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CAIIB ABM practice questions

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Question 1Advanced Bank Management (ABM)

Under the Basel III liquidity framework, which ratio requires a bank to hold sufficient high-quality liquid assets to survive a 30-day stressed cash outflow scenario?

  1. Capital Conservation Buffer
  2. Liquidity Coverage Ratio Correct answer.
  3. Leverage Ratio
  4. Net Stable Funding Ratio

Explanation

The Liquidity Coverage Ratio compares the stock of high-quality liquid assets with total net cash outflows estimated over a 30-calendar-day stress period, ensuring short-term resilience. The other metrics address structural funding, leverage, or capital buffers rather than a 30-day liquidity horizon.

Question 2Advanced Bank Management (ABM)

A firm's current ratio is 1.8 and its quick ratio is 1.1. Which conclusion best interprets this gap?

  1. Long-term debt exceeds working capital
  2. Inventory forms a substantial part of current assets Correct answer.
  3. Cash reserves exceed current liabilities
  4. The firm is technically insolvent

Explanation

The quick ratio strips inventory out of current assets, so a large fall from the current ratio to the quick ratio signals that inventory is a heavy component of current assets. The other conclusions cannot be drawn from these two ratios alone.

Question 3Advanced Bank Management (ABM)

In cost-volume-profit analysis, the contribution margin per unit is best described as:

  1. Selling price per unit minus total cost per unit
  2. Net profit divided by units sold
  3. Selling price per unit minus variable cost per unit Correct answer.
  4. Total fixed cost divided by output volume

Explanation

Contribution margin per unit equals selling price less variable cost per unit, and it contributes first toward fixed costs and then toward profit. Dividing fixed costs by volume gives fixed cost per unit, while price less total cost per unit gives unit profit.

Question 4Advanced Bank Management (ABM)

A bond with a face value of 1000 pays an annual coupon of 80 and is currently priced at 950. What is its current yield?

  1. 8.42% Correct answer.
  2. 8.00%
  3. 7.60%
  4. 10.53%

Explanation

Current yield equals the annual coupon divided by the market price, so 80 divided by 950 gives approximately 8.42 percent. The 8.00 percent figure is the coupon rate on face value, and the other figures misapply the denominator.

Question 5Advanced Bank Management (ABM)

When a bank's asset duration exceeds its liability duration, a rise in interest rates will typically:

  1. Increase net worth because liabilities are repriced downward
  2. Leave net worth unchanged because duration gaps offset automatically
  3. Reduce the bank's net worth because assets lose more value than liabilities Correct answer.
  4. Increase net worth because assets reprice faster than liabilities

Explanation

Duration measures price sensitivity to interest rate changes, so a positive duration gap means asset values fall more than liability values when rates rise, eroding net worth. The other options misstate the direction or assume automatic offsetting.

Question 6Advanced Bank Management (ABM)

Under a floating exchange rate regime, which factor would most directly place downward pressure on a currency's value?

  1. A narrowing of the trade deficit
  2. A rise in the domestic central bank policy rate
  3. An increase in foreign direct investment inflows
  4. A sharp fall in export demand reducing foreign currency inflows Correct answer.

Explanation

Weaker export demand reduces the supply of foreign currency and demand for the domestic currency, tending to depreciate it. Higher policy rates and stronger capital or trade inflows generally support the currency instead.

Question 7Advanced Bank Management (ABM)

In the Basel capital framework, Common Equity Tier 1 capital primarily consists of:

  1. Subordinated debt with a maturity of at least five years
  2. General provisions for standard assets
  3. Revaluation reserves from property
  4. Ordinary shares and retained earnings Correct answer.

Explanation

Common Equity Tier 1 is the highest-quality capital, made up mainly of ordinary shares, share premium and retained earnings after regulatory deductions. Subordinated debt belongs to Tier 2, and provisions are not core equity.

Question 8Advanced Bank Management (ABM)

A bank estimates that a portfolio has a one-day 99 percent Value at Risk of 20 million. Which interpretation is correct?

  1. Average daily loss over a year will be 20 million
  2. The portfolio will lose exactly 20 million once every hundred days
  3. The maximum possible loss on any single day is 20 million
  4. Losses are expected to exceed 20 million on about one trading day in a hundred Correct answer.

