8008 Exam Dumps : PRM Certification - Exam III: Risk Management Frameworks, Operational Risk, Credit Risk, Counterparty Risk, Market Risk, ALM, FTP - 2015 Edition

When VaR is based on an assumption of normality with a static mean and volatility, it means anything that violates these assumptions will introduce model error. Volatility clustering implies a non-static volatility. Heavy tails imply non-normality of the shape of the distribution. Autocorrelation of squared returns implies that returns are not independent and identically distributed. Therefore all of these introduce model error. Choice 'd' is therefore the correct answer.

Bank B's exposure is measured by the price it paid for the bonds, which in this case is $7m ($10m x 70/100). Hence Choice 'c' represents the correct answer.

(Note that the question is asking for 'exposure' and not the legal claim in the event of default. The legal claim in the event of default would be the full notional of $10m. )

The initial issue price and issue size are irrelevant.

Normal mixtures address fat or heavy tails, not volatility clustering. Therefore statement I is not correct.

Statement II is not correct. Where VaR is calculated at low levels of confidence, VaR based on normal mixtures may be lower than that under a normal assumption. This is no different than for other fat tailed distributions.

Statement III is correct. In situations where multiple market scenarios can unfold with a given probability, and each scenario is normal, we can express the result with a normal mixture where the underlying normal distributions have the probabilities of the different scenarios.