PRMIA 8010 Exam - Topic 1 Question 40 Discussion

Actual exam question for PRMIA's 8010 exam

Question #: 40
Topic #: 1

Company A issues bonds with a face value of $100m, sold at $98. Bank B holds $10m in face of these bonds acquired at a price of $70. Company A then defaults, and the recovery rate is expected to be 30%. What is Bank B's loss?

A$7m

B$4m

C$2.1m

D$4.9m

Show Suggested Answer

Suggested Answer: C

The current Basel rules for the basic VaR based charge for market risk capital set market risk capital requirements as the maximum of the following two amounts:

1. 99%/10-day VaR,

2. Regulatory Multiplier x Average 99%/10-day VaR of the past 60 days

The 'regulatory multiplier' is a number between 3 and 4 (inclusive) calculated based on the number of 1% VaR exceedances in the previous 250 days, as determined by backtesting.

- If the number of exceedances is <= 4, then the regulatory multiplier is 3.

- If the number of exceedances is between 5 and 9, then the multiplier = 3 + 0.2*(N-4), where N is the number of exceedances.

- If the number of exceedances is >=10, then the multiplier is 4.

So you can see that in most normal situations the risk capital requirement will be dictated by the multiplier and the prior 60-day average VaR, because the product of these two will almost often be greater than the current 99% VaR.

The correct answer therefore is = max(200mm, 3*250mm) = $750mm.

Interestingly, also note that a 99% VaR should statistically be exceeded 1%*250 days = 2.5 times, which means if the bank's VaR model is performing as it should, it will still need to use a reg multiplier of 3.

by Karl at Jan 28, 2024, 10:51 AM

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Roslyn

6 months ago

How can the recovery rate be only 30%? Seems low!

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Sunshine

6 months ago

Definitely $4m, can't believe some people are confused.

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Ozell

7 months ago

Wait, so they bought at $70? That's a huge discount!

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Lorrine

7 months ago

I think it's actually $4.9m, not sure about the math.

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Shawnta

7 months ago

Bank B's loss would be $4m based on the recovery rate.

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Garry

7 months ago

This question feels similar to one we practiced, but I’m confused about how the purchase price affects the loss calculation.

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Nenita

7 months ago

If I remember correctly, the recovery rate is applied to the face value, so I think I need to calculate that first before figuring out the loss.

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Paul

7 months ago

I think the loss is based on the difference between what Bank B paid and what they recover, but I can't recall the exact numbers.

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Ben

8 months ago

I remember we calculated losses based on recovery rates in class, but I'm not sure how to apply it here with the bond price.

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Sheron

8 months ago

I'm feeling pretty confident about this one. The key is to use the given information to calculate the difference between what Bank B paid and what they'll recover.

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Peggie

8 months ago

This seems straightforward enough. I'll start by calculating the total amount Bank B paid for the $10m in bonds, then subtract the expected recovery amount.

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Alida

8 months ago

Hmm, I'm a bit confused on how to approach this. Do we need to factor in the face value, sale price, and recovery rate somehow?

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Kate

8 months ago

Okay, let's think this through step-by-step. We need to calculate Bank B's loss on the $10m in bonds they acquired at $70 each.

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Stefania

8 months ago

Okay, I've got this. EBS snapshots are stored in S3, so we should be able to access them through the S3 APIs. Option A looks like the right answer here.

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Carlee

8 months ago

I'm leaning towards option C for the fixed costs, but I'm not absolutely certain. I'll need to double-check my calculations just in case.

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Jesus

8 months ago

I think D stands out as the bank is advertising securities brokerage services. That feels like something that could require registration.

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Kristin

1 year ago

This question is making my head spin. I need a calculator and a nap. Or maybe just the nap. Anyone else feeling like they're about to default on their exam?

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Dyan

11 months ago

I agree with you, C) $2.1m sounds right.

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Leonida

11 months ago

I'm going with C) $2.1m.

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Thurman

11 months ago

No, I believe it's B) $4m.

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Antione

11 months ago

I think the answer is A) $7m.

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Blair

1 year ago

Hmm, I'm not entirely sure about this one. Let me think it through. Oh, I know! The answer must be B) $4m. I'm confident in this one, trust me, I'm an expert in bond defaults. (Or at least, I think I am.)

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Nancey

12 months ago

I agree with you, it must be B) $4m.

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Geoffrey

12 months ago

I believe it's C) $2.1m.

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Aretha

12 months ago

I think the answer is A) $7m.

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Pamela

1 year ago

Wait, wait, hold on. If the recovery rate is 30%, that means 70% of the face value is lost. So, shouldn't the answer be C) $2.1m? I'm not sure, but it seems like the most logical solution to me.

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Leonardo

11 months ago

Yes, Bank B's loss would be $7m, so the correct answer is A) $7m.

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Kayleigh

11 months ago

So, Bank B's loss would be $7m, which is 70% of the $10m face value they hold.

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Kasandra

12 months ago

I think you're right, the recovery rate of 30% means 70% of the face value is lost.

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Vonda

1 year ago

Got it, so Bank B's loss would be $7m, and with a recovery rate of 30%, the final loss would be $2.1m. C) $2.1m is the correct answer.

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Ronna

1 year ago

Yes, that makes sense. Bank B's loss would be 70% of the $10m face value, which is $7m. So, the correct answer is C) $2.1m.

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Phil

1 year ago

I think you're right, the recovery rate of 30% means 70% of the face value is lost, so the answer should be C) $2.1m.

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Tamra

1 year ago

I'm not sure, but I think the answer might be A) $7m because Bank B holds $10m in face value of bonds and the recovery rate is 30%.

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Mi

1 year ago

I agree with Yolande, the recovery rate is 30% so Bank B's loss would be $7m.

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Yolande

1 year ago

I think the answer is A) $7m.

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Lynsey

1 year ago

But Bank B only holds $10m in face value of the bonds, so the loss should be $4m.

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Dusti

1 year ago

Okay, let's see. Bank B acquired the bonds at $70 each, and the face value is $100m. When Company A defaulted, the recovery rate was 30%. So, I'm guessing the correct answer is D) $4.9m.

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