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

Choice 'd' is correct because VaR is sub-additive in cases where correlation is less than one.

Specific VaR refers to the risk in the portfolio from security selection, ie the risk from holding the specific equities in the portfolio, while systematic risk refers to the market risk. Definitionally, specific risk and systematic risk are uncorrelated, ie their correlation is zero. Since their correlation is zero, combining them will produce a VaR number lower than their stand alone aggregate. Total risk includes both specific risk and systematic risk, and can be calculated taking into account the specific and systematic VaRs and their correlation.

All other answers are therefore incorrect.

Historical Simulation VaR is conceptually very straightforward: actual prices as seen during the observation period (1 year, 2 years, or other) become the 'scenarios' forming the basis of the valuation of the portfolio. For each scenario, full revaluation is performed, and a P&L data set becomes available from which the desired loss quantile can be extracted.

Historical simulation is based upon actually seen prices over a selected historical period, therefore no distributional assumptions are required. The data is what the data is, and is the distribution. Statement I is therefore not correct.

It uses full revaluation for each historical scenario, therefore statement II is correct.

Since the prices are taken from actual historical observations, a correlation matrix is not required at all. Statement III is therefore incorrect (it would be true for Monte Carlo and parametric Var).

Historical simulation VaR suffers from the limitation that if enough representative data points are no available during the historical observation period from which the scenarios are drawn, the results would be inaccurate. This is likely to be the case for new products. Therefore Statement IV is incorrect.

The actuarial or CreditRisk+ model considers default as an 'end of game' event modeled by a Poisson distribution. The annual number of defaults is a stochastic variable with a mean of μ and standard deviation equal to √μ.

The probability of n defaults is given by (μ^n e^-μ) /n!, and therefore in this case is equal to (=2^4 * exp(-2))/FACT(4)) = 0.0902.

Note that CreditRisk+ is the same methodology as the actuarial approach, and requires using the Poisson distribution.