Exam 2

Question #1 of 80 Question ID: 1268646
With the recent hiring of a newly created chief risk o cer (CRO) position, Baker, Ltd.,
has charged the company's rst CRO with building an enterprise risk management
(ERM) program. In helping the CRO prepare for an upcoming presentation to Baker's
board of directors, a junior risk o cer has crafted the following notes regarding the
core components of the ERM framework. Which of the following points prepared by
the junior risk o cer is most accurate?
Risk transfer requires that risks be transferred to third parties outside of the
A)
company.
Line management speci cally excludes expected losses and the cost of risk capital in
B)
pricing the company’s products.
Even with an extremely strong ERM program in place, the multiple systems
C)
implemented by the company will present di erent metrics on price and volatility.
The collective determination between the board and management of the company’s
D)
risk appetite and tolerance for loss is part of the risk analytics component.
An analyst at Bank A is looking to use a machine learning method to make predictions

on in ation levels. An analyst at Bank B is looking to use a model that will help lter
incoming email into "spam" and "not spam." Which of the following machine learning
methods is most appropriate for the analysts?
Bank A Bank B
A) Regression Clustering
B) Clustering Classi cation
C) Classi cation Regression
D) Regression Classi cation

The due diligence process for assessing investment managers should include
information on the investment background and reputation of the managers and past
performance. In addition, there should be an assessment of the fund's investment
process, risk controls, operations, and business model. Which of the following
statements regarding due diligence on potential fund investments is most accurate?
A) The due diligence approach should not be altered based on the fund strategy.
The track record of the manager, rather than the fund, should be carefully
B)
scrutinized.
A checklist approach should be used rather than asking open-ended questions to

C)
managers and associated parties.
An investor must assess the skills of a fund’s management team with regard to
D)
investing, operations, and business model.
A risk manager uses a mean reversion model to estimate changes in correlations over
time. Suppose that in November the average monthly correlation for all Dow Jones
Industrial Average (DJIA) stocks was 25% and that the long-run mean correlation of
DJIA stocks is 27%. The risk manager gathers current and historical stock prices, S, and
runs a regression where St − St−1 (i.e., the dependent variable) is regressed with
respect to St−1 (i.e., the independent variable). The regression output estimates the
following regression relationship: Y = 0.153 − 0.63X. What is the expected correlation

for December given the mean reversion rate estimated in the regression analysis?
A) 23.7%.
B) 25.7%.
C) 26.3%.
D) 28.3%.

Melvin Brown manages a long portfolio of debt and equity investments for an
insurance company and has been trying to implement a new risk management
program based on estimating and reporting the daily value at risk (VaR) for each
manager's portfolio. Brown is writing a report to gain support for his proposal. If
Brown determines that daily VaR (10%) for his portfolio is equal to $20,000, which of
the following statements should he include in his report?
Computationally, delta-normal VaR is more complex than standard deviation but

A)
easier to interpret from a risk management perspective.
VaR was developed speci cally for the purpose of measuring the economic capital
B)
required to protect bank portfolios against losses.
The risk of losing more than $20,000 in Brown’s portfolio value in any given week is
C)
10%.
D) Portfolio diversi cation is not fully accounted for using the VaR methodology.
The International Accounting Standards Board (IASB) prepared IAS37 to establish

guidelines on loss provisions that inform rms about the reporting of expected
operational losses. Which of the following statements is not an important
requirement for the reporting of expected operational losses? Loss provisions are:
A) not recognized for future operating losses.
recognized for onerous contracts where the costs of ful lling obligations exceed
B)
expected economic bene ts.
recognized for restructuring costs when a rm has a detailed restructuring plan in

C)
place.
D) recognized for o -balance sheet transactions.

How many of the following statements regarding risk budgeting are correct?
I. Tracking error is de ned as the standard deviation of the di erence between

the returns on a portfolio and the benchmark portfolio.
II. Using only information ratios allows risk of entire ( rm) portfolios to be
budgeted (allocated) across various portfolios managed by separate managers.
III. The optimal weights of the allocations to various fund managers (of a rm) do
not necessarily have to sum to one.
IV. The benchmark portfolio cannot be assigned any weight under the optimal
allocation scheme across active fund managers of a rm.
A) One statement is correct.
B) Two statements are correct.
C) Three statements are correct.
D) Four statements are correct.
Ludington Bank and Trust expects to make $200 million new loans in the coming
quarter. The bank also expects to invest $10 million in Treasury bonds and $15 million
in mortgage-backed securities. It expects current loan customers to draw down an
additional $20 million on revolving credit lines. The bank expects to retire 10 ATMs
during the period. The machines will likely be sold at auction for less than they are
carried on the balance sheet. Ludington Bank will also break ground on two new
branches, each expected to cost approximately $15 million. The bank expects new
deposits to be $175 million in the coming quarter. The available funds gap (AFG) for
the coming quarter is closest to:
A) $25 million.
B) $70 million.
C) $225 million.
D) $245 million.

According to the Merton model, if the rm's debt has a face value of $60 and the
value of the rm is $50 when the debt matures, what are the payo s to the
debtholders and to the shareholders?
Payo to Debtholders Payo to Shareholders
A) $50 $0
B) $50 $10
C) $10 $0
D) $10 $10
Historical data on hedge fund performance was di cult to obtain prior to the early
1990s. In early 1994, hedge fund databases were developed so that participants could
better obtain and analyze hedge fund performance. Which of the following
statements best describes hedge fund performance during the 2001–2010 time
period?
All three hedge fund databases slightly underperformed equities but with a smaller
A)
standard deviation range compared to equities.
All three hedge fund databases substantially outperformed equities; however, their
B)
range of standard deviation was nearly double that of equities.
Hedge fund performance su ered following the Long-Term Capital Management

C)
(LTCM) hedge fund collapse.
All three hedge fund databases substantially outperformed equities, accompanied

