Free PRMIA 8005 Practice Exam with Questions & Answers | Set: 7

Equity futures are by far the most traded futures contracts in terms of value, followed by interest rate products. Choice 'd' is the correct answer.

Each of the choices describes various scenarios related to the issue of bonds. A when-issued market is a market in government securities where securities are traded as forward contracts prior to their issue. Choice 'c' is the correct answer.

Choice 'd' refers to a 'bought deal'. Choice 'b' refers to the 'grey market', usually in corporate bonds. Choice 'a' refers to a fixed price re-offer mechanism.

KMV Moody's uses a proprietary database to convert the distance to default to expected default probabilities.

The term 'data quality' has multiple elements, ie, data in order to be considered of a high quality must have multiple attributes such as completeness, timeliness, auditability etc. Because this is not an exact science, every expert or text book will have a different view of what goes into data quality. For our purposes however, we will stick to what the PRMIA study material specifies, and according to the study material the following are the elements that can be considered attributes that make for quality data:

1. Integration

2. Integrity

3. Completeness

4. Accessibility

5. Flexibility

6. Extensibility

7. Timeliness

8. Auditability

I am not going to describe each of these here as that would be repetitive of the study material, but suffice it to say that the break-down of a number into its constituents should tie to the aggregate total. If that is not true, then the data lacks integrity - and therefore Choice 'b' is the correct answer. The other choices address other aspects of data quality but not this, and therefore are not correct.

High frequency and low severity risks, for example the risks of fraud losses for a credit card issuer, may have high expected losses, but low unexpected losses. In other words, we can generally expect these losses to stay within a small expected and known range. The capital requirement will be the worst case losses at a given confidence level less expected losses, and in such cases this can be expected to be low.

On the other hand, medium severity medium frequency risks, such as the risks of unexpected legal claims, 'fat-finger' trading errors, will have low expected losses but a high level of unexpected losses. Thus the capital requirement for such risks will be high.

It is also worthwhile mentioning high severity and low frequency risks - for example a rogue trader circumventing all controls and bringing the bank down, or a terrorist strike or natural disaster creating other losses - will probably have zero expected losses & high unexpected losses but only at very high levels of confidence. In other words, operational risk capital is unlikely to provide for such events and these would lie in the part of the tail that is not covered by most levels of confidence when calculating operational risk capital.

Note that risk capital is required for only unexpected losses as expected losses are to be borne by P&L reserves. Therefore the operational risk capital requirements for a low severity high frequency risk is likely to be low when compared to other risks that are lower frequency but higher severity.

Thus Choice 'c' is the correct answer.

Bootstrapping is not one of the various approaches to try to value a convertible security. The rest of them are, and therefore Choice 'b' is the correct answer.

The bond equivalent yield for a treasury bill can be calculated as [(Future value - Present value)/Present value x 365/days to maturity]. In this case this works out to ($100-$98)/$98 * 365/90 = 8.28%

[Why do we use 365 days and not 360? And is there a different way to calculate treasury bill yields?

The answer to this question is that there are alternate ways to calculate these yields. For the exam, I would suggest that you calculate according to one method, see if you get an answer that matches, and pick that. I found the below on the NY Fed's website - a very clear example: (http://newyorkfed.org/aboutthefed/fedpoint/fed28.html)

The Discount Yield Method

The following formula is used to determine the discount yield for T-bills that have three- or six-month maturities:

Discount yield = [(FV - PP)/FV] * [360/M]

FV = face value

PP = purchase price

M = maturity of bill. For a three-month T-bill (13 weeks) use 91, and for a six-month T-bill (26 weeks) use 182

360 = the number of days used by banks to determine short-term interest rates (the investment yield method is based on a calendar year: 365 days, or 366 in leap years).

Example

What is the discount yield for a 182-day T-bill, auctioned at an average price of $9,659.30 per $10,000 face value?

Discount yield = [(FV - PP)/FV] * [360/M]

FV = $10,000 PP = $9,659.30 M = 182

Discount yield = [(10,000) - (9,659.30)] / (10,000) * [360/182]

Discount yield = [340.7 / 10,000] * [1.978022]

Discount yield = .0673912 = 6.74%

For the 13-week bill, the same formula would be used, dividing 360 by a maturity of 91 days rather than 182 days.

The Investment Yield Method

When comparing the return on investment in T-bills to other short-term investment options, the investment yield method can be used. This yield is alternatively called the bond equivalent yield, the coupon equivalent rate, the effective yield and the interest yield.

The following formula is used to calculate the investment yield for T-bills that have three- or six-month maturities:

Investment yield = [(FV - PP)/PP] * [365 or 366/M]

Example

What is the investment yield of a 182-day T-bill, auctioned at an average price of $9,659.30 per $10,000 face value?

Investment yield = [(FV - PP)/PP] * [365/M]

FV = $10,000 PP = $9,659.30 M = 182

Investment yield = [(10,000 - 9,659.30) / (9,659.30)] * [365/182]

Investment yield = [340.70] / 9,659.30] * [2.0054945]

Investment yield = .0707372 = 7.07%

For the 13-week bill, the same formula can be used, dividing 365 (or 366) by a maturity of 91 days.