Explanation

Value at Risk at 99 percent states that there is a one percent probability of loss exceeding the stated amount over the horizon, here one day. It is a probabilistic threshold, not a maximum loss or a deterministic average.

Question 9Advanced Bank Management (ABM)

Which of the following best describes the function of a cash flow statement in financial analysis?

  1. It determines the tax liability of the entity
  2. It explains movements in cash across operating, investing and financing activities Correct answer.
  3. It records revenue when earned regardless of cash receipt
  4. It shows the break-up of share capital and reserves

Explanation

The cash flow statement classifies cash movements into operating, investing and financing activities, reconciling opening and closing cash balances. Accrual revenue recognition belongs to the income statement, and capital break-up appears in the balance sheet.

Question 10Advanced Bank Management (ABM)

A project requires an initial outlay of 500000 and generates annual cash inflows of 150000 for five years. Using a discount rate of 10 percent, the decision under the net present value rule should be to:

  1. Reject, because the internal rate of return is below 10 percent
  2. Accept, because total inflows exceed the outlay in nominal terms
  3. Accept, because the present value of inflows exceeds the outlay Correct answer.
  4. Reject, because the payback period exceeds three years

Explanation

At 10 percent the annuity factor for five years is about 3.791, giving a present value of inflows near 568650, which exceeds the 500000 outlay and yields a positive NPV. Payback and undiscounted totals are not the NPV decision criteria.

Question 11Advanced Bank Management (ABM)

Under the Basel III framework, the Capital Conservation Buffer is designed primarily to:

  1. Restrict distributions when capital falls within the buffer range Correct answer.
  2. Set a floor on the leverage ratio
  3. Replace the minimum capital requirement entirely
  4. Fund deposit insurance premiums

Explanation

The Capital Conservation Buffer requires banks to build capital above the minimum and restricts dividends and bonuses when capital falls into the buffer range. It supplements rather than replaces minimum requirements.

Question 12Advanced Bank Management (ABM)

In a documentary letter of credit, which party assumes the primary undertaking to pay the beneficiary against compliant documents?

  1. The advising bank
  2. The applicant
  3. The issuing bank Correct answer.
  4. The negotiating bank

Explanation

The issuing bank gives the primary irrevocable undertaking to honour a complying presentation. The advising bank merely communicates the credit, the applicant is the buyer, and a negotiating bank may discount documents without assuming the issuing bank's primary obligation.

Question 13Advanced Bank Management (ABM)

A bank's net interest margin is computed as:

  1. Net interest income divided by average earning assets Correct answer.
  2. Net profit divided by total assets
  3. Interest income divided by total deposits
  4. Operating profit divided by net worth

Explanation

Net interest margin measures net interest income as a proportion of average earning assets, showing the spread earned on productive assets. The other ratios measure overall profitability or return on equity rather than interest spread efficiency.

Question 14Advanced Bank Management (ABM)

A bank holds a portfolio of loans where defaults are assumed to be independent and each loan has a 2 percent probability of default. If the bank holds 100 such loans, the expected number of defaults is:

  1. 0.2
  2. 2 Correct answer.
  3. 50
  4. 20

Explanation

The expected number of defaults is the number of exposures multiplied by the default probability, so 100 times 0.02 equals 2. Independence affects the variance of defaults, not the expected count.

Question 15Advanced Bank Management (ABM)

Which of the following best explains why a bank with a high proportion of demand deposits may still face liquidity risk?

  1. Demand deposits must be invested only in government securities
  2. Demand deposits can be withdrawn at short notice while loans are illiquid Correct answer.
  3. Demand deposits are excluded from regulatory liquidity metrics
  4. Demand deposits always carry the highest interest cost

Explanation

Demand deposits are payable on demand, while the loans funded by them are typically long-term and hard to sell quickly, creating a maturity mismatch. Interest cost and regulatory treatment do not remove this structural vulnerability.

