCreditVaRapproachofaBond/LoanPortfolio ExplaintheConditionalTransitionProbabilities–CreditPortfolioViewModel Explaintheideaofcontingentclaimapproachincreditriskmeasurement DemonstrateStructuralModelofDefaultRisk:Merton’s(1974)Model DemonstrateEstimationofCreditRiskasafunctionofEquityValue DemonstratetheKMVapproach DemonstratetheActuarialApproachTM8PRMSELF-STUDYGUIDE—EXAMIII
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||: ExplainthecalculationofEconomicCreditCapitalusingCreditPortfolioModels DemonstrateMinimumCreditCapitalRequirementsunderBaselI ListtheWeaknessesoftheBaselIAccordforCreditRisk ExplaintheLatestproposalforMinimumCreditCapitalrequirements DescribetheStandardisedApproachinBaselII DescribetheInternalRatingsBasedApproach(IRB)forCorporate,BankandSovereignExposures DescribetheInternalRatingsBasedApproach(IRB)forRetailExposures DescribetheInternalRatingsBasedApproach(IRB)forSMEExposures DescribetheInternalRatingsBasedApproach(IRB)forSpecialisedLendingandEquityExposures ListthenewcomponentsofPillarIIforcreditrisk ExplainCreditModelEstimationandValidationinBaselII DescribeSecuritisationinBaselII DescribetheapplicationofcreditriskcontributionmethodologiesforEconomicCreditCapitalAllocation DemonstratetheShortcomingsofVaRforEconomicCreditCapitalandCoherentRiskMeasuresCREDITRISK9
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||,itexplainshowitmaybeidentified,: ListtheemergingOperationalRisksinBanks Discussmaintypesoflossesthatoccurredinpractice DefineOperationalRisk DescribetheOperationalRiskAdvancedMeasurementApproach(AMA)Framework Listtheobjectivesofanoperationalriskmanagementfunction Describethescopeofanoperationalriskmanagementfunction DescribetheKeycomponentsofOperationalRisk DescribetheSupervisoryGuidanceonOperationalRisk ExplaintheRiskCatalogue ExplaintheOperationalRiskAssessmentProcess : ExplaintherelevanceofOperationalRiskManagement(ORM) Describehowtodevelopandapplyoperationalriskmodels DescribethevariousORMtools DescribetheTop-downmodels DescribetheBottom-upmodels DescribetheKeyAttributesoftheORMFramework DescribetheIntegratedEconomicCapitalModel StatetheobjectivesofanORMprogramme DemonstrateRiskTransfer DiscusstheITOutsourcingcasestudyTM10PRMSELF-STUDYGUIDE—EXAMIII
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||,includingdiscussionoflossmodels,standardfunctionalforms,bothanalyticalandsimulationmethods,-at-RiskLearningOutcomeStatementThecandidateshouldbeableto: ExplaintheLossModelApproach ExplaintheFrequencyDistribution ExplaintheSeverityDistribution DemonstratetheInternalMeasurementApproach ExplaintheLossDistributionApproach DemonstrateAggregatingOperationalRiskCapital(ORC)OPERATIONALRISK11
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||STUDYQUESTIONSMARKETRISKDurationandConvexityQ:Whendoesthedurationofabondequalitsmaturity?Durationbeingtheweightedaverageofthematurityof(discounted)cashflows,durationandmaturityequatewhenthereisonlyafinalcashflowtobereceivedatmaturity(inotherwords,forasinglecashflow,orazero-couponbond).CashFlowMapping,PVBPQ:Whathappenstothevarianceofabondportfoliowhencash-flowmapped?andInterestRateSensitivityTheaimofsuchprocedureistoaggregatetheconstituentsofaportfoliointoasetofcashflowswithdifferentmaturities,,:
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||CalculationofVaRforQ:UnderthestandardparametricVaRmethodology,whichofthefollowingLinearPortfoliosassumptionsistrue?a)Returnsfollowalognormaldistributionb)Logreturnsfollowanormaldistributionc)MeanlogreturniszerofordailyVaRd)AlloftheaboveThevaluesofthelognormaldistributionareallpositive,)wouldmeanthatreturnsbealwayspositive,b)).HistoricalCalculationofVaR,Q:WhenisaMonteCarloapproachmostadvantageousforcomputingVaRMonteCarloa)Involatilemarketsb)Whenthemarketsexpectedbehaviourisnon-normallydistributedc)Whenquickcalculationsarerequestedd)WhenregulatorsaregettingnervousaboutVaRcalculationsMonteCarloapproachesprovideagoodflexibilityinsettingthedistributionsofreturns,:b).CovarianceMatrixConstructionQ:ForEWMA(ExponentiallyWeightedMovingAverage),%(%),theeffectivenumberofdatapointsusedtoestimatethecovariancematrixis:a)74b)150c)100d)250xThedecayfactorcompoundsbyday,hencewehave:=,xLog()=Log().Hencex=,a).Weshallnotethat250appearedasthemostplausibleanswer,:Whatshouldhappenifasuccessfultraderconsistentlyusesbetween80%and95%ofhistradinglimit?Thetraderhasnotexceededhistradinglimits,sohehasnottransgressed,howeveronewouldexpecttoseehisriskriseandfallwithmarketopportu-nities,andifthemarkethadanunexpectedmove,–MARKETRISK13
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||traderremindedoftheneednottoexceedlimits,
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||AlternativeRiskMeasuresQ:WhichofthefollowingaretypicalfunctionsofthemarketriskandAdvancedVaRmanagementdepartment?I)IdentificationII)AssessmentIII)MonitoringIV)Control/MitigationV)CollateralDocumentationa)I,II,IIIandIVb)I,IIandIIIonlyc)Vonlyd)IonlyI,II,,,:Whyhasthedevelopmentofderivativesnecessitatedcreditriskregulations,whentheseinstrumentsaredesignedtodealwithmarketrisk?Derivatives,beingoff-balancesheet,,theyofferawidepotentialforleverage,andinvolveveryvolatilecreditriskexposuresbetweenmarketparticipants:,foralltheirmerits,,besidestheirusefulnessintransferringrisk,theycreatedanincreaseincreditriskinthesystem,:Whatarethemainlimitationsofstandarddeviationasanindicatorofcreditrisk?Thedistributionofcreditrisklossesisskewed(asymmetric).Hencethestandarddeviationcombinesinformationrelatedtotheright-handsideofthecurve(upside),,–MARKETANDCREDITRISK15
