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Question 1 of 21
1. Question
Presettlement credit risk (aka, credit risk) is the risk of loss due to default by a borrower or counterparty and its basic quantitative drivers (or components ) are exposure at default (EAD), default probability (PD, aka EDF), loss given default (LGD), default correlation, ρ, concentration, and time horizon. About these components, which of the following statements is TRUE?
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Question 2 of 21
2. Question
Analyst Jennifer needs to make an assumption for exposure at default (EAD) in the case of a revolving credit line that has been extended to a client, so that she can compute an expected loss (EL) on the credit line. The credit limit (aka, commitment) is $20.0 million, of which $6.0 million has been drawn (aka, outstanding). Her assumption, based on a single Brating equivalent for the Loan Equivalency Factor (LEQ; aka, usage given default, UGD) is 50.0%. Finally, her assumption for default probability (PD) is 5.0% and her assumption for loss given default (LGD) is 75.0%. What is the expected loss (EL) on the credit line?
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Question 3 of 21
3. Question
A credit portfolio consists of two $10.0 million exposures:
 Exposure #1 has an unexpected loss, UL(Exposure #1) = $557,000
 Exposure #2 has an unexpected loss, UL(Exposure #2) = $726,000
 The portfolio’s unexpected loss, UL(Exposure #1 + Exposure #2) = $1.0 million
 Their default correlation, ρ(Exposure #1, Exposure #2) is 20.0% or 0.20
Which is nearest to the risk contribution (RC) of Exposure #2?
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Question 4 of 21
4. Question
The risk management staff at an investment bank uses the Merton model to estimate the distance to default (DD) and expected default frequency (EDF) in evaluating default conditions for both potential and existing client firms. One such client currently has total assets valued at USD 20.0 billion, asset volatility, σ(A) of 28.0% per year, and debt with a face value of USD 12.0 billion. The expected return on the firm’s assets is 9.0% per year and the riskfree rate is 1.0%
per year. The firm does not pay any dividends. The rating schedule at a 1year horizon is shown in the table below: (inspired by GARP’s 2017 P2 Question #3).What is the suggested credit rating of the firm at a 1year horizon using the provided rating schedule?
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Question 5 of 21
5. Question
Below is plotted the cumulative survival time distribution under the assumption of a constant hazard rate.
Each of the following statements about this plot is true EXCEPT which is false?
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Question 6 of 21
6. Question
Consider a fiveyear bond that pays 7.0% semiannual coupon. If we assume the upwardsloping riskfree zero rate curve shown below, where the zero rates are expressed with continuous compounding, then the bond’s price is $103.57 and its implied yield 6.07% per annum with continuous compounding (which is equivalent to a yield of 6.16% with semiannual compounding):
However, assume the bond actually trades at par (that is, it’s current price is $100.00). If we recall that duration assumes a parallel shift in the rate curve (necessary given it is a singlefactor model), which is nearest the bond’s zspread when this bond prices at par?
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Question 7 of 21
7. Question
Suppose there are twenty (20) credits in a portfolio. Each credit has the same default probability of 5.0% and the (pairwise) default correlations are all zero; that is, as defaults are i.i.d. the portfolio is characterized by a binomial distribution, as displayed below. For example, the probability of exactly five defaults is equal to C(20,5)*0.050^5*0.950^15 = 0.0022446 = 0.22%.
If the par value of each position is $100.0 million such that the total portfolio value is $2.0 billion, and we assume the loss given default (LGD) is always 100.0%, then what is the 95.0% credit value at risk (CVaR) of the portfolio?
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Question 8 of 21
8. Question
Consider a pair of credits, one B+ and the other Brated, with default probability π(1) = 0.070 and π(2) = 0.110. If the defaults are uncorrelated, then the joint default probability π(12) = 0.070*0.110 = 0.00770. If, however, the default correlation is 0.20, then which is nearest to the corresponding INCREASE in the joint default probability? (inspired by Malz’ Example 8.1).
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Question 9 of 21
9. Question
Structured credit products (aka, portfolio credit products) are backed by creditsensitive (risky!) loans or bonds and tend to be characterized by the sequential distribution of credit losses via tranches which can be categorized into three groups: equity, junior and senior. The “waterfall” refers to the rules about how the cash flows from the collateral are distributed to the various securities in the capital structure. According to Malz’ analysis, each of the following is true about structured credit risk EXCEPT which is false?
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Question 10 of 21
10. Question
Today Plextech Bank enters into a fairly priced interest rate swap (“fairly priced” implies the value of the swap is zero at inception, T0) where Plextech Bank pays a fixed rate of 3.0% per annum with semiannual compounding in exchange for receiving sixmonth LIBOR from its counterparty; in this way, Plexttech Bank is the fixedrate payer. Interest payments are exchanged every six months (twice a year). The notional amount is USD $100.0 million and the tenor (swap life) is two years. When the bank enters the swap, the LIBOR/swap rate curve is flat at 3.0% per annum with semiannual compounding. Six months later, the LIBOR/swap rate shifts up by 50 basis points to 3.50%. At this time (T0 + 0.5 years), (immediately after the exchange) the current exposure of the bank will be nearest to what?
