PRMIA 8008 Exam With Confidence Using Practice Dumps

As part of a reverse stress test, a firm has to identify and assess the scenarios most likely to cause it to fail, or in other words using the language used by the FSA in the UK, for its current business plan to become unviable. A firm's business plan should be considered to become unviable at the point that crystallizing risks cause the market to lose confidence it it, with the consequence that counterparties and other stakeholders are unwilling to transact with it or provide capital to the firm and, where releant, that existing counterparties may seek to terminate their contracts. Recent experience suggests that this point is reached well before a firm's regulatory capital is exhausted.

Large known losses, or negative EBITDA (earnings before interest , tax, depreciation and amortization) may be indicators or contribute to the loss of confidence, but do not of themselves make the current business plan unviable. Therefore Choice 'd' is the correct answer.

Choice 'b', Choice 'c' and Choice 'a' correctly describe a bilateral close out netting as recommended by the ISDA. However Choice 'd' is not correct as it suggests individual settlement of transactions without netting which is the whole point of bilateral close out netting.

Under the contingent claims approach, a firm will default on its debt when the value of its assets fall to less than the face value of the debt. Debt holders can protect themselves against such an event by buying a put on the assets of the firm, where the strike price is equal to the value of the debt. In other words, Risky Debt + Put on the firm's assets = Risk free debt. This is because if the value of the assets is greater than the value of the debt, they will be paid in full. If the value of the assets is lower than the value of the debt, they will exercise the put and be paid in full.

Therefore the value of the put on the firm's assets with a strike equal to the value of the debt represents the cost of eliminating credit risk. Choice 'b' is the correct answer.

Note that it is improbable that a put on the firm's assets is available in real life to debt holders. However, the same effect can be synthetically achieved by using the shares of the firm as a proxy for its assets, and shorting an appropriate number of shares. Such a synthetic put will require frequent readjustments.