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||Exposure,LossGivenDefaultQ:HowisthelossgivendefaultincorporatedintheCreditMetrics(LGD)andExposureTechnicalDocument?a)Thedocumentdoesnotconsideritb)Byaparameterizeddistributionc)Byalookuptabled)ByaconstantAlthoughthedocumentdoesnotmentionthetermoflossgivendefault,thisconceptishandledinchapter7(-80)‘highlyuncertain’,butcanbeassessedthroughbetadistributions(),withdifferentparametersfordifferentseniorityclasses:b).RatingAgenciesandQ:WhatarethemainlimitationsofanassessmentexclusivelybasedonTheirGradesaccountingfigures?,however,thefollowingreasonscanbealleged: accountingfigures,bynature,arebasedonthepast,whilearatingisaimedatinformingaboutfuturepossibleevents thepossibilityofafirmtoaccesscashthroughcapitalmarketscanchangedaily accountingfiguresmustbeusedwithjudgementwheneverpossibleSettlementRiskandQ:HerstattRiskrelatesto:NettingSystemsa)ThemarketriskofanFXcontractb)TheGermanMarkdebacleof1978c)ThesettlementriskofanFXcontractd)NoneoftheaboveHerstattBank,in1974,,thecandi-dateneedstounderstandwhatisHerstattrisk,).MarginalandCumulativeQ:Thedefaultratesonaportfoliohavebeenestimatedat2%forthecomingDefaultRiskyearand4%-yearobligations?Thecumulativedefaultrateis()*()=,94%-STUDYGUIDE—EXAMIII
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||TransitionMatrixQ:Givenaone-yearprobabilityofdefaultof20%,whatwouldbethecumulativeprobabilityofdefaultforthebondforthethreeyears?a)%b)%c)%d)NoneoftheaboveTheprobabilityofnon-defaultis80%,**=%,%:b)JointTransitionMatricesQ:,
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||RecoveryRateDistributionsQ:Thedistributionofrecoveryratesischaracterisedby:a)Fairlyconsistentmean,lowstandarddeviationb)Fairlyuncertainmean,highstandarddeviationc)Fairlyconsistentmean,lowstandarddeviationd)Fairlyuncertainmean,highstandarddeviationThemeanisbetween0%and100%(overlongperiods,50%isaboutright).Asforthestandarddeviation,uncertaintyreignsevenmore:d).ImpliedDefaultProbabilityQ:,iftheexpectedrecoveryrateis50%andrisk-freeinterestrateis5%?p=probabilityofdefaultr=risk-freerates=spreadTheexpectedvalueofthecashflowsfromtheriskybondis:100*((1-p)+p/2).Thisdiscountedvalue,attherateof1+r+s,*(1+p/2)/(1+r+s)=100/(1+r).Hencep=%.MertonandKMVModelsQ:TheMerton(1974)modelimpliesthatapositioninacredit-sensitivebondisequivalentto:a)Alongpositioninthefirm’sequityandashortpositioninarisk-freebondb)Alongputandalongcallpositiononthefirm’sassetsc)Alongpositioninacredit-risk-freebondandashortputonthefirm’sassetsd)Anup-and-incallonacredit-risk-freebondandashortcallonthefirm’,thebondholderisleftwithabadloss,): ashortpositiononarisk-freebondmeansaborrowing;thisisnotthecaseofalongbondposition:a)falls suchapositionasinb)wouldmaketheputveryvaluableincaseofissuers’default:b)falls ifthefirm’s(net)assetsareworthnothing,ashortputrepresentsaloss(aswithariskybond) anup-and-incall(besidesthefactthatthisexoticwasunknownin1974)givestheholder,afterthebondhasgonehigherthanacertainlevel,therighttopurchasethebond:-STUDYGUIDE—EXAMIII
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||RAROCandEconomicQ:Whichofthefollowingisanappropriatewaytomeasureoperationalrisk?CapitalAllocationa)VaRb)Notionalexposurec)Lossdatadistributiond)InsurancevaluesVaRisamarketriskmanagementtool,notionalexposuresarerelatedtocreditrisk,:c).OPERATIONALRISKTypologiesofOperationalRiskQ:Whichoneofthefollowingisariskdriverratherthanariskindicator?a)Staffturnoverb)Productcomplexityc)Systemsdowntimed)ModelerrorsIndicatorsareresponsevariables,whiledriversaredecisionvariables,sotheanswerisb).InsuranceandRe-insuranceQ:WhatisthemainhurdleseenbytheBaselCommitteeinfullyrecognisingtheuseofinsurance?Themarketforinsuranceproductsforbankingoperationsis‘stilldeveloping’,,“onthenail,”theygenerallyseektoreduceaclaimthroughlossadjustmentandlitigationandhencehaveadifferent“riskmodel”:Whichofthefollowingprinciplesdoesnothelpinanoperationalriskmeasurementprocess:a)Consistencyb)Transparencyc)Timelinessd),(contrarilytomarketrisk),–CREDITRISKANDOPERATIONALRISK19
RiskManagementProcessesQ:Whenusedtoprotectagainstcatastrophicrisks,Insurance:a)Reducestheneedforcapitalbymorethan50%b)Transformscatastrophicriskintocounterpartyriskc)Isalwaystooexpensive,asactuariespricetoacertainreturnfortheinsurancecompaniesd)EliminatesdefaultriskInsuranceisawaytotransformamoreesotericandlessmeasurableriskintosomethingmorewidelyunderstoodlikecounterpartyrisk,c).LossEventDatabasesandQ:Whatarethemainadvantagesofusingexternallossdatabases?TheirUsesa)Accesstoawiderpoolofdatab)Potentialaccesstocompetitors’datac)Accesstowell-structureddatad),thesedatabasesarenotdesignedformutualspying,,attheoutset,regulation-compliant,-impactlow-frequencydata,:a).RAROCandEconomicQ:Whatcouldbethemosteffectivehedgeofaportfolioofweatherderivatives?CapitalAllocationa)Back-to-backmatchingb)Globaldiversificationc)Catastrophebondsd)EquitysectorequityindexfuturesWeatherderivativesarenotlikelytofindperfecthedges,astheseinstrumentsarenew,-to-backmatching(buyingprotectionfromwintersportsresorts,sellingtobeachresorts,orsimilarapproaches),iftherewereenoughoftheseinstruments,-tioncanhelpcompensatetheeffectofdryweatherinaregionwithexcessiveraininanotherone:b).TM20PRMSELF-STUDYGUIDE—EXAMIII
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||PRMSelf-StudyResourcesomeetthedemandfromPRMcandidatesfordistancelearningopportunities,,inpartnershipwithTheICMACentre,UniversityofReading,offersacompletepersonallearningtrainingpackageforthePRMexamsI,II,IIIandIVfeaturingleadingfacultymemberslikeCarolAlexander,JacquesPezier,SalihNeftci,MooradChoudhry,JohnBoard,,: Studio-recordedlecturesonDVD AdobeCaptivatedemonstrationsofExcelworkbooks ,theePRMCoachisequippedwithconceptsandpractices,including: Exhaustivetheoreticalmaterialsupplementedwithcontemporarycasestudies Learnerfriendlycoursescompletewithformulae,definitions,concisesummaries,andinteractivesimulations State-of-the-artsimulatedlearningenvironment Solvedexamples,practiceexercisesandquizzes Mockexamsfromaproprietarydatabase Timedtestsinexamformat Personalizedresultsforselfassessment Glossary,FAQs,tipscenterandpocketreference Valuablereferenceextracts Onlineaccesswith24x7customersupportEPRMDIAGNOSTICEXAMSePRMDiagnosticExamsaremockexamsdesignedinaccordancewithPRMIA’sexamstructureandfeature:TM SimulationoftheactualPRMExam State-of-the-artlearningenvironment Timedtestsinexamformat Personalizedresultsforself-assessment @.