D)
by less than half the standard deviation of equities.
Suppose you are using the volatility-weighted historical simulation approach to

estimate value at risk (VaR) and expected shortfall (ES) for asset Y. The actual return
for the asset 30 days ago was 1.5% with a daily volatility estimate of 1.0%. What is the
volatility-adjusted return if the current daily volatility is 1.4%?
A) 0.9%.
B) 1.6%.
C) 1.8%.
D) 2.1%.
Speci c methods are often used in structuring the securitization process of issuing
notes to meet speci c needs of investors. Which of the following statements most
accurately describes a method used in structuring the securitization process?
A) The credit quality on the highest-rated tranche is enhanced by overcollateralization.
The rst-loss piece or equity piece is the class of assets with the highest credit
B)
quality, and, therefore, the originator often maintains ownership of this tranche.
Under the cash waterfall process of securitization, a third party is often hired to run
C) tests to ensure cash ows are su cient to pay all senior tranches prior to making
payments to junior tranches.
The master trust is a special type of structure that is used for infrequent issuers
D)
who demand unique one-time o erings.
Risk aggregation is one of the challenging areas within the economic capital
implementation framework. Risk aggregation involves identifying the individual risk
types and making certain choices in aggregating those risk types. Classi cation by risk
types (market, credit, operational, and business) may be approximate and prone to
error. For example, the de nitions of risk types may di er across banks or within a
given bank, which complicates the aggregation process. Most banks begin by
aggregating risk into silos by risk-type across the entire bank. Other banks prefer
using business unit silos, while others combine both approaches. Which of the
following statements regarding risk aggregation is correct?
Combining two portfolios, for risk aggregation across di erent portfolios or
A) business units of a bank, will result in lower risk per investment unit in the
combined portfolio versus the weighted average of the two separate portfolios.
A simple summation method of risk aggregation adds together individual capital

B)
components, di erentiates between risk types, and produces unequal weighting.
A variance-covariance matrix risk aggregation method summarizes the

C) interdependencies across risk types and provides a exible framework for
recognizing diversi cation bene ts.
A full modeling/simulation method of risk aggregation combines marginal

D) probability distributions into a joint probability distribution through copula
functions.
Grayson Ballentine, an analyst with Platinum Consultants, is analyzing the economic

e ects of buying stock with borrowed funds for a high net worth individual client.
Assume that the client has $200 cash invested (i.e., no borrowed funds) and then uses
the cash to purchase stock. The client then decides to use 50% borrowed funds to
purchase stock on margin. After the margin transaction, the total assets on the full
economic balance sheet and the leverage ratio are closest to:
Total Assets Leverage Ratio
A) $200 1.0
B) $300 1.5
C) $300 2.0
D) $400 2.0

Senior management of a large commercial bank is concerned about the increased
climate change risk and the impact on outstanding loans. The risk management team
was given the task of pricing climate change risk, enabling the bank to allocate
resources appropriately and mitigate climate change risk for the institution. This is a
challenging task for the team due to numerous factors that lead to the mispricing of
climate change risk. Which of the following factors is most likely to cause climate
change risk to be mispriced?
A) Time horizon of the climate change.
B) Ability to measure carbon factors accurately.
C) The increased speed of climate change in recent years.
D) Ability to create qualitative measures of climate change.
The Financial Conduct Authority (FCA) is the supervisory authority in the United
Kingdom responsible for evaluating harm that can result from operational failures of
business services in the banking industry. Supervisory authorities are primarily
concerned with harm to consumers, market participants, and systemic risks that arise
from the interconnectedness of business service providers and rms. Which of the
following statements is the least likely potential harm arising from business service
disruptions and the integrity of data for market participants?
Failure of a shared facility or market infrastructure required to complete a market

A)
function.
B) Failure to properly record consumer market reactions to business unit changes.
C) Failure to control access or misuse of market data.
D) Failure to complete post-sale activities.

Mill Street Bank has accumulated a long history of loan returns. Mill Street believes
that the underlying distribution of loan returns should follow a normal distribution
with a mean of 10 and a standard deviation of three. The following table identi es tail
VaRs at di erent con dence levels. Assume the initial analysis uses ve tail slices.
Calculate the expected shortfall at the 95% con dence level and identify the e ect on
ES when the number of tail slices increases.
Con dence Level Tail VaR

95% 3.00
96% 3.25
97% 3.60
98% 4.00
99% 4.75
Expected Shortfall Increasing Slices
A) 3.72 ES increases
B) 3.72 ES decreases
C) 3.90 ES increases
D) 3.90 ES decreases
Brenden Hemme, a portfolio manager with Quantum Funds, is constructing an

equally weighted, two-asset portfolio. Asset returns are normally distributed. Hemme
would like to limit the portfolio VaR to $45 million at the 95% con dence level. He will
invest $200 million in each asset. Given the following information, determine which
two-asset portfolio allows Hemme to remain within the proposed risk budget.
Asset Standard Deviation Correlation

Asset A 10% Correlation of A with B = 0.6
Asset B 9% Correlation of B with C = −0.4

Asset C 11% Correlation of C with A = 0
A) Portfolio AB.
B) Portfolio AC.
C) Portfolio BC.
D) All three potential portfolios exceed Hemme’s risk budget.
A bank has the following interest sensitive gap positions. The average duration of the
bank's assets is 4.7 years, and the average duration the bank's liabilities is 1.1 years.
Interest rates are expected to decrease 75 basis points. Assume the average yield on
interest sensitive assets is 7%, and the average cost of funds on interest sensitive
liabilities is 3%. Additionally, assume the average yield on xed-rate assets is 8%, and
the average cost of xed-rate liabilities is 4.5%. Assume earning assets equals $2,900
million. Which of the following statements regarding the bank's interest rate risk is
most correct?
Interest Rate Sensitivity of Assets and Liabilities
One Month Next 31– Next 91– More Than

(0–30 Days) 90 Days 365 Days One Year
Rate sensitive $900 $500 $1,000

$500 million
(repricable) assets million million million
Rate sensitive $400 $600 $1,200
$700 million
(repricable) liabilities million million million
The bank’s positive duration gap means net interest income (NII) will increase if
A)
interest rates fall.
The 75 basis point decrease in interest rates will cause the bank’s capital (net worth)
B)
to increase.
The 75 basis point decrease in interest rates will result in a decrease in net interest
C)
margin (NIM) in the 31-to-90-day maturity bucket of 21 basis points.
The bank should, before the expected interest rate decrease, adjust the balance
D) sheet to a positive interest sensitive gap position in each maturity bucket to improve
net interest income (NII).
Q i #20 f 80 Question ID: 1268655

