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Question 1 of 24
1. Question
Zoomplanet is a large company in the retail sector and Peter is drafting the first version of the company’s Operational Risk Register. The Operational Risk Register (aka, risk log) is a repository of each operational risk identified within the company and will be used in the operational risk management process. Peter starts by analyzing a list of Zoomplanet’s historical loss events in order to identify possible OPERATIONAL risk loss event categories. Each of the following is an operational risk loss event EXCEPT which is NOT an operational risk but instead PROBABLY belongs in a different category?
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Question 2 of 24
2. Question
Which of the following is MOST LIKELY to be considered a loss event classified under operational risk?
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Question 3 of 24
3. Question
Wayne Financial Enterprises is an international bank that trades publicly. Each of the following is an operational risk at Wayne EXCEPT which is probably NOT classified as an operational risk?
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Question 4 of 24
4. Question
Whitestreet Bank is merging with another bank and the newly merged international financial services firm is developing its executive organizational chart. There is an important question about the location of operational risk. Put another way, “who will own” operational risk; or, to which executive or committee will the operational risk report?
Each of the above is plausible but which is the LEAST LIKELY?
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Question 5 of 24
5. Question
Peter is developing an operational risk taxonomy (i.e., classification of operational risk categories) for his firm’s operational risk system. His manager says to Peter, “The most important criteria for your classification framework is that it identifies operational risk losses by their CAUSE(S) rather than their effect or some other event-type categorization, because we want to use this to proactively MANAGE operational risk and, in order to manage risk, we need to act on root causes.” In this case, which of the following classifications does the BEST job of classifying by CAUSES of operational risk rather than effects or some other factor?
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Question 6 of 24
6. Question
In an effort to re-establish trust with stakeholders in the wake of a public scandal that exposed key deficiencies in its culture and governance, Alphaholding International Bank has redesigned and re-staffed its risk management function. In particular, the bank’s new operational risk framework endeavors to reflect “sound practices” and/or “best practices” with respect to operational risk. Consequently, each of the following is an advisable (or at least plausible) practice EXCEPT which is the LEAST LIKELY to be a component of the new operational risk management framework?
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Question 7 of 24
7. Question
Acebase International Bank is a new international financial services firm that is the product of a merger between two different banks with very different geographical footprints, cultures and a somewhat different mix of business lines. Acebase has just designed a risk appetite framework (RAF) as the foundational element of its NEW operational risk framework (ORF). Each of the following features of Acebase’s RAF comports with best practice(s)–or is at least plausible–EXCEPT FOR which of these features is unlikely to be a key feature of its operational risk appetite framework?
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Question 8 of 24
8. Question
Gogogreen International Bank has a well-developed Operational Risk Governance framework that utilizes three lines of defense:
Assuming Gogogreen employs good or “best practices,” which of the following is TRUE about its three lines of defense?
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Question 9 of 24
9. Question
Techitrax Corporation has implemented an enterprise risk management (ERM) program by following these four steps (endorsed by Nooco and Stulz which happens to be an assigned FRM reading!):
- Management determined the firm’s risk appetite including chose the probability of financial distress expected to maximize firm value; in this case, credit ratings were used as the primary indicator of financial risk, so management determined a target (optimal) credit rating based on this risk appetite and the cost of reducing its probability of financial distress and calibrated the firm’s target rating at AA3 (Moody’s) or AA- (S*P)
- Given this target rating, management estimated the amount of capital required to support the risk of its operations.
- Management determined the optimal combination of capital and risk expected to yield its target rating.
- Management decentralized the risk-capital tradeoff with the help of a capital allocation and performance evaluation system that motivates managers throughout the organization to make investment and operating decisions that optimize this tradeoff.
Each of the following is true about this ERM program EXCEPT which is false?
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Question 10 of 24
10. Question
Operational data governance at Alphafind Financial Services includes the following data quality rules and/or procedures:
I. Each transaction record has a identifier (ID) called the primary key which prevents duplicates and manages dependencies in the SQL relational database
II. Key data samples from the database are routinely checked against a third-party “system of record” in order to ensure the values are corroborated by real-life entities
III. Key financial and market variables that are published in, and inform, client recommendation reports are time-stamped and include an “expiration (aka, to be used by) date”
IV. When financial values such as trailing 12-month earnings per share (EPS) are aggregated from different sources into the database, the values employ similar calculations so that they are comparable and comparisons are reasonable
These data quality rules do reflect EACH of the following desirable data quality dimensions EXCEPT which is NOT specifically reflected in Alphafind’s four rules above?
