2016-FRR Exam Dumps : Financial Risk and Regulation (FRR) Series

Back testing VaR models involves comparing the predicted losses (VaR estimates) with the actual daily profits and losses to assess the accuracy and reliability of the VaR model. This process helps in validating whether the model is effective in predicting risk and in identifying any discrepancies between predicted and actual outcomes. Therefore, the correct statement about back testing the VaR models is option B.

Bonds and loans are fundamentally different in their legal structures and treatment. Bonds are typically issued in the public markets and are subject to securities laws and regulations, while loans are generally private agreements between a borrower and a lender.

Both instruments can be used to estimate credit capital under Basel II provisions, so option C is incorrect.

The pricing drivers for bonds and loans can overlap significantly, such as interest rates and credit risk, so option B is not the core difference.

Both bonds and loans can be subject to credit counterparty regulations, making option D incorrect.

Moral hazard occurs when one party in a contractual relationship can take risks because the consequences of those risks will be borne by another party. In this scenario, the credit associate is concerned that the obligor might use the loan proceeds for purposes not sanctioned by the lender, thereby increasing the risk of default. This situation is a classic example of moral hazard, where the obligor's behavior after receiving the loan could change in a way that increases the lender's risk without the lender having control over those actions.