Victor Stanislavsky is a recently promoted senior manager at a bank. As one of his rst
tasks in his new position, he is responsible for reviewing the choices for the allocation
of capital within the bank and the measurement of absolute risk, respectively. Which
of the following combinations of value at risk (VaR) and/or expected shortfall (ES)
should Stanislavsky determine to currently be the most widely used by banks.
Capital Allocation Absolute Risk
A) VaR ES
B) VaR VaR
C) ES ES
D) ES VaR
A risk manager is concerned about the impact of changes in correlations between

three large investments in a portfolio. He uses a correlation swap to trade a xed
correlation with the correlation that actually occurs. The terms of the correlation swap
state that the correlation swap buyer pays a xed correlation rate of 0.2 with a
notional value of $1 million for one year for a portfolio of three assets. Suppose that
the realized pairwise correlations of the daily log returns at maturity for three assets
are ρ2,1 = 0.5, ρ3,1 = 0.3, and ρ3,2 = 0.07. What is the correlation swap buyer's payo at
maturity?
A) −$100,000.
B) $29,000.
C) $90,000.
D) $100,000.

Banks frequently outsource some or most of their key operational activities to third-
party service providers. Which of the following statements about contract provisions
and service agreements pertaining to such activities is most accurate?
A) The bank should always be responsible for resolving customer complaints.
There should always be a description of any amounts payable for non- recurring
B)
items and special requests.
The ownership and control of any data created by the service provider should
C)
always remain the property of the service provider.
Agreements with foreign-based service providers should always provide su cient

D) exibility to allow the laws of one or both jurisdictions to apply for dispute
resolution purposes.
An analyst conducting linear discriminant analysis (LDA) has established a current Z-

score cut-o point of 1.00 to di erentiate between default and solvency. Based on
several years of data, the analyst derives the following:
Average default rate: 2.25%.

Opportunity cost: 17.50%.
Loss given default (LGD): 38.50%.
Given the data above, the adjustment needed to the Z cut-o score will be closest to:
A) 2.98.
B) 3.56.
C) 3.98.
D) 4.56.

Jim Rodgers is looking to make alphas benchmark-neutral within his portfolio. Assume
Stock A has an alpha of 50 basis points, an information coe cient of 0.15, and a beta
coe cient of 1.24. If the benchmark has an alpha of 10 basis points, what is the new
modi ed alpha that would essentially reduce this security's beta to 1?
A) 45.2 bps.
B) 60.0 bps.
C) 55.3 bps.
D) 37.6 bps.
MaxCo is attempting to compute a single hurdle rate to use for all of its business
activities. The following information has been provided:
Book value of common equity $0.8 million
Market value of common equity $1.5 million
Book value of preferred equity $0.5 million

Market value of preferred equity $0.75 million
Beta of common equity 1.15
After-tax RAROC of proposed

5%
project
Risk-free rate 2%
Cost of preferred equity 6%
Expected return on market portfolio 7%
Based on the information provided, which of the following statements is correct?
A) MaxCo’s hurdle rate is 4.30%.
B) MaxCo’s hurdle rate is 7.17%.
C) MaxCo’s hurdle rate is 9.95%.
D) MaxCo should accept the proposed project.

The trading desk at Big Bank is pricing an o -market swap. The quantitative analysis
team has identi ed the interest rate drift in periods 1 and 2 to be 25 basis points and
−10 basis points, respectively. These values were calibrated from liquid swap prices.
The current short-term interest rate is 5.4% with a long-run mean reverting level of
15.1%. Additionally, the long-run true interest rate is 12.6%. The half-life of the
process is 6.3 years. Using the Ho-Lee Model, what is the expected short-term interest
rate in two annual periods?
A) 5.25%.
B) 5.40%.
C) 5.55%.
D) 5.75%.
A risk manager with Forest Investments is developing a risk appetite statement for his
organization. He knows that the objective of a risk appetite statement is to provide a
guideline for risk management within the organization. The risk manager is also
aware that the risk appetite should tie into operational, compliance, and reporting
goals to achieve optimal performance. Which of the following characteristics is
incorrect regarding the development of a risk appetite statement? An e ective risk
appetite statement:
can be revised, taking into account that the organization’s goals may change over
A)
time.
B) is su ciently speci c, yet also clear enough to be conveyed within the organization.
assists with setting aggressive risk limits that can help an organization achieve goals
C)
faster than industry leaders.
D) is congruent with the organization’s goals.

A $200 million bond portfolio consists of two bonds with the cash ows and VaR
percentages at the 95% con dence level presented in the following table. (Note that $
gures are in millions.) Using the stress test methodology, what is the VaR for this
portfolio?
Year Portfolio CF Spot Rate PV(CF) VaR % PV Factor
1 $107 2.50% $104.39 0.4696 0.9756

2 $3 2.60% $2.85 0.9868 0.9500
3 $3 2.90% $2.75 1.4841 0.9178
4 $3 3.10% $2.66 1.9714 0.8850

5 $103 3.35% $87.35 2.4261 0.8481
$200.00
A) $2.41 million.
B) $2.57 million.
C) $2.62 million.
D) $2.73 million.
A risk manager at SRS Investments is evaluating the potential bene ts and risks of
arti cial intelligence (AI) and machine learning (ML) on nancial markets. Which of the
following items is most likely associated with a bene t of AI and ML?
A) Decision making of AI systems is not transparent.
B) Operational or nancial problems at one rm have widespread e ects.
Automation of much of the work performed by nancial institutions increases

C)
customer options.
ML algorithms and other AI models have learned over a period of unusually low
D)
volatility in the nancial markets.
Overview for Questions #30-31 of

Question ID: 1268668
80
Questions 30 and 31 refer to the following information.
RLT, Ltd., is engaging in two repurchase agreement (repo) transactions during Year 1.
The details of the rst transaction it enters into, with BigTrade, Inc., as the
counterparty, are provided in the following table.
Repo #1 Terms Amounts
Amount borrowed $7.5 million
Date/length July 1, 61 days
KRL bonds, face $6.75 million, market value $7.5

