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3、Economic capital protects the company against insolvency due to unexpected operational losses. In identifying the appropriate level of economic capital, a bank should focus on the part of the loss probability distribution represented by losses:

A) in excess of the loss at a given level of confidence.
 
B) between the loss at a given level of confidence and the expected loss.
 
C) below the loss at a given level of confidence.
 
D) greater than the expected loss.

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The correct answer is B

Economic capital is the difference between the loss at a given confidence level and the expected loss.

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4、Which of the following is TRUE about economic capital?

For most financial institutions, economic capital held exceeds regulatory capital.
It protects financial institutions from expected and unexpected losses.
It is the capital required to keep the banking system safe.
It is a function of the risk of the financial institutions and inversely related to performance.
A) I and IV.
 
B) I and II.
 
C) II and III.
 
D) II and IV.

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The correct answer is A

Statement II is not true. Economic capital protects financial institutions from unexpected losses; reserves protect the financial institutions from expected losses. Statement III is the function of regulatory capital.

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The correct answer is C

Operational risk economic capital is the difference between the loss at a given confidence level and the expected loss. In this case, $1,500,000 – $250,000 = $1,250,000.

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2、The primary purpose of operational risk economic capital is to:

A) protect the company against insolvency due to expected and unexpected operational losses. 
 
B) meet financial reporting requirements. 
 
C) protect the company against insolvency due to unexpected operational losses. 
 
D) meet regulatory guidelines.