[ 2009 FRM ] Medium Practice Exam 2 Q21-25

21. There are 10 bonds in a credit default swap basket. The probability of default for each of the bonds is 5%. The probability of any one bond defaulting is completely independent of what happens to the other bonds in the basket. What is the probability that exactly one bond defaults?

A. 5%

B. 50%

C. 32%

D. 3%

Correct answer is D

The probability of exactly one default is:fficeffice" />

10 * (0.05)1 * (1 - 0.05)9 = 32%

One particular bond defaults and the other nine do not with probability 0.05 * 0.959, and there 10 different ways this can happen.

22. In the Basel II Standardized Approach for operational risk, the beta factor serves as a proxy for the industry-wide relationship between the operational risk loss experience for a given business line and the aggregate level of gross income for that business line. Which of the following business lines has the highest beta factor?

A. Corporate finance

B. Retail banking

C. Commercial banking

D. Asset management

Correct answer is A

A is correct as it has the highest Beta factor of 18%.

B is incorrect as it has a Beta factor of 12%.

C is incorrect as it has a Beta factor of 15%.

D is incorrect as it has a Beta factor of 12%.

23. Banks which need to qualify for the IRB approach need to fulfill certain minimum requirements. One of these is "Corporate Governance and Oversight". Under this, credit risk control is an important component. Which of the following is not an area of responsibility of credit risk control function?

A. Testing and monitoring internal grades.

B. Implementing procedures to verify that rating definitions are consistently applied across departments and geographic areas.

C. Reviewing and documenting any changes to the rating process, including the reasons for the changes.

D. Origination of various types of credit exposures.

Correct answer is D

A is incorrect as it is an area of responsibility of Credit Risk Control function.

B is incorrect as it is an area of responsibility of Credit Risk Control function.

C is incorrect as it is an area of responsibility of Credit Risk Control function.

D is correct as it is not an area of responsibility of Credit Risk Control function.

24. Under the comprehensive approach for foundation IRB, which of the following methods is used for calculating the effective loss given default (LGD*) where:

l            LGD* is the effective loss given default(considering risk mitigation measures)

l            LGD is that of the senior unsecured exposure before recognition of collateral (45%);

l            E is the current value of the exposure (i.e. cash lent or securities lent or posted);

l            E* is the exposure value after risk mitigation

l            IRB-Internal Rating Based Approach

A. LGD* = LGD x (E* / E)

B. LGD* = LGD x (E* )*(E)

C. LGD* = LGD x (E* +  E)

D. LGD* = LGD x (E* - E)

Correct answer is A

A is correct as the formula for LGD* is correct.

B is incorrect as the formula for LGD* is incorrect.

C is incorrect as the formula for LGD* is incorrect.

D is incorrect as the formula for LGD* is incorrect.

25. Which of the following cases of losses was not the result of unauthorized or rogue trading?

A. Long-Term Capital Management

B. Allied Irish Bank

C. Sumitomo

D. Daiwa 

Correct answer is A

A. LTCM was an example of strategies that were deliberately undertaken and approved but that didn't pay off. LTCM was subject to operational risks like model risk, but the trades that led to the losses were not unauthorized.

B. Allied Irish Bank involved a rogue trader making fx trades.

C. Sumitomo's rogue trading in copper killed it.

D. Daiwa had a fixed income rogue doing unauthorized trades.

Reference: Gallati, Chapter 6