Underlying
million
Contract price $7.5 million
Interest on the buy

25 basis points
back
The second transaction, also with BigTrade, Inc., involves an on-the-run (OTR) bond
issued on January 1 that trades at a special spread of 0.26%. The bond is expected to
trade at general collateral (GC) rates past May 1, with the nancing value of the bond
over 120 days.
Using the information from the provided table, the repurchase price for the rst repo
transaction is closest to:
A) $7,496,875.
B) $7,501,615.
C) $7,503,175.
D) $8,770,835.
Using the information from the provided table, what is the cash value per $1,000
market value for the OTR bond underlying the second repo transaction?
A) 0.72 cents.
B) 2.60 cents.
C) 4.34 cents.
D) 8.67 cents.
Suppose an investor expects that the 1-year rate will remain at 5% for the rst year
for a 2-year zero-coupon bond. In addition, the investor estimates a 50% probability
that 1-year spot rates will be 6% in one year and a 50% probability that 1-year spot
rates will be 4% in one year. Which of the following inequalities most accurately
re ects the convexity e ect for this 2-year bond using Jensen's inequality formula?
A) $0.95247 > $0.95238.
B) $0.91584 > $0.91575.
C) $0.90711 > $0.90703.
D) $0.89856 > $0.89847.
A portfolio includes a position of $1 million invested in DEF shares. The price volatility
of the shares over one week is 0.5%. The bid-ask spread is a constant 0.6%. What is
the 1-week liquidity adjusted VaR (LVaR) for this position at the 95% con dence level?
A) $1,000.
B) $5,250.
C) $8,000.
D) $11,250.

To account for counterparty risk, the fair net present value (NPV) of a position must
be adjusted by the counterparty credit value adjustment (CVA). Which of the following
factors is not taken into account with the calculation of the CVA?
A) Collateralization.
B) Hedging.
C) Nature of the transaction.
D) Risk-free price.
A constant maturity Treasury (CMT) swap pays ($1,000,000 / 2) × (yCMT − 8%) every six
months. There is an 80% probability of an increase in the 6-month spot rate and a
70% probability of an increase in the 1-year spot rate. The rate change in all cases is
0.50% per period and the initial yCMT is 8%. What is the value of this CMT swap?
A) $1,838.
B) $3,608.
C) $3,747.
D) $3,897.
When using statistical models in quantitative validation procedures, data quality is

crucial. Which of the following aspects relating to credit default data is likely to be the
most controllable in the context of maximizing data quality?
A) Lending technology stability.
B) Sample size.
C) Sample homogeneity.
D) Time span.
Practices that result in a strong and e ective capital adequacy process for a bank
holding company (BHC) include risk identi cation, internal controls (including model
review and valuation), corporate governance, and capital policy (including setting
goals and targets and contingency planning). When considering these key practices
within the capital adequacy process, BHCs should do all of the following except:
develop a detailed process to e ectively identify only those risk exposures that have
A)
severely impacted company functions in the past.
have boards actively involved in evaluating and approving their internal capital
B)
adequacy plans.
develop a capital policy clearly de ning the principles and guidelines for capital
C)
goals, issuance, usage, and distributions.
establish a mechanism for a comprehensive, independent, and regular review and

D)
validation of all models used for capital adequacy planning purposes.
As a pension fund manager, you are considering two competing investment

opportunities for inclusion in one of the funds that you manage. The current risk-free
rate is 2.3%. Investment A has an expected return of 12% and a standard deviation of
15.5%, while Investment B has an expected return of 14% and a standard deviation of
18%. Based on only this information, which investment would you pick and why?
A) Investment A because it has a lower Sharpe ratio.
B) Investment B because it has a lower Sharpe ratio.
C) Investment A because it has a higher Sharpe ratio.
D) Investment B because it has a higher Sharpe ratio.

Following the nancial crisis in 2007–2009, numerous scandals in the nancial
industry indicate a need for change in the nancial industry. Senior management at a
large bank has made it a priority to change their culture in hopes of repairing
reputation and trust issues. Which one of the following is least likely to be a
motivating factor for bank industry change?
A) Rising interest rates leading to less pro ts in the industry.
B) Di culties in acquiring and retaining talented employees.
C) Technology gaps in an industry with increased reliance on digitization.
D) Higher standards demanded by regulators and the public.
Which of the following statements is a recommended step in predicting the outcome

of an event where the lines are blurred between correlation and causation?
Use ordinary least squares (OLS) regression to determine correlations between

A)
variables.
Use econometrics to forecast what would have happened if no action were taken
B)
and then measure the actual results post-change against the forecasted outcome.
Use a curated control group where no change has occurred to test correlation and
C)
causation between variables in a dataset.
Use a random control group where no change has occurred to test correlation and
D)
causation between variables in a dataset.
The single-factor model is used to examine the impact of varying default correlations
based on a credit position's beta. Each individual rm or credit, i, has a beta
correlation, βi, with the market, m. Which of the following statements most accurately
describes the implication of using a speci c value m for the market parameter in the
single-factor model?
The conditional probability of default will be greater than the unconditional

A)
probability of default when βi is equal to zero.
The unconditional standard deviation is less than the conditional standard
B)
deviation.
C) Individual idiosyncratic shocks, εi, are positively correlated to other rms’ shocks.
D) Individual asset returns, ai, are independent from other rms’ shocks and returns.
Suppose a relative value trade is established whereby a trader sells a U.S. Treasury
bond and buys a U.S. Treasury TIPS (which makes in ation-adjusted payments) to
hedge the T-bond. Over time, changes in yields on nominal bonds and TIPS do not
track one-for-one. To illustrate this hedge, assume the following data for yields and
DV01s of a TIPS and a T-bond. Assuming that the trader is selling 100 million of the T-
bond and buys an $85 million position in TIPS as a hedge, what is the regression
hedge adjustment factor (i.e., regression beta)?
Bond Yield (%) DV01

