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4、The two variables that are modeled in probability distribution functions of operational risk are loss:

A) frequency and loss severity. 
 
B) type and loss severity.
 
C) frequency and loss cause.
 
D) frequency and loss type. 

nayizhenfeng

 The correct answer is A

The two variables that are modeled in probability distribution functions of operational risk are loss frequency and loss severity.

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5、Referring to the bottom-up models for measuring operational risk, how many of the actuarial models use a standardized distribution to estimate one or several components of operational risk? How many of the actuarial models focus on LFHS?

A) 2; 2.
 
B) 2; 1.
 
C) 1; 2.
 
D) 1; 1.

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The correct answer is B

Parametric loss distributions and Extreme Value Theory use standardized distributions and Extreme Value Theory focuses on LFHS.

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6、Which of the following characterize extreme value theory (EVT)?

Focuses on catastrophic losses that are more likely than standard distributions suggest.
Uses a different distribution to describe losses in the right tail.
Most commonly uses a lognormal distribution in the tails.
Estimates expected losses beyond an established confidence interval.
A) I and III only.
 
B) I and IV only.
 
C) I, II, and IV only.
 
D) II and III only.

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 The correct answer is C

EVT incorporates the notion that extreme losses are more likely than standard distribution would suggest. In other words, empirical distributions often have "fatter" tails than assumed distributions. EVT therefore treats the tails of assumed distributions differently than the rest of the distribution by assuming this region follows a different distribution, such as the generalized Pareto distribution (most common). Rather than estimating losses up to, say, the 99th percentile as in value-at-risk (VAR) analysis, EVT estimates the expected value of the losses beyond the 99th percentile in the "fat" tail of the distribution. This approach yields estimates of operational risk that are much larger than standard VAR approaches.

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AIM 4: List and describe ways a firm can hedge against catastrophic operational losses.

 

1、Which of the following help insurance companies to manage the moral hazard problem associated with insuring operational risks?

  I. Deductibles.
 II. Reinsurance.
III. Co-insurance.
IV. Diversification.

A) I and III only. 
 
B) II and III only. 
 
C) II and IV only. 
 
D) I, II, III, and IV. 

nayizhenfeng

The correct answer is A

Moral hazard is the notion that an insured will engage in more risky behavior than would be the case in the absence of insurance. Deductibles and co-insurance features cause the insured to participate in at least a portion of losses incurred by the firm. An insurance policy with a deductible does not cover losses below the deductible amount. A policy with a co-insurance feature does not cover losses above the co-insurance limit. Diversification and reinsurance are techniques insurance companies use to manage other risks.

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2、Parametric notes are fixed income instruments with cash flows:

A) determined by parametric distributions. 
 
B) that are triggered by internal risk events, such as fraud. 
 
C) linked to an index of underwriting losses. 
 
D) linked to an external risk event, such as an earthquake. 

nayizhenfeng

 The correct answer is D

All the bonds described above, except for one, are types of catastrophe bonds. Parametric notes link cash flows to the magnitude of an external risk event, such as hurricane severity in a particular region. Indemnified notes offer the issuing firm debt relief based on internal events, such as a large underwriting loss for an insurance company. Indexed notes provide cash flows related to the value of an independent index, such as a weather index or an insurance underwriting loss index. Bonds with cash flows determined by parametric distributions are quixotic