TheProfessionalRiskManagers’InternationalAssociation··support@.....
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||™THEPROFESSIONALRISKMANAGER(PRM)CERTIFICATIONPROGRAMMEPRMSelfStudyGuide–ExamIV(FOUROFFIVE)CASESTUDIES·STANDARDSOFBESTPRACTICECONDUCTANDETHICS·PRMIAGOVERNANCE
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||[]ECRADLETOTHEPINNACLEOFYOURCAREERPREE·mFROMTHee·ahAHigherStandardforRiskProfessionalssanon-profit,member-ledassociationofprofessionals,theProfessionalRiskManagers’InternationalAssociation(PRMIA). CONNECTIONTOALOCALCHAPTERNETWORKOF54,000MEMBERSINOVER180COUNTRIES–Over150meetingseachyearareofferedthroughmorethan65localPRMIAchapters,givingmembersaccesstothebestpracticesoftheglobalriskprofessionandtoalocalnetworkofcolleagues. THEPROFESSIONALRISKMANAGER(PRM)CERTIFICATION–Endorsedbyleadinguniversitiesandbusinesses,thePRMcertificationistheglobalstandardforfinancialriskmanagersandisofferedin140countries. ASSOCIATEPRMCERTIFICATE–Coversthecoreconceptsofriskmanagement,allowingnon-specialiststointerpretriskmanagementinformationandreports,makecriticalassessments,andevaluatetheimplicationsandthelimitationsofsuchresults. THEPRMIAJOBSBOARD–. PRMIAEDUCATION–Offeringclassroominstructionandover500onlineprofessionaldevelopmentcourses,,@.
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||TMPRMSELF-STUDYGUIDE–EXAMIVCaseStudies,StandardsofBestPractice,ConductandEthics,andPRMIAGovernanceOVERVIEWTMxamIVofthePRMcertificationtestsacandidate’sknowledgeandunderstandingoftheCaseStudies,EStandardsofBestPractice,,standardsfortheperformanceofthedutiesofaProfes-sionalRiskManager,andthegovernancestructureofourassociation,theProfessionalRiskManager’–
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||,!WORDDEFINITIONSInthisguide,,withafewadditionalwords,,;specifically,;toillustrateandexplain,,animpression,;;;;toprovideanunderstandingof;;,account,ordescription;-study,,,orasmuchastenormore,,it’-STUDYGUIDE–EXAMIV
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||,iftheexamhas30questionsin90minutes,,decideonthebestansweryoucan(ignoringtheobviouslywrong),,makeabsolutelysurethatyouhaveananswerforeveryquestionattheendoftheexam!,,withanswers,,
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||,“ReportoftheBoardofBankingSupervisionInquiryintotheCircumstancesoftheCollapseofBarings,18July1995.”BaringsLearningOutcomeStatementThecandidateshouldbeableto: Describehowthemassivelosseswereincurred Describewhythetruepositionwasnotnoticedearlier DescribetheroleoftheExternalAuditors DescribethesupervisiondonebytheBankofEngland DescribetheroleofTheSecuritiesAndFuturesAuthority(SFA,nowknownastheFinancialServicesAuthority,theFSA) DescribetheLessonslearntfromtheBaringsCaseStudy Discusstheeventsleadinguptothelosses,therisksincurredandthemitigationprocessesdescribedEvents MassiveLossesincurredbyNickLeeson,theGeneralManagerandHeadTraderofBaringsFinancialServices(BFS)byreasonofunauthorisedandconcealedtradingactivitieswithinBFS. ThetruepositionwasnotnoticedearlierbyreasonofaseriousfailureofcontrolsandmanagerialconfusionwithinBarings. Theexternalauditors, OperationalRisk–(HandbookVolumeIII,Chapter12). OperationalRisk–ThelackofunderstandingofBFS’stradingactivities,thelackofreconciliationtoclientrecordsofthefundingprovidedbyBaringsinLondontoBFSandthelackofverificationofthe(false)informa-tionprovidedbyBFS,thedeficienciesandinaccuraciesinlargeexposurereportingtotheBankofEngland(HandbookVolumeIII,Chapter12). OperationalRisk–ThesystemofchecksandbalancesnecessaryforthepropermanagementandcontrolofafinancialinstitutionfailedinthecaseofBaringswithregardtoBFSinamostseriousway,atanumberoflevelsandinmorethanonelocation(HandbookVolumeIII,Chapter12).PotentialMitigation Managementteamshaveadutytounderstandfullythebusinessestheymanage. Responsibilityforeachbusinessactivityhastobeclearlyestablishedandcommunicated. -STUDYGUIDE–EXAMIV
|||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||| Relevantinternalcontrols,includingindependentriskmanagement,havetobeestablishedforallbusinessactivities. TopmanagementandtheAuditCommitteehavetoensurethatsignificantweaknesses,identifiedtothembyinternalauditorotherwise,–FXOPTIONSThiscasestudyconsistsofthe“InvestigationintoforeignexchangelossesattheNationalAustraliaBank,12March2004.”NationalAustraliaBank–LearningOutcomeStatementFXOptionsThecandidateshouldbeableto: Describethesequenceofeventsandtradingactivitiesthatledtothelosses Describetheanalysisofthelossesandhowtheyoccurred,withaninitialfocusonforeigncurrencyoptiontransactionsenteredintoonorafter1October2003 Describethekeypolicies,procedures,systemsandcontrolfailureswithintheforeigncurrencyoptionstradingbusinessresponsibleforthelosses. DescribetheImpactsoncustomersandthirdparties Discusstheeventsleadinguptothelosses,therisksincurredandthemitigationprocessesdescribedEvents TheNationalAustraliaBankstaffmembersinvolvedinthecurrencyoptionstradingarereferredtoasTraders. TheTraders’activitieswerecontrarytotheNAB’. Bythe12thofJanuary2004,falsetransactionswithareportedvalueofA$185millionwereincludedinHorizon(thecurrencyoptionstradingandprocessingsystem),andon13January2004theNABmadethefirstannouncementofthelosses,thenestimatedatA$,afteradjustingforarevaluationoftheportfolio,totallossesofA$360millionwereannounced. TheTradersconcealedlossesbyenteringvarioustypesoffalsetransactionsintothetradingsystem,: Incorrectlyrecordinggenuinetransactions Enteringfalsetransactions