TIPS 1.2 0.095
T-bond 3.5 0.065
A) 0.58.
B) 0.85.
C) 1.24.
D) 1.72.
Shawn Owens is giving a presentation on time-varying volatility and how it results

from volatility uctuations over time. Speci cally, he is discussing the e ect of time-
varying volatility on the accuracy of value at risk (VaR) measures. What e ect does
time-varying volatility have on accurate VaR measures?
The e ects of time-varying volatility on accurate VaR measures decrease as time

A)
horizon lengthens.
The e ects of time-varying volatility on accurate VaR measures decrease as time
B)
horizon shortens.
The e ects of time-varying volatility on accurate VaR measures increase as time

C)
horizon lengthens.
D) Accurate VaR measures are not a ected by time horizon.
The asset-liability committee (ALCO) for a large bank in the United Kingdom prepares
a report for regulators identifying all large customers with deposits that are 5% or
greater of total liabilities. The ALCO for this bank set a maximum single-source
concentration limit of 10%.
Large Depositors as a Percentage of Country and Total

Funding
Percentage of Country's External
Funding
Customer Amount (000s) A B C D E F
ABC 945,102 9.1% 1.8% 0.9%

XYZ 672,712 6.7%
QRT 543,241 11.3% 3.0%
BF3 352,887 4.7%
Based on the concentration report of large depositors illustrated in the table, what
concerns should the ALCO address at this time?
A) No concerns are warranted at this time.
B) Customer QRT exceeded the limit by 1.3%.
C) Both Customer ABC and Customer QRT have total deposits exceeding the limit.
D) Country A and Country B have total deposits exceeding the limit.

Dave Johnson, a risk manager at a small hedge fund, has noticed several economic
factors that have caused him concern. A bird u outbreak in some large cities in Asia
has resulted in an extreme number of deaths, data on productivity indicates a
weakening trend, with productivity falling in the United States, Europe, and China for
several quarters in a row, and the volatility index (VIX) has been rising. Fearing
another global nancial crisis, Johnson would like to mitigate the fund's volatility risk.
Which of the following actions would be least e ective at mitigating volatility risk in
the event of a nancial crisis?
A) Buying out-of-the-money put options.
Shifting the asset mix from heavily weighted toward equities to a more balanced
B)
mix of investment-grade corporate bonds and stocks.
C) Investing a greater proportion of the portfolio in U.S. Treasury securities.
D) Shifting to a greater proportion of the portfolio invested in currency strategies.
An investment advisor is looking for a securitized asset for one of his client's
portfolios. The advisor believes that he found the right investment, which he notes is
created from mortgages but remains on the issuer's balance sheet, segregated from
other assets. The investment advisor is most likely referring to:
A) a mortgage-backed bond.
B) a mortgage pass-through security.
C) a real estate mortgage investment conduit (REMIC).
D) a collateralized mortgage obligation (CMO).
In calibrating a portfolio risk model, a risk manager is estimating the growth of the
ntech credit markets for di erent regions. Which of the following driving factors of
ntech credit market growth is least likely to impact the United States and United
Kingdom markets?
A) Access to credit.
B) A country’s economic growth.
C) The level of economic and nancial development.
D) Legal and institution quality.
The rate parameter in the exponential distribution measures the rate at which it takes
an event to occur. In the context of waiting for a company to default, the rate
parameter is known as the hazard rate and indicates the rate at which default will
arrive. Which of the following statements about hazard rates (i.e., default intensity) is
correct assuming a constant default intensity of 0.2?
A) The cumulative default probability after 3 periods = e−(0.2)3.
B) The conditional default probability after 1 period = 2%.
C) The unconditional default probability is memoryless.
D) The default probability in the second period = 14.9%.
A portfolio consists of two positions. One position has a VaR equal to $50, and the
other has a VaR equal to $80 million. If the returns of the two positions are not
correlated, the VaR of the portfolio would be closest to:
A) $61.10 million.
B) $70.00 million.
C) $130.00 million.
D) $94.34 million.

A risk manager is examining capital requirements for central counterparties (CCPs).
After his assessment, he discusses the advantages and disadvantages of CCPs with a
colleague. Regarding this discussion, why would adverse selection be a disadvantage
in the CCP's centrally cleared structure?
In performing extensive member due diligence, the CCP may omit a member rm in
A)
error.
Only member rms can transact with a CCP, which limits the pool of available
B)
transactions.
A CCP has a transparent viewpoint from which to see all transactions in its network,
C)
which puts an information gap advantage squarely on the side of the CCP.
The trading desks at major nancial institutions know derivatives products inside
D) and out, which may create a one-sided information gap that puts the CCP at a
disadvantage.
Sally Baughman is a risk manager at a bank who believes her bank has very sound risk
management processes in place. Baughman is in charge of all risk management
activities in her bank and reports directly to the asset liability management (ALM)
committee. Operational risk management is not separate from other types of risk
management at the bank. Given the above description, which of the following
statements is most likely true?
A) Baughman works at a small bank.
B) Baughman’s bank likely has a corporate operational risk function (CORF) in place.
C) Baughman’s bank is state chartered.
D) Baughman’s bank is out of compliance with risk management best practices.
Several jurisdictions are concerned with the sudden transition to e-money and allow
some nonbank issuers access to central bank reserves. The following are potential
bene ts of allowing e-money providers access to central bank reserves except:
e-money backed by central bank reserves provides stability of e-money by
A)
mitigating liquidity, market, and default risk.
e ective monetary policy transmission could be maintained by allowing domestic e-

B)
money issuers to o er competitive e-money instead of foreign e-money.
monopolies could be eliminated by central banks providing interoperability of

C)
payments.
D) central banks could oversee license requirements and monitor e-money providers.
Assume the current short-term interest rate is 4.2% with a long-run mean-reverting
level of 15.1%. Additionally, assume the long-run true interest rate is 12.6% with an
interest rate drift of 0.20%. Using the Vasicek model with mean reversion, what is the
approximation of the model's mean-reverting parameter?
A) 0.02.
B) 0.08.
C) 0.17.
D) 1.19.
In 2015, the Group of Thirty (G30) created a report that recommended changes in
banking conduct and culture issues. The report provided speci c bank methods for
improving culture. One of the recommendations was for creating an e ective three
lines of defense. Which of the following is the rst line of defense recommended in
the 2015 G30 report?
Training sessions should reinforce sta development, promotion, and hiring

