## Questions on quiz feedback - PRM-III

shubhankar.limaye
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Posts: 14
Joined: Thu Feb 05, 2015 9:29 am

### Questions on quiz feedback - PRM-III

I have doubt in following question

bank overall loss at 1%worst case scenario is 10% of its assets of \$100 million. If the cost of liabilities is 5%p.a, and return an assets 7%p.a, what is the economic capital required by the bank on one year horizon.
Select one:
a. 2.86 million
b. 12.57 million Correct
c. 14.29 million
d. 5.00 million

The solution given is

ECO= AO(1-(1+RA)(1-L)/(1+RD)
=100(1-(1.02)(.90)/1.05)
=100X(1-.8743) = 12.57.
The correct answer is: 12.57 million.

However as per the I am confused with the arithmetic of the solution as the spread is taken in numerator instead of return on asset. I think correct answer should be 8.2857

shubhankar.limaye
Good Student
Posts: 14
Joined: Thu Feb 05, 2015 9:29 am

### Questions on quiz feedback - PRM-III

then the VaR of the portfolio C = A + B (perhaps under non normal conditions):
Select one:
a. Will certainly be smaller than or equal to 300
b. Will be exactly equal to 300
c. Can be greater or smaller than 300 Incorrect
d. Will be greater than 300

Feedback is

Will certainly be smaller than or equal to 300.
You cannot just add tail observations without knowing the distribution, and even then it takes some work. VaR is subadditive only under normal dist. Under non-normal dist, VaR of A+B can be greater than 300
The correct answer is: Will certainly be smaller than or equal to 300.

Based on the feedback correct answer seems to be C

shubhankar.limaye
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Posts: 14
Joined: Thu Feb 05, 2015 9:29 am
Also pl explain the math in following question

The Westover Fund is a portfolio consisting of 42% fixed-income investments and 58% equity investments. The manager of the Westover Fund recently estimated that the annual VAR (5%), assuming a 250-day year, for the entire portfolio was \$1,367,000 based on the portfolio's market value of \$12,428,000 and a correlation coefficient between stocks and bonds of zero. If the annual loss in the equity position is only expected to exceed \$1,153,000; 5% of the time, then the daily expected loss in the bond position that will be exceeded 5% of the time is closest to:
Select one:
a. \$72 623 Incorrect
b. \$46,445.
c. \$21,163.
d. \$55,171.

Feedback give is as under which is not clear

Feedback
\$46,445.

shubhankar.limaye
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Posts: 14
Joined: Thu Feb 05, 2015 9:29 am
Company EFG is a large derivative market-maker that has many contracts with counterparty JKL, some transacted in the same legal jurisdiction and others across different legal jurisdictions. As a result, EFG has some contracts with JKL covered under legally enforceable netting agreement A, some contracts with JKL covered under legally enforceable netting agreement B, and some contracts with JKL with no netting agreement. Ignoring the effect of margin, if the current value (i.e., market value of the contract minus collateral and recovery value) and the netting agreement status of each contract with JKL are as shown below, what is EFG’s current counterparty credit exposure to JKL?

Select one:
a. USD 6,914
b. USD 8,612
c. USD 2,341
d. USD 14,899 Incorrect

Feedback given is

USD 2,341.
Let PVi denote the EFG’s current value to JKL of contract i.e. Given the netting agreement coverage, current counterparty credit exposure to JKL (CE) is: CE = max(PV1 + PV2 + PV3, 0) + max(PV4 + PV5 + PV6 + PV7, 0) + max(PV8, 0)+max(PV9, 0) = max(USD 763, 0) + max(USD 6914, 0) + max(USD 2439, 0) + max(-USD 1504, 0) = USD 763 + USD 6914 + USD 2439 + 0 = USD10,116
USD 2,341

The explanation and answer are different

edupristine
Finance Junkie
Posts: 709
Joined: Wed Apr 09, 2014 6:28 am

### Questions on quiz feedback - PRM-III

Hi, the formula for economic capital is A0[1-(RA)(1-L)/(1+RD). Where, A0 is assets at time 0, Ra is nominal returns on asset, L is worst case loss from all the sources and Rd is nominal returns on liabilities. Therefore according to the question, A0= \$100mn, Ra= 2%, L=10%, rd=5%.Hence the calculations are correct and answer should be \$12.57million.

edupristine
Finance Junkie
Posts: 709
Joined: Wed Apr 09, 2014 6:28 am

### Questions on quiz feedback - PRM-III

Hi, answer to your query question : The Westover Fund is a portfolio consisting of 42% fixed-income investments and 58% equity investments. The manager of the Westover Fund recently estimated that the annual VAR (5%), assuming a 250-day year, for the entire portfolio was \$1,367,000 based on the portfolio's market value of \$12,428,000 and a correlation coefficient between stocks and bonds of zero. If the annual loss in the equity position is only expected to exceed \$1,153,000; 5% of the time, then the daily expected loss in the bond position that will be exceeded 5% of the time is closest to:
Select one:
a. \$72 623 Incorrect
b. \$46,445.
c. \$21,163.
d. \$55,171.
Is "B"
Explanation: VAR^2(portfolio)= VAR^2(stocks)+VAR^2(Bonds)+2VAR(stocks)*VAR(Bonds)*correlation(stocks,bonds)
(1367000)^2= (1,153,000)^2 + VAR^2 Bonds +2(1,153,000)*VAR(bonds)*(0)
Therefore, VAR(bonds)= [(1,367,000)^2-(1,153,000)^2]^0.5
which is equal to, 7,34,357
Next we have to convert the annual \$VAR(bonds) to Daily \$VAR(bonds) : 734357/(250)^0.5
= \$46,445