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||RisksIncurred OperationalRisk–Integrityofpeople(HandbookVolumeIII,Chapter12). OperationalRiskandMarketRisk–Riskandcontrolframework(HandbookVolumeIII,Chapter12andHandbookVolumeIII,Chapters2and3). Thecurrencyoptionstradingactivitylackedadequatesupervision. Riskmanagementfailed. Therewasanabsenceoffinancialcontrols. Thereweresignificantgapsinbackofficeprocedures. OperationalRisk–Governanceandculture(HandbookVolumeIII,Chapter12).PotentialMitigation Thedailyprofitandlossanalysisforlargemovementsis“notaneffectivetool”,. Theextentofproprietarytradingandhowtomonitorandcontrolit. TheinvolvementoftheChairmanandCEOintheriskinfrastructureandregularreportingtothemtomonitorthetradingbusiness. Thatalltransactionsshouldbecheckedforreasonablenessofmarketpriceandeconomicrationale. Properlimitsneedtobeinplace. -STUDYGUIDE–EXAMIV
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||BANKGESELLSCHAFTBERLINThiscasestudyfocusesonthelossesincurredatBankgesellschaftBerlin,oneofGermany’: DescribetheTimelineofEvents Describehowproperty-basedfundscarriedunforeseenanduncoveredrisks Describethelessonslearnt Discusstheeventsleadinguptothelosses,therisksincurredandthemitigationprocessesdescribedEvents ’slandmarkregenerationprojects. ThepropertybubbleburstsinBerlinandsurroundingregionsleadingtomassivelossesandliabilitiesinthebank’sproperty-linkedportfolios. Earlyinsummer2001,theBerlinsenatewasinformedthatBankgesellschaftBerlin,oneofGermany’s10largestbanks, CreditRisk–Loanstopropertydevelopers(HandbookVolumeIII,Chapter6). OperationalRisk–Management(HandbookVolumeIII,Chapter12).PotentialMitigation Investmentguaranteescanproveadisastrouslyexpensivewaytobuildbusinessvolumes:thedownsideeconomicrisksmustbeassessed,trackedandmanaged. Strictloanapprovalprocedures,andbest-practiceapproachestotrackingcreditriskconcentrationanddeteriorationarecriticaltosoundbankriskmanagement. Supervisoryboards,likeboardsofdirectorsintheUSandUK,mustensurethattheyarewelleducatedandinformedabouttheeconomicriskfactorsunderlyingkeybusinessactivities. Strictloanapprovalprocedures,andbest-practiceapproachestotrackingcreditriskconcentrationanddeteriorationarecriticaltosoundbankriskmanagement. Politiciansandbankriskmanagementdon’tmixwell,alessonthatcouldhavebeenlearnedfromParis’
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||RIGGSBANKThiscasestudyfocusesonhowRiggsBankmadelossesbecauseitdisregardeditsanti-moneylaundering(AML): DescribethefindingsregardingAML Understandwhichregulationswereinvolved DescribeRiggs’AMLDeficienciesandRegulators’InadequateOversight DescribetheRecommendations Discusstheeventsleadinguptothelosses,therisksincurredandthemitigationprocessesdescribedEvents Sinceatleast1997,Riggshasdisregardeditsanti-moneylaundering(AML)obligations. MaintainedadysfunctionalAMLprogramdespitefrequentwarningsfromOCCregulators. Andallowed,orattimes, OperationalRisk–Theanti-moneylaunderingprogramatRiggsBankwasalmostcompletelydysfunctional(HandbookVolumeIII,Chapter12).PotentialMitigation Strengthenanti-moneylaunderingenforcementprocesses. Carryoutannualanti-moneylaunderingassessments. Developpolicieswhenofferingemploymenttothosepreviouslyemployedbyregulatorsandsupervisors. Developfacilitiesfordisclosureofinformationbetweenbanks. -STUDYGUIDE–EXAMIV
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||CONTINENTALILLINOIS/PENNSQUAREThiscasestudyfocusesonhowinMay1984,ContinentalIllinois,Chicago’slargestbankandoneofthetoptenbanksintheUS, DescribetheTimelineofEvents Understandportfoliorisk Understandreputationalrisk Describethelessonslearnt Discusstheeventsleadinguptothelosses,therisksincurredandthemitigationprocessesdescribedEvents $33billionassetbankhadcompoundeditsmistakesbylendinglargeamountstolesser-developedcountriespriortotheAugust1982startofthemajorLDCcrisisofthe1980s. Withinvestorsandcreditorsspookedbyrumorsthatthebankmightfailorbetakenover,Continentalwasquicklyshutoutofitsusualdomesticandinternationalwholesalefundingmarkets. OnMay9,1984, PortfolioRisk–Excessivedependencyononesector(HandbookVolumeIII,Chapter10). OperationalRisk–Asharpdropinconfidencecanleadcounterpartiesinthewholesalemarketstosuddenlywithdrawfundingfromadamagedbank,spinningtheinstitutionintoafundingliquiditycrisis(HandbookVolumeIII,Chapter12).PotentialMitigation It’. Decentralizedlendingdecisionsrequirecontrolsandriskmonitoringatthecenterofthebank. Deterioratingcreditportfolios,leadingtomarketrumorandthewithdrawalofcompetitivelypricedfunding,cansendevenlargeinstitutionscareeningdowntheliquiditydeathspiral.