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Question 11 of 21
11. Question
Consider a netting set consisting of only two trades that tend to be negatively correlated, as illustrated below under five scenarios:
The expected exposure (EE) should assume each scenario has equal weight, such that here expected exposure is the simple average of the five scenario exposures. If we define the netting factor as the ratio of net (i.e., with netting) expected exposure to gross (i.e., without netting) expected exposure, then what is the netting factor?
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Question 12 of 21
12. Question
About the potential future exposure (PFE) of various instruments, each of the following is true EXCEPT which is false?
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Question 13 of 21
13. Question
In counterparty credit risk (CCR), exposure profiles plot credit exposure against time. The metric is typically expected exposure (EE) or potential future exposure (PFE). Consider the following four exposure profiles for (a) a vanilla fixedforfloating interest rate swap, (b) a 5year loan, (c) a short European option position and (d) and long credit default swap; i.e., buying protection which is synthetically short the reference:
Each of the (above) four profiles is a plausible credit exposure curve except which is FALSE?
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Question 14 of 21
14. Question
Each of the following statements about credit exposure metrics is true EXCEPT which is false?
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Question 15 of 21
15. Question
A chief risk officer (CRO) asked her risk department to evaluate the bank’s 3year derivative exposure to a counterparty. The 1year credit default swap (CDS) on the counterparty is currently trading at a spread of 100 bps. The table below presents trade and forecast data on the the expected exposure, collateral, CDS spread, and the recovery rate with respect to the position:
Additionally, the CRO has presented the risk team with the following set of assumptions to use in conducting the analysis:
 The counterparty’s default probabilities follow a hazard rate process
 The investment bank and the counterparty have signed a credit support annex (CSA) to cover this exposure, which requires collateral posting throughout the life of the contract; as illustrated above, projected posted collateral will be $10.0, $15.0 and 20.0 million, respectively, in Years 1, Year 2, and Year 3.
 The current riskfree rate of interest is 3.0% per annum with continuous compounding and the term structure of interest rates is predicted to remain flat over the 3year horizon
Given the information and the assumptions above, what is nearest the correct estimate for the credit valuation adjustment (CVA) for this positon? Note: this question is inspired by GARP’s 2017 P2 Practice Exam Question #76.
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Question 16 of 21
16. Question
According to Jon Gregory, wrongway risk (WWR) is a subtle but potentially strong effect and further WWR is “often a natural and unavoidable consequence of financial markets.”
Wrongway risk (WWR) generally describes an unfavorable codependency between exposure and the credit quality of the counterparty. In more exact and operational terms, in a wrongway risk (rightway risk) the exposure increases (decreases) as the probability of the counterparty’s default increases (decreases). In this way, we can either say that wrongway risk is a positive correlation, or dependence, between exposure and default probability; or equivalently WWR is a
negative correlation between exposure and counterparty credit quality.Which of the following statements is additionally TRUE about wrongway risk?
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Question 17 of 21
17. Question
Since the global financial crisis (GFC), there has been a push for better stress testing of counterparty credit risk (CCR) exposures. In many cases, a financial institution will consider its unilateral credit valuation adjustment (CVA) for stress testing which concerns the fact that its counterparties could default under various market scenarios. But in addition, the financial institution will evaluate its bilateral CVA, which adds the possibility of its own default to counterparties.
According to David Lynch of the Board of Governors of the Federal Reserve, each of the following is true–or at least GOOD ADVICE, EXCEPT which is not true?
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Question 18 of 21
18. Question
Gadgetron has a twoway credit support annex (CSA) with a counterparty covering a portfolio that has just been marked to a value of $1,980,000 or $1.980 million. The collateral terms include the following:
 Initial margin: $250,000
 Portfolio marktomarket (MTM) value: +$1,980,000 (from Gadgetron’s perspective)
 Threshold: $1,000,000
 Marktomarket (MTM) of collateral already held: $770,000
 Minimum transfer amount: $100,000
 Rounding: $25,000 (always in favor of Gadgetron; i.e., round up a collateral call, round down a collateral return by Gadgetron)
Which of the following is the collateral call amount that must be posted by Gadgetron’s counterparty?
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Question 19 of 21
19. Question
Both the credit default swap (CDS) and the total return swap (TRS, aka TRORS) can be used to hedge risk, but the TRS is a more comprehensive hedge instrument. While the CDS hedges credit risk–in particular, default risk and credit deterioration risk–the TRS hedges both credit and market risk. Consider the mechanical similarities and differences, as illustrated below.
About the CDS and TRS, each of the following statements is true EXCEPT which is false?
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Question 20 of 21
20. Question
You are pricing (aka, valuation) a tobe newly issued mortgagebacked security (MBS) where the mortgage pool has an original loan balance of $20.0 million. Due to lower interest rates, your model makes an assumption of 235% Public Securities Association (PSA). Under this assumption, which of the following is the nearest to the model’s prepayments in the first month (excluding the scheduled prepayment, of course)?
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Question 21 of 21
21. Question
Consider the following schedule for a 60month loan with an original principal balance of $300,000 and yield of 5.0%. The loan fully amortizes (please note the schedule is truncated such that months six through 56 are skipped).
Each of the following is true EXCEPT which is false?
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