PRMIA 8008 Exam With Confidence Using Practice Dumps

According to the Basel II framework, Tier 1 capital, also called core capital or basic equity, includes equity capital and disclosed reserves.

Tier 2 capital, also called supplementary capital, includes undisclosed reserves, revaluation reserves, general provisions/general loan-loss reserves, hybrid debt capital instruments and subordinated term debt issued originally for 5 years or longer.

Tier 3 capital, or short term subordinated debt, is intended only to cover market risk but only at the discretion of their national authority. This only includes short term subordinated debt originally issued for 2 or more years.

An interesting thing to note is the difference between 'subordinated term debt' under Tier 2 and the 'short term subordinated debt' under Tier 3. The distinction is based upon the years to maturity at the time the debt was issued. The remaining time to maturity is not relevant. For the subordinated term debt included under Tier 2, the amount that can be counted towards capital is reduced by 20% for every year when the debt is due within 5 years. This takes care of the time to maturity problem for Tier 2 subordinated debt. For Tier 3 short term subordinated debt, this is not an issue because debt will only qualify for Tier 3 if it has a lock-in clause stipulating that the debt is not required to be repaid if the effect of such repayment is to take the bank below minimum capital requirements.

When VaR is based on an assumption of normality with a static mean and volatility, it means anything that violates these assumptions will introduce model error. Volatility clustering implies a non-static volatility. Heavy tails imply non-normality of the shape of the distribution. Autocorrelation of squared returns implies that returns are not independent and identically distributed. Therefore all of these introduce model error. Choice 'd' is therefore the correct answer.

GARCH is a mean reverting model of volatility, with a steady state mean that the model reverts to in the absence of market shocks. EWMA is not mean reverting and volatility under EWMA stays constant in the absence of shocks. Therefore statement I is correct.

Both EWMA and GARCH models are designed to address volatility clustering, which explains much of the non-normality of returns. When returns are standardized to the volatility calculations under either of these methods, the returns appear far closer to the normal distribution than non-standardized returns. (If it were not to, then there would have been no point in using these techniques.) Statement II is correct.

Steady state variance under GARCH is defined as ω / (1 - α - β), where α and β are the two parameters (called the reaction and persistence coefficient respectively). Clearly, it is affected by more than just the persistence coefficient, therefore statement III is not correct.

Sub-additivity is a very desired property in risk measures. It implies the sum of the parts is greater than the whole. In the case of risk measures, the whole is smaller than the sum of the parts due to diversification. Statement IV is true.

Therefore the correct answer is Choice 'c'