41. Based on a 90% confidence level, how many exceptions in back testing a VaR would be expected over a 250-day trading year?

A. 10

B. 15

C. 25

D. 50

42. Which of the following statements regarding liquidity risk is CORRECT?

A. Asset liquidity risk arises when a financial institution cannot meet payment obligations

B. Flight to quality is usually reflected in a decrease in the yield spread between corporate and government issues

C. Yield spread between on-the-run and off-the-run securities mainly captures the liquidity premium, and not the market and credit risk premium

D. Funding liquidity risk can be managed by setting limits on certain markets or products and by means of diversification

43. Which of the following credit risk models in Basel II attempts to recognize diversification effects through a granularity adjustment?

A. Standardized approach based on external credit ratings provided by external credit assessment institutions

B. Standardized approach based on internal portfolio credit risk model

C. Internal Rating Based approach using internal estimate of creditworthiness, subject to regulatory standards

D. All of the above

44. According to the Basel Committee which of the options below is NOT a qualitative standard that a bank must meet before it is permitted to use the Advanced Measurement Approach (AMA) for operational risk capital:

A. Internal and/or external regulators must perform regular reviews of the operational risk management processes and measurement systems. This review must include both the activities of the business units and of the independent operational risk function

B. There must be regular reporting of operational risk exposures and loss experiences to business unit management, senior management and to the board of directors

C. The bank's internal operational risk measurement system should not be integrated into the day-to-day risk management processes of the bank but should provide a general overview of the operational risks involved in the processes and operations

D. The bank must have an independent operational risk management function that is responsible for the design and implementation of the bank's operational risk framework.

45. According to the Basel Committee which of the options below is NOT a quantitative standard that a bank must meet before it is permitted to use the Advanced Measurement Approach (AMA) for operational risk capital:

A. A bank's risk measurement system should be sufficiently 'granular' to capture the major drivers of operational risk affecting the shape of the tail of the loss estimates

B. Supervisors will require the bank to calculate its regulatory capital as the Unexpected Loss (UL), disregarding the Expected Losses (EL)

C. Internally generated operational risk measures used for regulatory capital purposes must be based on a minimum 5-year observation period of loss data. When the bank first moves to the AMA a 3-year historical data window is acceptable.

D. The tracking of internal loss data

41. Based on a 90% confidence level, how many exceptions in back testing a VaR would be expected over a 250-day trading year?

A. 10

B. 15

C. 25

D. 50

Correct answer is C

The number of exceptions = (1 ? confidence interval) * (number of days)fficeffice" />

    = (1 ?0.90) * (250) = 25.

Reference: Understanding Market, Credit, and Operational Risk, Allen, Boudoukh and Saunders, 2004.

42. Which of the following statements regarding liquidity risk is CORRECT?

A. Asset liquidity risk arises when a financial institution cannot meet payment obligations

B. Flight to quality is usually reflected in a decrease in the yield spread between corporate and government issues

C. Yield spread between on-the-run and off-the-run securities mainly captures the liquidity premium, and not the market and credit risk premium

D. Funding liquidity risk can be managed by setting limits on certain markets or products and by means of diversification

Correct answer is C

'A' is incorrect. Asset liquidity risk arises when transactions cannot be conducted at quoted market prices due to the size of the required trade relative to normal trading costs.

'B' is incorrect. Flight to quality occurs when there is a shift in demand away from low-grade securities towards high-grade securities.  The low grade market then becomes illiquid with depressed prices.  This is reflected in an increase in the yield spread between corporate and government issues.

'C' is correct. On-the-run securities are very similar in terms of market and credit risk to off-the-run securities, hence the yield spread mainly captures the liquidity premium, while the market and credit risk premiums must be immaterial.

'D' is incorrect. Asset liquidity risk can be managed by setting limits on certain markets or products and by means of diversification.  Funding liquidity risk refers to the inability to meet payment obligations when the institution runs out of cash and is unable to raise additional capital.  Funding liquidity risk can be managed by proper planning of cash flow needs

Reference: Financial Institutions Management, Saunders and Cornett, 2005.

43. Which of the following credit risk models in Basel II attempts to recognize diversification effects through a granularity adjustment?

A. Standardized approach based on external credit ratings provided by external credit assessment institutions

B. Standardized approach based on internal portfolio credit risk model

C. Internal Rating Based approach using internal estimate of creditworthiness, subject to regulatory standards

D. All of the above

Correct answer is C

The Standardized approach does not recognize diversification effects. Capital requirements under Internal Rating Based (IRB) approach are modified to reflect the overall diversification or "granularity" in a bank's loan portfolio.  The granularity adjustments construct a specific regulatory measure of diversification of a bank's portfolio. This measure is then used to increase or decrease the baseline IRD regulatory capital requirements. If the regulatory diversification measure indicates that a portfolio is well (poorly) diversified, the granularity adjustment decreases (increases) regulatory capital from the IRB baseline. Under IRB banks estimate default probabilities of counterparties using their own methods subject to regulatory standards, which are then used with modified standardized inputs that come from the standardized approach.

Reference: Measuring and Managing Credit Risk, De Servigny and Renault, 2004.

44. According to the Basel Committee which of the options below is NOT a qualitative standard that a bank must meet before it is permitted to use the Advanced Measurement Approach (AMA) for operational risk capital:

A. Internal and/or external regulators must perform regular reviews of the operational risk management processes and measurement systems. This review must include both the activities of the business units and of the independent operational risk function

B. There must be regular reporting of operational risk exposures and loss experiences to business unit management, senior management and to the board of directors

C. The bank's internal operational risk measurement system should not be integrated into the day-to-day risk management processes of the bank but should provide a general overview of the operational risks involved in the processes and operations

D. The bank must have an independent operational risk management function that is responsible for the design and implementation of the bank's operational risk framework.

Correct answer is C

'C' is not a qualitative standard. According to the Basel Committee, a "bank's internal operational risk measurement system must be closely integrated into the day-to-day risk management processes of the bank. Its output must be an integral part of the process of monitoring and controlling the bank's operational risk profile."

Reference: ffice:smarttags" />Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework, Bank for International Settlements, 2005.

45. According to the Basel Committee which of the options below is NOT a quantitative standard that a bank must meet before it is permitted to use the Advanced Measurement Approach (AMA) for operational risk capital:

A. A bank's risk measurement system should be sufficiently 'granular' to capture the major drivers of operational risk affecting the shape of the tail of the loss estimates

B. Supervisors will require the bank to calculate its regulatory capital as the Unexpected Loss (UL), disregarding the Expected Losses (EL)

C. Internally generated operational risk measures used for regulatory capital purposes must be based on a minimum 5-year observation period of loss data. When the bank first moves to the AMA a 3-year historical data window is acceptable.

D. The tracking of internal loss data

Correct answer is B

'B' is not a quantitative standard. According to the Basel Committee, "Supervisors will require the bank to calculate its regulatory capital requirement as the sum of expected loss (EL) and unexpected loss (UL), unless the bank can demonstrate that it is adequately capturing EL in its internal business practices."

Basel II: International Convergence of Capital Measurement and Capital Standards: A Revised Framework, Bank for International Settlements, 2005.

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