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

Statement I is not correct as VaR does not set an upper limit on losses. In this case, the bank expects the losses to exceed $253m 5% of the times, and the VaR number does not indicate any theoretical maximum amount of losses.Statement II is incorrect as there is a 95% (and not 5%) probability that the bank's losses will not exceed $253mStatement III is correct and describes VaR.Statement IV is incorrect, as regulatory capital is a more complex computation for which VaR is only one of the various input.Therefore Choice 'b' is the correct answer.

If the marginal probability of default of two securities A and B is P(A) and P(B), then the probability of both of them defaulting together is affected by the default correlation between them. Marginal probability of default means the probability of default of each security on a standalone basis, ie, the probability of default of one security without considering the other security.

The relationship that expresses the probability of joint default of the two is given by the following expression:

It is easy to see that in a situation where the Default Correlation of A & B = 0, ie, the defaults are independent, the combined probability of default is P(A)*P(B), exactly what we would intuitively expect. Also in the other extreme case where the default correlation is equal to 1 and P(A) = P(B) = p, ie the securities behave in an identical way, the expression resolves to just p, which is what we would expect.

From the above relationship, it is clear that the probability of joint default of A and B is the greatest when default correlation between the two is equal to 1, ie the securities behave in an identical way. Therefore Choice 'a' is the correct answer.

A situation where a firm has more liabilities than assets does not necessarily imply default, so long as the firm is able to pay its obligations when they come due. Therefore, short term debts have a greater bearing on a firm's default than longer term debt. However, this is not to say that merely having enough to pay off the short term debts (ie debts due within one year) is enough to avoid default. Over time, the long term debt will also be turning to short term debt, and it may not be possible for the firm to roll over its liabilities without lenders considering the long term debt. The KMV approach considers the entire short term debt and half of the long term debt as the critical value of assets below which default will be triggered. Therefore Choice 'c' is the correct answer.