A)
practices.
The board and executive team should champion compliance and risk management
B)
roles.
The sta and management of the rm should ensure conduct is consistent with
C)
culture.
There should be a properly sta ed team with a clear mandate to review and
D)
examine rm standards.
A 2-year credit default swap (CDS) specifying physical delivery defaults at the end of
two years. If the reference asset is a $200 million, 8.0% ABC corporate bond, and the
CDS spread is 125 basis points, the buyer of the CDS will:
A) receive payments of 800 basis points for the next two years.
B) receive a payment of $167.5 million.
C) deliver the bond and receive a payment of $200 million.
D) continue to receive payments of 675 basis points for the next two years.
A portfolio manager notes in his presentation to investors that there are several
di erences between the assumptions of multifactor models and the capital asset
pricing model (CAPM). The manager notes two speci c di erences:
Statement 1: In multifactor models, the average investor holds the

market portfolio, whereas under the CAPM, he holds a
non-market portfolio.
Statement 2: In multifactor models, valuable assets have low risk
premiums, whereas under the CAPM, they have high risk
premiums.
Is the manager correct with respect to his statements?
A) The manager is correct with respect to both statements.
B) The manager is correct with respect to statement 1 only.
C) The manager is correct with respect to statement 2 only.
D) The manager is incorrect with respect to both statements.

A deposit operations manager is an employee of Star Bank. Star Bank, as well as a
competitor bank that operates on the other side of the same town, uses a conditional
deposit pricing model. The manager is comparing his bank's deposit fee structure to
that of the competitor bank. Based on the data presented in the following table, which
statement is most likely correct?
Star Bank: Checking and

Local Competitor: Checking and
Savings Fee and Rate
Savings Fee and Rate Structure
Structure
Checking Accounts
Checking Accounts
Minimum daily checking
Minimum daily balance is $1,500; no
account balance is $300;
monthly fee
no monthly fee
Balance is $500–$1,500: $3 monthly

Balance is less than fee
$300: $3 monthly fee Balance is less than $500 minimum
balance: $5 monthly fee
ATM fees: $0 per transaction for any

ATM fees: $0.50 per bank ATM if minimum balance of
transaction, for both Star $1,500 is met
Bank and competitor Zero fee for home ATMs regardless
bank ATMs if minimum of balance, and fee of $3 per
balance of $300 is not transaction if using a competitor
met ATM when minimum balance is not
met
Check writing and debit

fees: $0.25 per item No item charge for checks or other
regardless of minimum debits
balance
Savings Accounts
Savings Accounts
No fees on savings
Minimum daily balance is $10,000 or
accounts
less: $5 monthly fee per account
No minimum daily
No minimum daily balance to earn
balance required to earn
the standard savings rate; for
standard savings
accounts with more than $10,000
account interest rate
minimum daily balance, earn a
earned on all savings
premium savings rate of interest
accounts
Free online banking Free online or in-bank funds transfer
services services
A) Neither bank is targeting younger or less a uent customer bases.
Star Bank is more likely to attract both a uent and less a uent customers than the
B)
competitor bank.
Star Bank is targeting an a uent customer base, while the competitor bank is
C)
targeting a younger, less a uent customer base.
Star Bank is targeting a younger, less a uent customer base, while the competitor
D)
bank is targeting an a uent customer base.
Jason Connor, FRM, is a hedge fund manager who is explaining implied volatility for
currency options to junior analysts. Which of the following statements best completes
his explanation? If the implied volatilities are greater for away-from-the-money actual
currency options than they are for at-the-money currency options, then currency
traders must believe that:
there is a greater chance of extreme price movements than predicted by a

A)
lognormal distribution.
B) arbitrage opportunities clearly exist.
C) the implied volatility of currency options is expected to increase in the near future.
there are no arbitrage opportunities unless the implied volatility versus strike price
D)
represents a skewness that is referred to as a smirk rather than a smile.

The following scenarios illustrate exposures for two trades with and without the
impact of netting. Given the below expected positive exposures (EPE), what is the
corresponding netting factor? Assume that the average correlation between
exposures is 0.55.
Without With
Scenario Trade 1 Trade 2
Netting Netting
1 20 15 35 35
2 15 10 25 25
3 10 –10 10 0
4 5 –10 5 0
5 –10 –15 0 0
EPE 10 5 15 12
A) 0.55.
B) 0.67.
C) 0.80.
D) 1.25.
An analyst is backtesting a daily holding period VaR model using a 97.5% con dence
level over a 255-day period and is using a 3.84 test statistic. The following table shows
the calculated values of a log-likelihood ratio (LR) at a 97.5% con dence level.
Number of Exceptions
1 2 3 4 5 6 7 8 9 10 11 12
7.16 4.19 2.27 1.04 0.33 0.02 0.06 0.39 0.98 1.81 2.84 4.06
Based on the above information, which of the following statements accurately

describes the VaR model that is being backtested?
A) If the number of exceptions is more than 3, we would not reject the model.
If the number of exceptions is more than 2 and less than 12, we may commit a Type
B)
II error.
If the number of exceptions is less than 2, we would accept the hypothesis that the
C)
model is correct.
D) If the number of exceptions is less than 2, we may commit a Type II error.
A large nancial institution uses the matched-maturity marginal cost of funds

approach for liquidity transfer pricing (LTP). Under this approach, the bank's actual
market cost of funding is used to calculate the correct liquidity spread. In addition,
xed-rate borrowing costs are converted to oating-rate borrowing costs through
internal swap transactions between business units using the swap curve as a
reference. Which of the following statements best describes the relationship of the
marginal cost of funds curve to other approaches? The marginal cost of funds curve:
A) is greater than the average cost of funds curve for long-term assets.
re ects the additional liquidity premium that is determined by short-term current