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||: DescribetheTimelineofEvents Describethelessonslearnt Discusstheeventsleadinguptothelosses,therisksincurredandthemitigationprocessesdescribedEvents Thebankuseditsfreedomtocreateamassiveportfolioofpoorqualityassetsineverysectorfrompublishingthroughtofilmandfinance,whileunderwritingordirectlyinvestinginastringofhugelyexpensiverealestateanddevelopmentprojectsthatneverpaidtheirway. Poorinternalcontrolsleftthebankopentofraudfromwithinandwithout,whiledeficienciesinfinancialandriskreportingledtoagrossunderestimationofthebank’sdangerousconditionasEurope’seconomicboomranoutofsteamintheearly1990’ CreditRisk–Management(HandbookVolumeIII,Chapter6). CreditRisk–Exposure(HandbookVolumeIII,Chapter8). OperationalRisk–Management(HandbookVolumeIII,Chapter12).PotentialMitigation Independentandtimelyriskreportingiscriticalduringperiodsofexpansionandeconomicboom. Animperiousmanagementstyledoesnotmeanthatthingsareundercontrol. Governmentguaranteescantakeawayanymarketconstraintsonhowmuchmoneyabankcangamble. -STUDYGUIDE–EXAMIV
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||USS&LCRISISThiscasestudyfocusesontheUSSavingsandLoanCrisisthatoccurredinthe1980’sand1990’&LCrisisLearningOutcomeStatementThecandidateshouldbeableto: DescribetheTimelineofEvents Describethelessonslearnt Discusstheeventsleadinguptothelosses,therisksincurredandthemitigationprocessesdescribedEvents Between1986and1995,theunderwritingoftheUSSavingsandLoanindustrybythefinancialindustryandtheUStaxpayercostanextraordinary$153billion. Thelossesweretheresultofunmanagedasset/liabilitygapsthatledtointerestrateexposures,speculativeinvestmentsinjunkbondsandserviceindustries,fraud,andespecially, MarketRisk–InterestRateRisks(HandbookVolumeIII,Chapter2). OperationalRisk–Fraud(HandbookVolumeIII,Chapter12).PotentialMitigation Regulatorycapitalandaccountingnumbersarenotagoodguidetorisk-adjustedprofitabilityinthebankingindustry. It’seasyforwoundedinstitutionstomoveoutofthefryingpanandintothefirebytakingcashup-frontforassuminglong-termorunreportedrisks. Poorlycontrolledlendinginstitutionscaneasily‘recycle’poorloans(bygrantingmorecredit)andfabricatefeeincome(bychurningtransactions)todisguisetheirtruelevelofriskandreturn.
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||LTCMThiscasestudyfocusesonthecollapseofhedgefund,: DescribetheeventsthatledtothecollapseofLTCM Describethelessonslearnt DescribehowUBSmadealossduetoLTCM Discusstheeventsleadinguptothelosses,therisksincurredandthemitigationprocessesdescribedEvents %ofthevalueofanytop-gradecollateral,andwiththatcashtobuymoresecuritiesandpostthemascollateralforfurtherborrowing:intheoryitcouldleverageitselftoinfinity. MostofLTCM’sbetshadbeenvariationsonthesametheme,’scounterparties,markingtheirLTCMexposuretomarketatleastonceaday, MarketRisk–‘ourcounterpartyandthemarketitwasoperatingin,wereperformingwithinmanageablelimits’(HandbookVolumeIII,Chapters2and5).PotentialMitigation Modelrisk Unexpectedcorrelationorthebreakdownofhistoricalcorrelations Theneedforstress-testing Thevalueofdisclosureandtransparency Thedangerofover-generousextensionoftradingcredit ThewoesofinvestinginstarqualityandinvestingtoolittleingametheoryTM12PRMSELF-STUDYGUIDE–EXAMIV
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||BANKERSTRUSTThiscasestudyfocusesonthelossesandlossofreputationatBankersTrust(BT): DescribetheTimelineofEvents Describethelessonslearnt Discusstheeventsleadinguptothelosses,therisksincurredandthemitigationprocessesdescribedEvents BT’,costingthecompanymillionsofdollarsinsettlementandpossiblymuchmoreindamagetoitsreputation. TherootcauseappearstohavebeenthatBT’sclientsfeltthatBThadunfairlyexploitedtheircomparativelackofsophisticationinhandlingthesesophisticatedderivativeproducts. ,BankersTrustdidn’, OperationalRisk–Salespractices(HandbookVolumeIII,Chapter12).PotentialMitigation “hardside”ofriskmanagement(includingpolicies,limitsandsystems)andthesoftside(includingpeople,cultureandincentives). Reputationriskmanagementsuggeststhatinatimeofcrisis,managementshouldfocusonintegrityandopennessindealingwithcustomercomplaintsandpublicperception. ,especiallyifincentivesandoversightarenotalignedproperly. ,too!Intherushtocreateprofitsforshare-holders,
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||ORANGECOUNTYThiscasestudyfocusesonthebankruptcyofOrangeCounty,USinDecember1994aftersufferinglossesof$: DescribetheTimelineofEvents Describethelessonslearnt Discusstheeventsleadinguptothelosses,therisksincurredandthemitigationprocessesdescribedEvents RobertCitron,thetreasurerofOrangeCountywhocontrolledthe$’-terminterestratesremainingrelativelylowwhencomparedwithmedium-terminterestrates. ButfromFebuary1994,theFederalReserveBankbegantoraiseUSinterestratescausingmanysecuritiesinOrangeCounty’sinvestmentpooltofallinvalue. OnDecember6,1994OrangeCountydeclaredbankruptcyaftersufferinglossesofarounf$ MarketRisk–InterestRateRisks(HandbookVolumeIII,Chapter2).PotentialMitigation Bewaretheunconstrainedstarperformer,’sexcessreward,there’srisk–thoughitmighttaketimetosurface. Iftheorganisationalstructure,planningandriskoversightmechanismsofaninstitutionarefractured,itiseasyforpowerfulindividualstohideriskinthegaps. Borrowingshortandinvestinglongmeansliquidityrisk,aseverybankknows. Risk-averseinvestorsmusttieinvestmentobjectivestoinvestmentactionsbymeansofastrictframeworkofinvestmentpolicies,guidelines,riskreportingandindependentandexpertoversight. Riskreportingshouldbecomplete,-STUDYGUIDE–EXAMIV