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Question 11 of 24
11. Question
Basel identifies seven high-level categories (Category Level 1) operational loss types, as follows:
- Execution, Delivery, and Process Management (EDPM)
- Clients, Products, and Business Practice (CPBP)
- Business Disruption and Systems Failures (BDSF)
- Internal Fraud
- External Fraud
- Employment Practices and Workplace Safety (EPWS)
- Damage to Physical Assets
Consider the following mistakes, mishaps and events:
I. Coding Error: a software code error causes the banks intelligent deposit machines to fail to create suspicious-transaction reports which leads the regular to impose fines due to a breach of anti money-laundering (AML) laws
II. Aggressive Sales: Motivated by compensation plans, certain retail branch managers use aggressive sales tactics to over-sell financial products to their customers, and in some cases the products are not “suitable” for the customers
III. Misunderstood Order: In the communication chain from client to banker to trader’s assistant to trader, because the client is a foreign-language speaker, the client’s trade is misunderstood and an order for $1,000,000 is placed rather than an order for $100,000 which is the trade the client intended (EDPM: Transaction Capture, Execution and Maintenance)
IV. Too-expensive Salesforce: The board hires a new chief executive officer (CEO) who re-organizes the sales force and and the sales incentive plan in order to accelerate cross-selling to large and national accounts, but the cost structure of the incentive plan is a persistent drag on profitability especially as competitors shift to cheaper online sales tactics
Which of these events or mistakes is an operational loss in the classic seven-category framework?
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Question 12 of 24
12. Question
Your colleague Barry shows you the first draft of a new Operational Risk Dashboard that will contains the firm’s operational key risk indicators (KRIs). The Risk Committee of the board has asked for key risk indicators and, specifically, that requested that the KRIs are distinguished from key performance indicators (KPIs) and key control indicators (KCIs). Here is Barry’s first draft:
At first glance, all four of these metric sets appear to be plausible key risk indicators (KRIs) EXCEPT which is the LEAST LIKELY to meet the board’s request for KRIs?
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Question 13 of 24
13. Question
Newzone International employs the loss distribution approach (LDA) to characterize the operational loss distribution over a one-year horizon. Under LDA, the loss frequency distribution is tabulated (aka, statistical convolution) with the loss severity distribution. For Newzone, the frequency and severity distributions are independent from one another and given by:
In this way, the expected frequency, E(F), is a probability weighted-average of 0.750 loss events per year, and the expected severity, E(S), is $12,000 which is equal to ($1,000 * 65.0%) + ($9,000 * 25.0%) + ($91,000 * 10.0%). What is the one-year operational unexpected loss (UL) at the 99.0% confidence level, which we could also refer to as the one-year relative (as opposed to absolute) operational value at risk (OpVaR) at the 99.0% confidence level?
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Question 14 of 24
14. Question
Sources of EXTERNAL operational loss data include news-based subscription service (for example, IBM Algo FIRST) or Consortium data (for example, ORX). Each of the following is true EXCEPT which is unlikely?
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Question 15 of 24
15. Question
704.3. In March 2016, the Basel Committee on Banking Supervision proposed the Standardized Measurement Approach (SMA) to operational risk regulatory capital. The proposal has been controversial. Consider the following five summary statements about the proposed SMA:
I. SMA proposes to eliminate the Advanced measurement approach (AMA) which currently (previously) allowed for the estimation of regulatory capital to be based on a diverse range of INTERNAL models
II. The SMA multiplies a Business Indicator (BI) Component by a Loss Multiplier (LM)
III. The SMA’s Business Indicator (BI) replaces the current (previous) Gross Income (GI) used in Basel’s BIA and STA approaches; the BI
IV. The Business Indicator (BI) consists of profit and loss (P&L) items that are mostly also found in the composition of Gross Income (GI)
V. The Loss Multiplier (LM) is calculated based on the bank’s own historical, internal operational loss data and the LM is meant to improve the risk sensitivity of the SMA
Which of the above statements is (are) TRUE?
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Question 16 of 24
16. Question
Techstreet Hedge Fund has active positions in cryptocurrency futures contracts and employs the peaks-over-threshold (POT) approach variation to characterize extreme potential loss tails according to extreme value theory (EVT). The fund estimates both value at risk (VaR) and expected shortfall (ES) at the 99.0% confidence level. Their choice of threshold, denoted (u) and shown below, is set at 3.0% which 30 losses among 1,000 observations; e.g., this might be sub-daily observations within a high-frequency environment. The full set of parameters are shown below, and further included are the formulas for both VaR and ES implied by the POT approach:
Each of the following statements is true EXCEPT which is false?
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Question 17 of 24
17. Question
Stephanie is a Risk Analyst who is trying to model the loss tail of an operation loss distribution that exhibits very low-probability but high-impact events. She decides to lean on extreme value theory (EVT) and consults with her colleagues. Among the following pieces of advice, each is basically true (ie., good advice) EXCEPT FOR which is likely untrue?
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Question 18 of 24
18. Question
Kevin Dowd outlines two basic approaches to extreme value tails. The first approach characterizes the set of each maximum loss within non-overlapping “blocks” of time (block maxima) with the generalized extreme value (GEV) distribution. The second approach characterizes the set of extreme losses above a threshold, regardless of their timing, with a generalized Pareto (GP) distribution. In regard to the extreme value theory (EVT) approach, which of the following statements is TRUE?
