MOCK 1

Part I – Open questions

(3 questions, each one is worth 4 points. Answers should not exceed 250 words)

1. Making reference to credit risk, explain what is the logic underlying the Merton
model and what are its main underlying assumptions.
2. Critically discuss, indicating whether true or false, the following statement: "PD and
LGD tend to be positively correlated. This is because a borrower with a high PD is
generally characterized by a poor quality of its assets. Therefore, in a liquidation
process following a default the LGD tends to be higher”.
 Part II – Multiple choice questions
(9 questions, each one is worth 2 points)
5. Which of the following does not represent an underlying assumption of the discriminant
analysis model?
A. The variance–covariance matrices of the independent variables are equal for the two
groups of companies (good and bad)
B. The multivariate normal distribution of independent variables (when the score is
used to estimate PDs)
C. The independent variables represented by the financial ratios are independent (zero
correlation)
D. All of the above are underlying assumptions of the discriminant analysis model
6. In the KMV model, EDF is estimated
A. Computing the exercise probability of a put option with a strike price equal to the
value of debt
B. Based on a sample of listed companies, some of which did default in the past
C. Based on a sample of rated companies, some of which did default in the past
D. Computing the probability of exercise of a call option with strike price equal to the
value of the company’s assets
7. Which of the following statement concerning the CreditRisk+ model is correct?
A. CreditRisk+ does not consider recovery risk but takes into account migration risk
B. CreditRisk+ does not consider migration risk and allows to indirectly model the
correlations among defaults
C. CreditRisk+ uses the banding technique to move from the distribution of losses to
the distribution of defaults
D. CreditRisk+ assumes constant exposures and considers recovery risk
8. With the Basel 3 reform, the highest quality form of capital is represented by (I), followed
by (II).
A. (I) Contingent capital, (II) Tier 2 Capital
B. (I) Common equity Tier 1, (II) Additional Tier 1
C. (I) Common equity Tier 1, (II) Capital conservation buffer
D. (I) Common equity Tier 1, (II) Upper Tier 1
9. Insurers’ liabilities share with the long-term liabilities of other institutions (i.e., bonds
issued by a financial or non-financial company):
A. the duty to pay fixed amounts of money as well as they share the certainty of the
timing of the future fixed cash flows
B. the duty to pay fixed amounts of money but do not share the certainty of the timing
of the future fixed cash flows
C. the duty to pay fixed or indexed amounts of money as well as they share the
certainty of the timing of the future fixed or indexed cash flows
D. the duty to pay fixed or indexed amounts of money but do not share the certainty of
the timing of the future fixed or indexed cash flows
DOMANDE PPT

Making reference to the Basel 2 framework for capital regulation:

I. describe the four parameters that are used to estimate a bank credit risk capital
requirement under the advanced internal ratings based (A-IRB) approach and explain
how their estimates differ from the one of the foundation approach;
II. explain what is downgrade/migration risk and how this is taken into account in the
IRB approach;
III. critically discuss, stating if true or false, the following statement: “Under the Basel 2
IRB approach the risk weights of different credit exposures are computed assuming
one unique correlation coefficient, thereby penalizing those exposures that have a
lower sensitivity to systematic factors”

Making reference to the new accord on bank prudential regulation known as Basel 3:
• explain what are “hybrid” and “innovative” capital instruments, why they were
successful before the 2007-2009 financial crisis, what negative role they played
during the crisis, and how Basel 3 has dealt with this issue;
• explain what is meant with the term “procyclycality” of capital requirements and
briefly describe the two additional capital buffers that have been introduced with
Basel 3 to reduce it;
• critically discuss, stating if true or false, the following argument: “The “bail-in” clause
introduced with Basel 3 implies that if a bank gets into a crisis, its common shares
will be converted into bonds before any government intervention takes place. This
way the existing shareholders will lose their voting rights and will not be able to
control the bank any longer.”

Making reference to LGD:

• explain at least three factors affecting the LGD of a credit exposure and how they
affect it;
• describe the difference between market LGD and workout LGD and show, through a
simple numerical example, how the workout LGD of a defaulted bank loan can be
computed;
• critically discuss, stating if true or false, the following statement: “Consider a loan
with a PD of 5% and an expected LGD of 50%. The volatility of the loss on such a loan
is an increasing function of the volatility of the LGD and goes to zero when the
volatility of LGD is zero (that is, if the bank can forecast with no error the actual loss
in the event of a default).”.

In the multinomial Merton model used by Creditmetrics it is necessary to identify a number

of «asset value return thresholds» («AVRT»). Which of the following statements is correct?
A. AVRTs are equal to the number of rating grades, plus default
B. AVRTs are identified based on the borrowing company financial statements
C. AVRTs depend on the correlation among borrowers
 D. AVRTs are identified based on the forward rates corresponding to different
rating grades

The model that estimates a corporate PD based on the equivalence of the expected values
at maturity starting from credit spreads:
E. Overestimates PD as it assumes investors are risk averse
F. Underestimates PD as it assumes that investors are risk averse
G. Overestimates PD as it assumes investors are risk neutral
H. Underestimates PD as it assumes investors are risk neutral

In the CreditRisk+ model, «banding» allows to

A. Use the Poisson random variable to estimate the probabilitiy associated to
losses
B. Inject correlation into the model
C. Divide the portfolio in many subportfolios where losses are proportional to
the number of defaults
D. Apply the Poisson also to portfolios with high PDs

In the creditmetrics model, a rating downgrade:

- Produces a loss that is greater the longer the loan’s maturity
- Does not lead to any loss as it does not produce a default
- Leads to a decrease in LGD and therefore value of the loan
- Gives rise to a loss which is larger the better the original credit rating

A loan portfolio RAROC…

A. Must be estimated as the ratio between net profit and the sum of the
individual loans marginal VaRs
B. Must be estimated as the ratio between net profit and portfolio VaR
C. Does not exist, as RAROC can only be computed for single loans as VaR is
never subadditive
D. Depends on the risk premium required by the bank’s shareholders

Assume a bank is evaluating, using the same historical data, alternative scoring models to
estimate the PDs for a set of borrowers. Which of the following statement is/are correct
I. While logit and probit models have the same coefficients, the resulting PDs are different
II. Linear probability models outputs need to be truncated between 0 and 1, for their results
to be equal to those of a logit model.
III.Linear probability models, unlike Iogit models., produce unhiased estimates
IV. While logit and probit models have different coefficients, their outputs are equivalent

A. None of them
B. Onv IV
C. Only I and Il
D. Only Ill