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||DAIWAThiscasestudyfocusesonthelossesatDaiwaBank,$: DescribetheTimelineofEvents Describethelessonslearnt Discusstheeventsleadinguptothelosses,therisksincurredandthemitigationprocessesdescribedEvents ToshihideIguchi,theexecutivevicepresidentofDaiwa’sNewYorkbranchhadtradedawaythebank’smoneyover11years,whileusinghispositionastheheadofthebranch’ssecuritiescustodydepartmenttocoverupthelossbysellingoffsecuritiesownedbyDaiwaandit’scustomers. Hehadlostaround$ OperationalRisk–Managementfailureofoversight,attemptedcover-ups,andthebreakdownofriskmanagementintheNewYorkbranch(HandbookVolumeIII,Chapter12).PotentialMitigation ’salessonthat’snowbeenlargelylearnedintermsofsegregatingtradersfromthebackoffice–butithasmuchwiderapplications. Structuralproblemsinriskmanagementdon’,butchosetobelievethatlocalmanagementhadlearneditslesson. ,butinsteadwhenherealisedthatthesituationmightotherwisecarryonindefinitely. Yearsafteranevent,
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||: DescribetheTimelineofEvents Describethelessonslearnt Discusstheeventsleadinguptothelosses,therisksincurredandthemitigationprocessesdescribedEvents CalifornianutilitiessufferedformorethanayearasamassivegaphadopenedupbetweentheratesthatCalifornianutilitieswereallowedtochargeconsumers,andthepricetheyhadtopayforsuppliesinthewholesaleelectricitymarket. OnApril6,2001,PacificGasandElectric,oneofthelargestinvestor-ownedutilitycompaniesintheUS, MarketRisk–PriceDifferentialintheelectricitymarket(HandbookVolumeIII,Chapter2).PotentialMitigation Ifthestructureofanindustryormarketriskchanges,predictionsof“likely”or“unlikely”marketextremescanbefarfromthemark. It’softentheinteractionbetweenrisks–market,credit,liquidity,regulatory–thatturnsasurvivableincidentintoacrisis. Inacompetititivemarket,playersbehaveselfishlyatcriticalmoments;profitandself-preservationaretheonlyrealmotivators. Don’trelyonregulatoryactionasaformofworst-casemarketriskmanagement,asgapscanopenupbetweenthemotivationsandpowersofkeyregulatorsandregulators’actionsmaybetoolittle,toolate. It’,-STUDYGUIDE–EXAMIV
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||METALLGESELLSCHAFTThiscasestudyfocusesonthelossesofapproximately$"EnergyGroup"ofMetallgesellschaftAGinDecember,: Describethetradingstrategiesemployedbytheconglomerate Describehowpropersupervisioncouldhaveaverteddisaster Describehowsimilarfinancialcrisesmaybeavoidedinthefuture Discusstheeventsleadinguptothelosses,therisksincurredandthemitigationprocessesdescribedEvents Metallgesellschaftrevealedpubliclythatits“EnergyGroup”wasresponsibleforlossesofapproximately$. MarketRisk–Alackofnecessaryfundsneededtomaintaintheirposition(HandbookVolumeIII,Chapter2).PotentialMitigation ,buttheblatantdisregardfortheseprinciplescostMGamere$. MG'
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||: DescribetheTimelineofEvents Describethelessonslearnt Discusstheeventsleadinguptothelosses,therisksincurredandthemitigationprocessesdescribedEvents ,WorldComspentalmost$60billionintheacquisitionofmanyofthesecompaniesandaccumulated$41billionindebt. MergersandAcquisitions,especiallylargeones,, OperationalRisk-Failedcorporategovernance,accountingabuses,andoutrightgreed(HandbookVolumeIII,Chapter12).PotentialMitigation Whenwellconceivedandexecutedproperly,
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||STANDARDSOFBESTPRACTICE,CONDUCTANDETHICS,: DescribetheTwentyFourRecommendationsmadebytheStudyGroupObjectivesMany,bothinsideandoutsideofthefinancialindustry,,,anOverviewofDerivativesActivity,andthreeAppendices:,fortheirpart,-userofderivativescover: TheRoleofSeniorManagementMeasuringCreditExposure MarkingtoMarketAggregatingCreditExposures MarketValuationMethodsMasterAgreements IdentifyingRevenueSourcesCreditEnhancement MeasuringMarketRiskPromotingEnforceability StressSimulationsProfessionalExpertise InvestingandFundingForecastsSystems IndependentMarketRiskManagementAuthority PracticesbyEnd-UsersAccountingPractices IndependentCreditRiskManagementDisclosuresInaddition,therearefourrecommendationsforlegislators,regulators,andsupervisors: RecognizingNetting LegalandRegulatoryUncertainties TaxTreatment AccountingStandardsGROUPOFTHIRTYBESTPRACTICES19
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||PRMIAGOVERNANCEPRINCIPLESAsanindependentassociationofprofessionalriskmanagersfromdiverseindustriesinmorethan150countries,PRMIAprovidesthepremiermeetingplaceforfinancialandnon-financialcorporations,: ListtheSevenPrinciplesofCorporateGovernance DescribetheapplicationsofthePrinciplesObjectivesThesevenprincipleshavebeengleanedfrominternationalsources,non-commercialandcommercial,andfromvariousdisciplines,-culturalnormsthatprovideBoards,,theyaredesignedtoaidcorporationsinthepursuitofmaximizingtherisk-adjustedreturnoncapitalandintheirtransformationofuncertainty,whichisunmanageableandunmeasurable,torisk,(seeSourceDocuments): PrincipleOne:SufficiencyofKeyCompetencies PrincipleTwo:SufficiencyofResourcesandProcess PrincipleThree:IndependenceofKeyParties PrincipleFour:ClearAccountability PrincipleFive:OngoingEducationandDiscernment PrincipleSix:DisclosureandTransparency PrincipleSeven:ExternalValidationTheseprinciplesareappliedinthefollowingareas:BoardandAuditCommittees,,theRiskManagementInfrastructure,-STUDYGUIDE—EXAMIV