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Question 19 of 24
19. Question
Patty is a Risk Analyst who has been asked by her firm’s Chief Risk Officer (CRO) to review the firm’s risk modeling practices. She is currently evaluating a popular risk model used by the firm to asses the risk of its equity portfolios, in particular the firm depends on a parametric linear value at risk (VaR) approach. Her boss, the CRO, has asked her specifically to ensure that model risk is mitigated and consistent with best practices. If Patty’s mission is to mitigate model risk, which of the following practices is advisable?
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Question 20 of 24
20. Question
Assume that you want to identify the risk-adjusted return on capital (RAROC) of a new, contemplated $3.0 billion corporate loan portfolio that offers a headline return of 10.0%. The bank has an operating direct cost of $15.0 million per annum and an effective tax rate of 30.0%. The loan portfolio is funded by $3.0 billion of retail deposits with a “transfer priced” interest charge of 5.0%. Risk analysis of the unexpected losses (UL) associated with the portfolio indicates that for this portfolio that bank should allocate economic capital (EC) of $360.0 million, which is 12.0% of the loan amount. This economic capital must be invested in risk-free securities and the current risk-free interest rate is 3.0%. The expected loss on this portfolio is assumed to be 3.0% per annum, i.e., $90 million. Finally, the bank’s equity beta, β(E), is 1.30, and the market’s excess return is 8.0% such that the equity risk premium is 5.0%.
What is this loan’s RAROC and, from the perspective of an adjusted RAROC, is the new portfolio advisable?
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Question 21 of 24
21. Question
Crouhy, Galai, and Mark say that “we should be careful not to confuse the concept of risk capital (aka, economic capital), which is intended to capture the economic realities of the risks a firm runs, and regulatory capital. First, regulatory capital only applies to a few regulated industries, such as banking and insurance companies, where regulators are trying to protect the interests of small depositors or policy holders. Second, while regulatory capital performs something of the same function as risk capital in the regulators’ eyes, it is calculated according to a set of industrywide rules and formulas and sets only a minimum required level of capital adequacy. It rarely succeeds in capturing the true level of risk in a firm—the gap between a firm’s regulatory capital and its risk capital can be quite wide. Furthermore, even if regulatory and risk capital are similar numbers at the level of the firm, they may not be similar for each constituent business line (i.e., regulatory capital may suggest that an activity is much riskier than management believes to be the case, or vice versa).”
In addition to the distinction between economic capital and regulatory capital articulated above, EACH of the following statements is true EXCEPT which is inaccurate?
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Question 22 of 24
22. Question
Suppose that a hedge fund account, Lever Brothers Multistrategy Masters Fund LP, opens with an initial placement of $125.0 million in equity by its owners and $75.0 million in debt. As such, the firm’s initial leverage is 1.60 as illustrated by this economic balance sheet:
Consider the following three transactions in sequence:
- The purchase of stock with a value of $40.0 million (ie., a long equity position) where 50.0% of the purchase is borrowed from the broker (aka, margin loan) and the fund’s cash is used for the remaining $20.0 million
- A three-month currency forward in which the firm is short $30.0 million against the euro
- An at-the-money two-month long call option on S&P 500 equity index futures with an underlying index value of $100; where the option is assumed to be 50-delta.
What is the leverage of the fund after these three transactions?
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Question 23 of 24
23. Question
A key distinction is between market liquidity risk (aka, transaction liquidity risk) and funding liquidity risk (aka, balance sheet risk). As Malz (chapter 12) explains, “The term “liquidity” has been defined in myriad ways that ultimately boil down to two properties, transactions liquidity, a property of assets or markets, and funding liquidity, which is more closely related to creditworthiness. Transaction liquidity is the property of an asset being easy to exchange for other assets. Most financial institutions are heavily leveraged; that is, they borrow heavily to finance their assets, compared to the typical nonfinancial firm. Funding liquidity is the ability to finance assets continuously at an acceptable borrowing rate. For financial firms, many of those assets include short positions and derivatives.”
Digging a bit deeper, each of the following statements about liquidity risk is true EXCEPT which is false?
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Question 24 of 24
24. Question
Peter is a Risk Manager who is analyzing an equity position of 20,000 shares in an semi-liquid, non-public stock that has a current price of USD $50.00 per share. While Peter assumes the stock’s daily expected return is zero, its estimated daily return volatility is 100 basis points (1.00%). The mean bid-ask spread is USD $0.40 (80 basis points). The bid-ask spread volatility is 20 basis points, and Peter will assume the volatility spread multiplier, k = 3.0. Finally, Peter will assume normally distributed arithmetic returns (he will not assume normally distributed geometric returns; aka, lognormal).
Which of the following is nearest to the one-day 95.0% confident normal liquidity-adjusted value at risk (LVaR) using the exogenous spread (aka, volatile spread) approach?
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