Online 8008 Questions Video

In December 2009 the BIS came out with a new consultative document on liquidity risk. Given the events of 2007 - 2009, it has been clear that a key characteristic of the financial crisis was the inaccurate and ineffective

management of liquidity risk

The paper two separate but complementary objectives in respect of liquidity risk management: The first objective relates to the short-term liquidity risk profile of institution, and the second objective is to promote resiliency over longer-term time horizons. The paper identifies the following two ratios - you should be aware of these - though I am not sure if these will show up in the PRMIA exam:

1. Liquidity Coverage Ratio addresses the ability of an institution to survive an acute liquidity risk stress scenario lasting one month. It is calculated as follows:

Liquidity Coverage Ratio = Stock of high quality liquid assets/Net cash outflows over a 30-day time period

2. Net Stable Funding Ratio has been developed to capture structural issues related to funding choices.

Net Stable Funding Ratio = Available amount of stable funding/Required amount of stable funding

Both ratios should be equal to or greater than 1. The statement contains detailed definitions of what is included or excluded from each of the terms used in the calculations for each of the ratios. In addition, the standard also describes the what the 'acute' scenario should include (things such as a 3 notch credit downgrade, reduction in retail deposits etc)

Therefore Choice 'b' is the correct answer. Book Value to Share Price and Earnings Per Share are accounting measures unrelated to liquidity.

The index option is affected by the spot value for the underlying index, as also the risk free interest rate, or the zero rate for the duration of the option. It is also affected by the volatility of the underlying. The 'strike price' is set and is fixed at the time the option is purchased, and therefore is not a risk factor.

Therefore other than IV, all other choices are valid risk factors that underlie an equity index option.

Other instruments may have other risk factors - for example, a long forex position will have the spot exchange rate as the only risk factor.

The recovery rate, the default hazard rate (also called the average default intensity) and the spread on debt are linked by the equation Hazard Rate = Spread/(1 - Recovery Rate). Therefore, the recovery rate implicit in the given data is = 1 - 8%/10% = 20%.

Choice 'c' is the correct answer. The Markov property is the assumption that there is no ratings momentum, and that transition probabilities are dependent only upon where the rating currently is and where it is going to. Where it has come from, or what the past changes in ratings have been, have no effect on the transition probabilities. ('Herstatt risk' refers to settlement risk, and is irrelevant.)