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||PRMIASTANDARDSOFBESTPRACTICE,CONDUCTANDETHICSItisthedutyofeveryPRMIAmembertoknowandabidebystandardsofconductthatreflectpositivelyonourprofession,instillconfidencefromourcolleaguesandemployersandthatareconsistentwithlocalrules,,ConductandEthicsThecandidateshouldbeableto: DescribethePurposeofProfessionalStandards DescribetheGuidanceonBestPractices DescribetheGuidanceonProfessionalConduct DescribetheGuidanceonEthicalBehavior . ,. BasicKnowledge RulesandRegulations GenerallyAcceptedRiskPractices AdvancesinRiskManagement HonestyandIntegrity Diligence IndependenceGuidanceonProfessionalConductProfessionalconductbyariskmanagerisconsistentwithaminimumsetofguidelinesdescribedbelow,forwhicheachPRMIAmembershouldbeexpectedtobeaccountable. RuSupervisionofOtherslesandRegulations CDeparturefromAcceptedPracticeslarityandAccuracy SuConflictsofInterestitability PConfidentialityresentationofResults DRespectLawsandRegulationsisclosureofLimits HRespectforLocalCustomsighLevelofProfessionalismGuidanceonConflictResolutionSTANDARDSOFBESTPRACTICE,CONDUCTANDETHICS21
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||GuidanceonEthicalBehaviorEthicalconductbyariskmanagerisconsistentwithaminimumsetofguidelinesdescribedbelow,forwhicheachPRMIAmembershouldbeexpectedtobeaccountable. PersonalBehavior Responsibility JudgmentandIndependence UseofRiskServices RespectLawsandRegulations : DescribeArticle1:Name,CorporateOfficesAndOfficialLanguage DescribeArticle2:MissionStatementAndPurpose DescribeArticle3:Membership DescribeArticle4:MeetingsOfMembersAndRegionalDirectors DescribeArticle5:BoardOfDirectors DescribeArticle6:OfficersAndDuties DescribeArticle7:Committees DescribeArticle8:RegionalChapters DescribeArticle9:Finances DescribeArticle10:Indemnification DescribeArticle11:GeneralProvisions DescribeArticle12:AmendmentsTM22PRMSELF-STUDYGUIDE—EXAMIV
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||STUDYQUESTIONSBaringsQ:WhichpositionwouldhavepartiallyhedgedNickLeeson'sprimaryoptionpositionatBarings?a)Longfuturesb)ShortStranglec)LongStrangled),asmalllossifnot(Vshape,butwithaflatbottom).Totalreturnswaps,whicharecreditderivatives,apartfromthefactthattheydidnotexistatthistime,:c).MetallgesellschaftQ:WhatcausedthelossesforMetallgesellschaft?a)Atthefinalmaturitydatethepriceinthefutureswaswellbelowthemarketpriceb)Toholdtheposition,theyassumedaconstantinterestratetoinvesttheproceedsc)Atthefinalmaturitydatethepriceinthefutureswaswellabovethemarketpriced)Toholdtheposition,)andb),whilethecoveringoftheunrealisedlossesduringtheoperationwaswhatmadetheparentcompanytounwindthepositions,judgedtoshowtoodeeplosses:d).LongTermCapitalManagementQ:LTCM’sbalancesheetasofAugust31,1998showedthefollowing(USD):a)100billioninassets,)125billioninassets,)400billioninassets,)125billioninassets,)wouldprobablyhavemeantliquidation,thisisreallyaquestionofknowingthedegreetowhichLTCMleveragedtheirbalancesheet,whichwasapproximately60:1:b).STUDYQUESTIONS23
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||Groupof30ReportQ:AccordingtotheG-30,derivativecreditexposureshouldbemeasuredby:a)CurrentExposureb)PotentialExposurec)a)plusb)d)a)plusb)minusPostedCollateralThisisprinciple10,,:d).PRMIABylawsandQ:WhichofthefollowingisNOTpartofPRMIA’sguidanceonBestPractices?CodeofConducta)Onlystandardmethodsofassessingriskshouldbeusedb)PRMIAmembersmustpossess,beunderthesupervisionofsomeonewhopossesses,orinformtheirsupervisorofthelackofrequiredskillsand/)PRMIAmembersmustnotintentionallydeceiveothersd),PRMIAdoesnotprescribeortho-doxy,andencouragesmemberstousesoundpracticesratherthanuse,letaloneblindlyuse,standardmethods:a)..TM24PRMSELF-STUDYGUIDE—EXAMIV
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||PRMSelf-StudyResourcesomeetthedemandfromPRMcandidatesfordistancelearningopportunities,,inpartnershipwithTheICMACentre,UniversityofReading,offersacompletepersonallearningtrainingpackageforthePRMexamsI,II,IIIandIVfeaturingleadingfacultymemberslikeCarolAlexander,JacquesPezier,SalihNeftci,MooradChoudhry,JohnBoard,,: Studio-recordedlecturesonDVD AdobeCaptivatedemonstrationsofExcelworkbooks ,theePRMCoachisequippedwithconceptsandpractices,including: Exhaustivetheoreticalmaterialsupplementedwithcontemporarycasestudies Learnerfriendlycoursescompletewithformulae,definitions,concisesummaries,andinteractivesimulations State-of-the-artsimulatedlearningenvironment Solvedexamples,practiceexercisesandquizzes Mockexamsfromaproprietarydatabase Timedtestsinexamformat Personalizedresultsforselfassessment Glossary,FAQs,tipscenterandpocketreference Valuablereferenceextracts Onlineaccesswith24x7customersupportEPRMDIAGNOSTICEXAMSePRMDiagnosticExamsaremockexamsdesignedinaccordancewithPRMIA’sexamstructureandfeature:TM SimulationoftheactualPRMExam State-of-the-artlearningenvironment Timedtestsinexamformat Personalizedresultsforself-assessment @.
TheProfessionalRiskManagers’InternationalAssociation··support@
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||THEPROFESSIONALRISKMANAGER(PRM™)CERTIFICATIONPROGRAMMEPRMSelfStudyGuide–SampleQuestions(FIVEOFFIVE)
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||[]ECRADLETOTHEPINNACLEOFYOURCAREERPREE·mFROMTHee·ahAHigherStandardforRiskProfessionalssanon-profit,member-ledassociationofprofessionals,theProfessionalRiskManagers’InternationalAssociation(PRMIA). CONNECTIONTOALOCALCHAPTERNETWORKOF54,000MEMBERSINOVER180COUNTRIES–Over150meetingseachyearareofferedthroughmorethan65localPRMIAchapters,givingmembersaccesstothebestpracticesoftheglobalriskprofessionandtoalocalnetworkofcolleagues. THEPROFESSIONALRISKMANAGER(PRM)CERTIFICATION–Endorsedbyleadinguniversitiesandbusinesses,thePRMcertificationistheglobalstandardforfinancialriskmanagersandisofferedin140countries. ASSOCIATEPRMCERTIFICATE–Coversthecoreconceptsofriskmanagement,allowingnon-specialiststointerpretriskmanagementinformationandreports,makecriticalassessments,andevaluatetheimplicationsandthelimitationsofsuchresults. THEPRMIAJOBSBOARD–. PRMIAEDUCATION–Offeringclassroominstructionandover500onlineprofessionaldevelopmentcourses,,@.