Question 16Advanced Bank Management (ABM)

In foreign exchange, a forward contract differs from a futures contract mainly because a forward contract:

  1. Is settled only through a clearing house
  2. Requires daily mark-to-market margining
  3. Is customised and traded over the counter Correct answer.
  4. Is standardised and exchange-traded

Explanation

Forwards are privately negotiated over-the-counter contracts tailored to the counterparties' needs, whereas futures are standardised, exchange-traded and daily margined. The other options describe futures characteristics.

Question 17Advanced Bank Management (ABM)

A company has earnings before interest and tax of 800000, interest expense of 200000 and a tax rate of 30 percent. Its interest coverage ratio is:

  1. 5.6
  2. 2.8
  3. 4.0 Correct answer.
  4. 1.6

Explanation

Interest coverage equals EBIT divided by interest expense, so 800000 divided by 200000 gives 4.0. Tax is irrelevant to this ratio, and the other figures misapply the calculation.

Question 18Advanced Bank Management (ABM)

Under the standardised approach to operational risk under Basel III, the capital charge is calculated using:

  1. A business indicator component multiplied by a marginal coefficient Correct answer.
  2. Number of employees multiplied by a loss factor
  3. Gross income multiplied by a fixed 15 percent
  4. Total assets multiplied by a beta factor

Explanation

The standardised approach uses a Business Indicator, scaled by marginal coefficients applied in bands, to derive the operational risk capital charge. It replaced the simpler gross-income approaches that used a single fixed percentage.

Question 19Advanced Bank Management (ABM)

Which instrument is most appropriate for a bank seeking to hedge against a fall in the value of a bond portfolio it holds?

  1. Entering a pay-fixed interest rate swap as receiver
  2. Selling interest rate futures Correct answer.
  3. Buying a call option on bonds
  4. Purchasing a currency forward

Explanation

Selling interest rate futures creates a short position that gains when bond prices fall, offsetting portfolio losses. Buying a call option profits when prices rise, and a currency forward hedges exchange rate rather than interest rate exposure.

Question 20Advanced Bank Management (ABM)

In the context of non-performing assets, a substandard asset is one that has remained non-performing for a period:

  1. Exceeding 36 months
  2. Exceeding 12 months
  3. Up to 12 months Correct answer.
  4. Exceeding 24 months

Explanation

A substandard asset is one classified as non-performing for a period up to 12 months. Beyond that it moves to doubtful, and loss assets are those identified as uncollectible.

Question 21Advanced Bank Management (ABM)

A bank's return on equity is 15 percent and its return on assets is 1.5 percent. Its equity multiplier is approximately:

  1. 22.5
  2. 1.5
  3. 0.1
  4. 10 Correct answer.

Explanation

By the DuPont relationship, return on equity equals return on assets multiplied by the equity multiplier, so 15 divided by 1.5 gives 10. The multiplier reflects leverage, meaning assets are about ten times equity.

Question 22Advanced Bank Management (ABM)

Which of the following is the primary purpose of stress testing in bank risk management?

  1. To set the interest rate on new retail loans
  2. To calculate the average historical loss rate for provisioning
  3. To determine the daily profit and loss of the trading book
  4. To assess the impact of severe but plausible adverse scenarios on capital and liquidity Correct answer.

Explanation

Stress testing evaluates how portfolios, capital and liquidity behave under severe but plausible adverse scenarios, including combinations of shocks. Historical loss averages and daily profit reporting serve different purposes.

Question 23Advanced Bank Management (ABM)

A firm reports a gross profit margin of 25 percent and a net profit margin of 6 percent. Which explanation is most consistent with this gap?

  1. The cost of goods sold is unusually high relative to sales
  2. Tax rates are negative for the firm
  3. High operating expenses and interest costs absorb most of the gross margin Correct answer.
  4. The firm has no fixed operating costs

Explanation

Gross margin reflects sales less cost of goods sold, while net margin deducts operating expenses, interest and tax, so a wide gap points to heavy operating and financing costs. High cost of goods sold would lower the gross margin itself.