B)
market rates compared to the pooled approach.
C) is higher than the average cost of funding curve for shorter-term assets.
D) is lower than the swap curve at longer maturities.
A portfolio manager estimates the VaRs for the two positions in his portfolio as
follows: VaR1 = $4.8 million and VaR2 = $2.6 million. What is the VaR for the portfolio if
the returns of the two securities are uncorrelated, and what is the VaR for the
portfolio if the returns of the two securities are perfectly correlated?
For zero correlation, VaR is $5.46 million, and for perfect correlation, VaR is $7.40
A)
million.
B)
million.
C)
million.
D)
million.
Using the Merton model, calculate the current value of a rm's equity and debt given
that the current value of the rm is $100 million, the principal amount due in ve
years on the zero-coupon bond is $100 million, the annual interest rate is 10%, and
the volatility of the rm is 20%.
A) $100 million in debt and $0 in equity.
B) $60.65 million in debt and $39.35 million in equity.
C) $58.38 million in debt and $41.62 million in equity.
D) $32.59 million in debt and $67.41 million in equity.
LIBOR became less useful as a reference rate after the most recent nancial crisis.
New reference rates are being considered by nancial authorities that do not have the
same problems associated with interbank o ering rates (IBORs), such as LIBOR. All
the following are problems associated with the continued use of LIBOR as a reference
rate except:
A) LIBOR is determined by survey data from banks that can be manipulated.
B) activity in the interbank market increased signi cantly following the crisis.
C) variance in individual bank credit increased signi cantly following the crisis.
D) e orts to reduce counterparty risk following the crisis led to more nonbank funding.

A risk analyst at a retail bank has been asked to review its lending practices to ensure
compliance with the Consumer Financial Protection Act (CFPA) requirements to issue
"quali ed mortgages" to prospective homeowners. Which of the following is least
likely to be considered as an underwriting standard when evaluating a borrower's
ability to repay?
A) Current income and assets.
B) Current employment status.
C) Monthly insurance and property tax burden for mortgaged assets.
D) Most recent quarter gross domestic product (GDP).
A bank located in an OECD member country uses the standardized approach to

estimate total risk weighted credit risk exposure. An external credit rating agency
assigns the following weights to the bank's risk exposures.
Risk Exposure Weight

$50 million 150%
$10 million No rating

$20 million 5%
$30 million 10%
$5 million 50%
According to the Basel II Accord, a bank should maintain a minimum capital amount
of:
A) $5.24 million.
B) $7.32 million.
C) $23.2 million.
D) $12.2 million.

A bank has two loans in its portfolio: a loan with counterparty A and a loan with
counterparty B. The bank estimated a 90% probability that counterparty A will not
default, a 10% loss if counterparty A were to default, and a $50 million exposure to
this counterparty at default. What is the expected loss (EL) for the bank from
counterparty A?
A) $4.5 million.
B) $4.0 million.
C) $1.0 million.
D) $0.5 million.
A binomial interest rate tree indicates a 6-month spot rate of 3.5%, and the price of
the bond is 97.25 if rates decline and 95.875 if rates increase. The risk-neutral
probability of an interest rate increase is 0.60. You hold a put option on the bond. The
put has an exercise price of 97.00 and expiration of six months. The option value is
closest to:
A) 0.10.
B) 0.43.
C) 0.66.
D) 0.76.
A mortgage lender is faced with default risk, which is the risk that the borrower will be
unable to make mortgage payments. Default risk is mitigated by the house, which is
pledged as mortgage collateral. The downside is that although default risk is
mitigated, additional risks may be created. Which of the following statements
correctly describes wrong-way risk in this situation?
The risk that the mortgage lender is unable to take possession of the house for legal
A)
or other reasons in the event of default.
The risk that the lender is unable to sell the house quickly or at a reasonable price in
B)
the open market while the property value declines.
C) The risk that the value of the collateral falls below the mortgage value.
The risk that there is a correlation between the property value and the default of
D)
the mortgagee.
Money managers are routinely evaluated using a wide array of performance analysis
tools. Examples of risk-adjusted performance measures include Sharpe's measure,
Treynor's measure, Jensen's alpha, and the information ratio. Which of the following
statements regarding these performance analysis measures is most likely correct?
The information ratio (IR) is the ratio of excess return to standard deviation of
A)
excess return.
B) The CAPM assumes the alpha (regression intercept) is positive.
C) Superior performance, as shown by the Sharpe ratio, implies a negative alpha.
A signi cant t-statistic requires a smaller alpha relative to its standard deviation, as
D)
well as fewer observations.
The cash ows in a 3-tiered securitization (senior, mezzanine, and equity) can be
broken out into the in ows from the collateral and the out ows to the investors. The
terminal cash ows in the nal year are the last interest payment plus principal and
recovery of defaulted assets. Suppose the original loan pool included 50 loans with $1
million par value each and a xed coupon of 7%. Also assume that the par value for
the senior and junior tranches was 80% and 15%, respectively, with the equity
investors contributed the remaining 5%. If the total amount available to satisfy all
claims is $55 million, what is the total equity claim?
A) $0.
B) $5 million.
C) $7.5 million.
D) $10 million.
Value at risk (VaR) determines the maximum value we can lose for a given con dence
level over a given period. For this reason, Kenneth Fulton is concerned that the VaR is
not providing the magnitude of the actual loss. He has prepared the following table
based on the assumption that returns are normally distributed and a corresponding n
= 5. What is the expected shortfall using the information in the following table?
Con dence
VaR Di erence
Level
95% 1.6392
96% 1.7507 0.1115
97% 1.8808 0.1301
98% 2.0537 0.1729

99% 2.3263 0.2726
A) 0.687.
B) 1.930.
C) 2.003.
D) 2.054.
Glenn Funds uses the information ratio (IR) as a performance measure. The rm
compares portfolio managers based on their IRs and uses this information to help
determine performance compensation. Which of the following statements does not
represent a strength of the IR in terms of its usefulness in comparing asset managers?
The information ratio:
A) can be applied to industries as well as individual asset and portfolio returns.
is easy to understand when used to compare a manager’s performance to the

B)
performance of a peer.
uses the portfolio’s forecasted tracking error in the calculation, making it a forward
C)
looking measure.
makes it easy for senior supervisors to rank order managers based on their
D)
generated excess returns relative to risk.
Spence, Inc., (Spence) is attempting to compute an adjusted risk-adjusted return on

capital (ARAROC) amount for a capital budgeting decision. The following information
has been collected:
Beta of the equity of the rm 1.2