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||TMPRMSELF-STUDYGUIDE–SAMPLEQUESTIONSOVERVIEWTMhePRMcertificationtestsacandidate’sknowledgeandunderstandingofthefoundationsofTfinancetheory,thefinancialinstrumentsthatprovidetoolsforthemitigationortransferofrisk,,thenreviewtheLearningOutcomeState-ments,,aswellasworkingasariskofficer,,orwhohascompletedthefirstyearofauniversitydegreeinamathematical-basedqualifi-cation(physics,economics,engineering,etc),,,’s“ahigherstandardinriskcertification”-StudyGuide,,!
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||WORDDEFINITIONSInthisguide,,withafewadditionalwords,,;specifically,;toillustrateandexplain,,animpression,;;;;toprovideanunderstandingof;;,account,ordescription;-STUDYGUIDE–SAMPLEQUESTIONS
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||(availableasstandardwithMicrosoftWindows)andoffersbothscientificandstandardfunctionalitywhichistoggledthrougha“View”-ingoutduringtheexamthattheexamvenuecalculatorisnotthesameasthatwithwhichyouarefamiliarisnotarecommendedstrategy!OVERVIEW3
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||–FINANCETHEORY,%,whiletheriskfreerateis3%.,theexpectedreturnonAis:a)%b)%c)%d)%,theexpression"changeofmeasure"means:a)Settingthedrifttozerob)Changeofvolatilityc)Both(a)and(b)d)
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||-monthLiborona1,000SwissFrancs(CHF)facevaluetwotimes:oneyearfromtodayandtwoyearsfromtoday(noprincipalpayment).Theratesaresetinarrears(paymentsattheendofayearreflecttheLiborrateatthebeginningoftheyear).Whatisthepriceofthisinstrumentifthe(zero-coupon)two-yearCHFswapcurveisa3%forallmaturities?a))CHF1000c)CHF1067d),whereonebuysaputandacallsimultaneouslyatthesamestrike,thefollowingistrue:a)Deltawillbezero,regardlessofthelevelofthespotpriceb)Gammawillbethehighestatthemoneyandapproachingmaturityc)Deltawillbenearto1atthemoneyandapproachingmaturityd):a)themarketriskofanFXcontractb)theGermanMarkdebacleof1978c)thesettlementriskofanFXcontractd),thetradeiscalled:a)Areverserepob)Aforwardsalec)Arepod)(MM)hasagreedtodelivergasat$3/$
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||$212$223$234$245$256$26Acustomerwantsatailoredsixmonthswapwithconstantvolumesbutrequestthefixedpriceforthelasttwomonthstobesetat$20/
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||EXAMII–MATHEMATICFOUNDATIONSOFRISKMEASUREMENT2x–(x)thatisatangent-lineapproximationforthefunction:ƒ(x)=eatthepointx=)–)+))+₂2xxedxʃ:₀a))))
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||:a)Isstrictlypositivedefinite,ifitexistsb)Isnonsingular,ifitexistsc)Alwaysexistsd)=ØO=.2=51{.5=02a).6785b).4277c).8291d).4281TM8PRMSELF-STUDYGUIDE–SAMPLEQUESTIONS
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||EXAMIII–,whichofthefollowingassumptionsistrue?a)Returnsfollowalognormaldistributionb)Logreturnsfollowanormaldistributionc)MeanlogreturniszerofordailyVaRd),(expressedasapercentageofcurrentyield)topricevolatilityis:a)PriceVol()=ModifiedDuration(MD)xinterestrate(Y)xYieldVol(σ)yσyb)PriceVol(σ)=MDxpYc)PriceVol(σ)=MDxσpyd)PriceVol(σ)=MDx(1+Y)(ExponentiallyWeightedMovingAverage),%(%),theeffectivenumberofdatapointsusedtoestimatethecovariancematrixis:a)74b)150c)100d)
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||%,whatistheexpectedlossonthefollowingportfolio?FacevaProbabilityofDefaultlueofthebond1,000Euros(EUR),)300EURb)900EURc)1,000EURd)
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||(1974)modelimpliesthatapositioninacredit-sensitivebondisequivalentto:a)Alongpositioninthefirm’sequityandashortpositioninarisk-freebondb)Alongputandalongcallpositiononthefirm’sassetsc)Alongpositioninacredit-risk-freebondandashortputonthefirm’sassetsd)Anup-and-incallonacredit-risk-freebondandashortcallonthefirm’-yearprobabilityofdefaultof20%,whatwouldbethecumulativeprobabilityofdefaultforthebondforthethreeyears?a)%b)%c)%d)’s,BaselCommitteeonBankingSupervision,hasdefinedOperationalriskas“Theriskoflossduetoinadequateorfailedinternalprocesses,people,andsystems,orfromexternalevents.”Thisdefinitionexcludes:a)Reputationalriskb)Strategicriskc)Legalriskd)a)andb)’s,BaselCommitteeonBankingSupervisionrecommendstheoperationalriskmanagementprocessatthecorporateandbusinessunitlevelstobevalidatedby:a)Auditb)Acommitteeoftheboardofdirectorsc)Adesignatedmemberofseniormanagementd)NoneoftheaboveEXAMIII–RISKMANAGEMENTPRACTICES11
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||EXAMIV–CASESTUDIES,PRMIASTANDARDSOFBESTPRACTICE,’sprimaryoptionpositionatBarings?a)Longfuturesb)ShortStranglec)LongStrangled)
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||’sbalancesheetasofAugust31,1998showedthefollowing:a)$100billioninassets,$)$125billioninassets,$)$400billioninassets,$)$125billioninassets,$-30,derivativecreditexposureshouldbemeasuredby:a)CurrentExposureb)PotentialExposurec)a)plusb)d)a)plusb)-30report,anISDAmasteragreementis:a)Sufficienttopreventlossfromcounterpartydefaultb)Notsubstantiallyenhancedbyanettingprovisionasbankruptcycourtswidelyrecognizenettingasabestpracticec)Enhancedwhenmultiplemasteragreementsexistbetweenthesamecounterpartiessothatthelegalriskofanoversightindocumentationisreducedd)
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||-STUDYGUIDE–SAMPLEQUESTIONS
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