Question 24Advanced Bank Management (ABM)

In the Basel framework, the leverage ratio is intended to:

  1. Constrain balance sheet build-up independent of risk weights Correct answer.
  2. Replace risk-weighted capital ratios
  3. Set limits on large exposures to single borrowers
  4. Measure short-term liquidity resilience

Explanation

The leverage ratio acts as a non-risk-based backstop, limiting total exposure relative to Tier 1 capital so that excessive leverage cannot build up through low-risk-weight assets. It supplements rather than replaces risk-weighted ratios.

Question 25Advanced Bank Management (ABM)

A bank's asset-liability committee observes that rate-sensitive liabilities exceed rate-sensitive assets in the one-year bucket. If interest rates fall, the bank's net interest income will most likely:

  1. Decrease because liabilities are fixed for the year
  2. Remain unchanged because the gap is within one year
  3. Decrease because assets reprice downward faster than liabilities
  4. Increase because liabilities reprice downward faster than assets Correct answer.

Explanation

A negative repricing gap means more liabilities than assets reprice within the bucket, so falling rates reduce interest expense more than interest income and net interest income rises. The gap is not neutral simply because it falls within one year.

Question 26Advanced Bank Management (ABM)

A bank's treasury desk wants to compare the interest-rate sensitivity of two assets with different maturities. Which measure directly indicates the percentage change in an asset's price for a one percent change in yield?

  1. Yield to maturity
  2. Convexity
  3. Macaulay duration
  4. Modified duration Correct answer.

Explanation

Modified duration expresses price sensitivity to a small parallel shift in yield, so a modified duration of 4 implies roughly a 4 percent price change for a 1 percent yield change. It is derived from Macaulay duration divided by one plus the periodic yield.

Question 27Advanced Bank Management (ABM)

A bank's GAP report shows rate-sensitive assets of 800 crore and rate-sensitive liabilities of 1000 crore for the next 90 days. If interest rates rise by 1 percent, the expected change in net interest income is approximately:

  1. A rise of 2 crore
  2. A fall of 18 crore
  3. A fall of 2 crore Correct answer.
  4. A rise of 18 crore

Explanation

The repricing gap equals 800 minus 1000, a negative gap of 200 crore. Change in net interest income equals gap times rate change, so minus 200 crore times 0.01 gives a fall of 2 crore when rates rise.

Question 28Advanced Bank Management (ABM)

A bank reports loans of 5000 crore, of which gross non-performing assets are 250 crore and provisions held against them are 100 crore. What is the net NPA ratio?

  1. 5.00 percent
  2. 4.00 percent
  3. 3.00 percent Correct answer.
  4. 2.00 percent

Explanation

Net NPA equals gross NPA minus provisions, giving 150 crore. The net NPA ratio divides this by net advances, that is 5000 minus 250, giving 150 divided by 4750, approximately 3.16 percent, closest to 3.00 percent among the choices.

Question 29Advanced Bank Management (ABM)

Which of the following best describes the role of the Asset-Liability Management Committee in a commercial bank?

  1. Setting the statutory cash reserve ratio applicable to all banks
  2. Managing the composition of assets and liabilities to control interest rate, liquidity and market risk within policy limits Correct answer.
  3. Auditing the bank's financial statements for compliance with accounting standards
  4. Approving individual retail loan applications above a branch threshold

Explanation

ALM committees coordinate balance sheet structure so that mismatches in maturity and repricing are kept within board-approved limits. They address interest rate risk, liquidity risk and market risk rather than statutory or audit functions.

Question 30Advanced Bank Management (ABM)

A bank has a liquidity coverage ratio requirement of 100 percent. It holds high-quality liquid assets of 900 crore and expects net cash outflows of 1000 crore over the 30-day stress horizon. Which action would most directly bring the ratio into compliance?

  1. Increase the projected net cash outflows by 100 crore
  2. Reduce the stock of high-quality liquid assets by 100 crore
  3. Extend the stress horizon beyond 30 days
  4. Increase holdings of high-quality liquid assets by 100 crore Correct answer.

Explanation

The liquidity coverage ratio equals high-quality liquid assets divided by net cash outflows over 30 days. At 900 divided by 1000 the ratio is 90 percent, so raising liquid assets by 100 crore lifts it to 100 percent.

Question 31Advanced Bank Management (ABM)

Which of the following is the most accurate description of a bank's Net Stable Funding Ratio?