After-tax RAROC of proposed
6%
project
Risk-free rate 4%
Expected return on market portfolio 8%
Based on the information provided, which of the following amounts re ects the
ARAROC?
A) 1.2%.
B) 2.0%.
C) 2.8%.
D) 4.8%.
What is the market risk capital requirement for a bank with an average daily VaR over
the previous 60 days of $250? Assume that the multiplicative factor is 3 and that the
previous day's VaR is less than average daily VaR times the multiplier.
A) $835.
B) $866.
C) $2,372.
D) $2,747.
Financial institutions globally have been increasingly analyzing "big data." Which of
the following parameters best describe big data?
A) High-quality, structured, high-frequency data.
B) Low-quality, unstructured, high-frequency data.
C) High-quality, structured, low-frequency data.
D) Low-quality, unstructured, low-frequency data.
The securitization process of asset-backed securities (ABS) provides bene ts to

nancial institutions and investors. Sometimes these bene ts result from speci c
credit enhancements of the securitization process. Which of the following statements
most accurately describe a bene t or credit enhancement of the securitization
process?
Securitization provides more of a funding bene t for very large nancial institutions
A) with a diversi ed product line, as opposed to nancial institutions with specialized
narrow product lines.
Securitization of ABS through a special purpose vehicle (SPV) allows nancial

institutions to enhance balance sheet management and their credit rating because
B)
the SPV o erings often have a lower credit quality and the SPV is not as concerned
about ratings.
One cash ow–related credit enhancement used with ABS is known as a margin
C)
step-up, which decreases the coupon structure after a call date.
Because special purpose vehicles (SPVs) are not subject to the same capital
D) requirements as banks, an originating bank is able to reduce capital requirements
by selling assets to an SPV.
In order to assign a rating for a new client, a credit analyst is looking at using a cash
ow simulation model. The analyst, in explaining the fundamentals of this model,
would be least likely to identify which of the following issues?
A) The actual occurrence of a default is di cult to forecast.
B) Models can be very costly to create, maintain, and calibrate.
C) If the default threshold is set too late, it will undervalue potential risk.
Model risk is a relatively light concern as long as discount rates are conservatively
D)
high.
Gilbert Granston has been analyzing bid-ask spreads on over-the-counter equities for
the last several years in his job as an equity analyst. He notes that with the exception
of the 2007–2009 nancial crisis, spreads have generally narrowed over his period of
study. If Granston is correct, this is an indication that:
A) liquidity has improved over the period.
B) the market has become more resilient over the period.
C) the depth of the market has improved over the period.
D) credit risk has fallen over the period.
Jenny Riley is a risk analyst at ESS analytics and is skeptical of reported returns in
asset markets that tend to be illiquid. She believes that returns in these illiquid asset
markets are somewhat overestimated and that risks, as measured by beta, are
somewhat underestimated. Regarding reporting biases that result in in ated returns
and underestimated risks, which of the following biases results from calculating
returns from only higher selling prices?
A) Survivorship bias.
B) Selection bias.
C) Infrequent trading bias.
D) Collection bias.

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Question #1 of 80 Question ID: 1268646

Question #2 of 80 Question ID: 1268689

An analyst at Bank A is looking to use a machine learning method to make predictions

B) Clustering Classi cation

C) Classi cation Regression

D) Regression Classi cation

A checklist approach should be used rather than asking open-ended questions to

Question #4 of 80 Question ID: 1268621

following regression relationship: Y = 0.153 − 0.63X. What is the expected correlation

Question #5 of 80 Question ID: 1268618

Computationally, delta-normal VaR is more complex than standard deviation but

Question #6 of 80 Question ID: 1268650

The International Accounting Standards Board (IASB) prepared IAS37 to establish

A) not recognized for future operating losses.

recognized for restructuring costs when a rm has a detailed restructuring plan in

D) recognized for o -balance sheet transactions.

Question #7 of 80 Question ID: 1268681

I. Tracking error is de ned as the standard deviation of the di erence between

A) One statement is correct.

B) Two statements are correct.

C) Three statements are correct.

D) Four statements are correct.

Question #8 of 80 Question ID: 1268667

Question #9 of 80 Question ID: 1268631

Payo to Debtholders Payo to Shareholders

Question #10 of 80 Question ID: 1268684

Hedge fund performance su ered following the Long-Term Capital Management

All three hedge fund databases substantially outperformed equities, accompanied

Question #11 of 80 Question ID: 1268615

Suppose you are using the volatility-weighted historical simulation approach to

Question #12 of 80 Question ID: 1268643

A) The credit quality on the highest-rated tranche is enhanced by overcollateralization.

Question #13 of 80 Question ID: 1268654

A simple summation method of risk aggregation adds together individual capital

A variance-covariance matrix risk aggregation method summarizes the

A full modeling/simulation method of risk aggregation combines marginal

Question #14 of 80 Question ID: 1268662

Grayson Ballentine, an analyst with Platinum Consultants, is analyzing the economic

Total Assets Leverage Ratio

Question #15 of 80 Question ID: 1268692

A) Time horizon of the climate change.

B) Ability to measure carbon factors accurately.

C) The increased speed of climate change in recent years.

D) Ability to create qualitative measures of climate change.

Question #16 of 80 Question ID: 1268660

Failure of a shared facility or market infrastructure required to complete a market

B) Failure to properly record consumer market reactions to business unit changes.

C) Failure to control access or misuse of market data.

D) Failure to complete post-sale activities.

Question #17 of 80 Question ID: 1268613

Con dence Level Tail VaR

Expected Shortfall Increasing Slices

Question #18 of 80 Question ID: 1268680

Brenden Hemme, a portfolio manager with Quantum Funds, is constructing an

Asset Standard Deviation Correlation

Asset B 9% Correlation of B with C = −0.4

D) All three potential portfolios exceed Hemme’s risk budget.

Question #19 of 80 Question ID: 1268672

Interest Rate Sensitivity of Assets and Liabilities

One Month Next 31– Next 91– More Than