  1. Total deposits relative to total advances at a point in time
  2. Tier 1 capital relative to total risk-weighted assets
  3. Liquid assets relative to net cash outflows over a 30-day horizon
  4. Available stable funding relative to required stable funding over a one-year horizon Correct answer.

Explanation

The Net Stable Funding Ratio compares the stable funding available to the stable funding required by the asset and off-balance-sheet profile, measured over a one-year horizon. It complements the short-term liquidity coverage ratio.

Question 32Advanced Bank Management (ABM)

A bank holds a bond with a face value of 1000, a coupon of 8 percent paid annually, and three years to maturity. If the required yield is 10 percent, the bond's price is closest to:

  1. 1000
  2. 1050
  3. 950 Correct answer.
  4. 1080

Explanation

Discounting each cash flow at 10 percent gives 80 divided by 1.10 plus 80 divided by 1.21 plus 1080 divided by 1.331, which totals approximately 950. Because the coupon is below the yield, the bond trades at a discount to par.

Question 33Advanced Bank Management (ABM)

In the context of credit risk, which statement best captures the meaning of expected loss under the Basel framework?

  1. It equals the worst loss observed in a stress scenario
  2. It equals probability of default multiplied by loss given default and exposure at default Correct answer.
  3. It equals the total exposure at default for a defaulted borrower
  4. It equals the unexpected loss covered entirely by regulatory capital

Explanation

Expected loss is the product of probability of default, loss given default and exposure at default, representing the long-run average loss. Unexpected loss above this level is what capital is designed to absorb.

Question 34Advanced Bank Management (ABM)

A bank's credit portfolio has an exposure at default of 200 crore, a probability of default of 2 percent and a loss given default of 45 percent. What is the expected loss?

  1. 4.00 crore
  2. 0.90 crore
  3. 1.80 crore Correct answer.
  4. 9.00 crore

Explanation

Expected loss equals exposure at default times probability of default times loss given default, that is 200 crore times 0.02 times 0.45, giving 1.80 crore.

Question 35Advanced Bank Management (ABM)

Which of the following best explains the difference between a bank's Tier 1 capital and its Tier 2 capital?

  1. Tier 1 is calculated from risk-weighted assets while Tier 2 is calculated from total assets
  2. Tier 1 is held only by foreign banks while Tier 2 is held by domestic banks
  3. Tier 1 consists only of subordinated debt while Tier 2 consists of equity
  4. Tier 1 is going-concern loss-absorbing capital while Tier 2 provides gone-concern loss absorption Correct answer.

Explanation

Tier 1 capital, including common equity and additional Tier 1 instruments, absorbs losses while the bank continues as a going concern. Tier 2 capital instruments absorb losses in resolution or gone-concern situations.

Question 36Advanced Bank Management (ABM)

A bank's capital adequacy statement shows Common Equity Tier 1 of 600 crore, Additional Tier 1 of 100 crore, Tier 2 of 150 crore and risk-weighted assets of 8000 crore. What is the total capital adequacy ratio?

  1. 8.75 percent
  2. 7.50 percent
  3. 10.63 percent Correct answer.
  4. 9.38 percent

Explanation

Total capital is 600 plus 100 plus 150, which equals 850 crore. Dividing by risk-weighted assets of 8000 crore gives 10.63 percent.

Question 37Advanced Bank Management (ABM)

Which of the following best describes the purpose of a bank's internal capital adequacy assessment process?

  1. Determining the interest rate to be charged on retail loans
  2. Computing the minimum cash reserve ratio prescribed by the central bank
  3. Setting the maximum permissible exposure to a single borrower
  4. Linking the bank's risk profile to its capital needs under both normal and stressed conditions Correct answer.

Explanation

ICAAP requires a bank to assess the capital needed to cover all material risks, including under stress, and to set internal targets above regulatory minima. It is a forward-looking risk and capital planning exercise.

Question 38Advanced Bank Management (ABM)

A bank's trading desk holds a position with a one-day 99 percent VaR of 15 crore. Over a 10-day horizon, assuming independent daily returns and using the square-root-of-time rule, the VaR is approximately:

  1. 47.4 crore Correct answer.
  2. 15 crore
  3. 4.7 crore
  4. 150 crore

Explanation

Scaling VaR by the square root of the horizon multiplies the one-day figure by the square root of 10, about 3.16. Thus 15 crore times 3.16 gives roughly 47.4 crore.

Question 39Advanced Bank Management (ABM)

Which of the following statements about the back-testing of a Value at Risk model is correct?

  1. It calculates the regulatory capital for credit risk
  2. It compares predicted VaR with actual trading losses to count exceptions Correct answer.
  3. It measures the liquidity of the trading book
  4. It replaces the need for stress testing entirely

Explanation

Back-testing counts the number of days on which actual losses exceed the predicted VaR, known as exceptions. A model generating too many exceptions is judged inadequate and attracts a higher regulatory multiplier.

Question 40Advanced Bank Management (ABM)

A bank's equity multiplier is 12 and its return on assets is 1.2 percent. What is its return on equity?

  1. 1.2 percent
  2. 14.4 percent Correct answer.
  3. 12.0 percent
  4. 10.0 percent

Explanation

Return on equity equals return on assets multiplied by the equity multiplier, so 1.2 percent times 12 gives 14.4 percent. The multiplier captures the leverage effect on shareholder returns.

Question 41Advanced Bank Management (ABM)

A bank reports interest income of 1200 crore, interest expense of 700 crore and average earning assets of 10000 crore. What is its net interest margin?

  1. 5.00 percent Correct answer.
  2. 1.20 percent
  3. 7.00 percent
  4. 12.00 percent

Explanation

Net interest income is 1200 minus 700, that is 500 crore. Dividing by average earning assets of 10000 crore gives a net interest margin of 5.00 percent.

Question 42Advanced Bank Management (ABM)

Which of the following best explains why a bank's return on equity can rise even when its return on assets is stable?

  1. An increase in the bank's operating expenses
  2. A reduction in the tax rate applied to the bank
  3. An increase in financial leverage raises the equity multiplier Correct answer.
  4. A fall in the proportion of earning assets

Explanation

Under the DuPont decomposition, return on equity equals return on assets times the equity multiplier. If the bank funds assets with more debt relative to equity, the multiplier rises and lifts return on equity even when asset returns are unchanged.

Question 43Advanced Bank Management (ABM)

A bank is considering using a currency swap to manage its foreign exchange exposure. Which statement best describes the primary function of a cross-currency swap?

  1. Converting a floating rate loan into a fixed rate loan in the same currency
  2. Guaranteeing a fixed exchange rate for a future spot transaction
  3. Exchanging principal and interest in two currencies to manage funding and currency mismatch Correct answer.
  4. Transferring credit risk on a loan portfolio to a third party

Explanation

A cross-currency swap involves exchanging principal amounts in two currencies and periodic interest payments, allowing a bank to obtain funding in one currency while servicing obligations in another. It addresses both currency and interest rate mismatches.

Question 44Advanced Bank Management (ABM)

A bank's treasury expects interest rates to fall over the next six months and wants to protect the margin on a floating-rate loan portfolio. Which action is most appropriate?

  1. Enter an interest rate swap to receive floating and pay fixed Correct answer.
  2. Sell a floor option on the benchmark rate
  3. Increase the proportion of fixed-rate liabilities
  4. Enter an interest rate swap to receive fixed and pay floating

Explanation

A floating-rate asset benefits from falling rates, but the bank may wish to lock in a spread by paying fixed and receiving floating, which converts the exposure to a fixed-rate profile. This protects the margin if rates fall further.

Question 45Advanced Bank Management (ABM)

Which of the following best describes the treatment of a restructured account under the RBI's prudential norms for non-performing assets?

  1. It is automatically written off from the loan book
  2. It may be classified as standard but is subject to a specified period of monitoring Correct answer.
  3. It is always classified as a loss asset
  4. It is excluded from the computation of gross NPA permanently

Explanation

A restructured account may be retained as standard if the restructuring is done under the applicable framework, but it remains under a monitoring period during which slippage triggers NPA classification. The exact treatment depends on the prevailing prudential norms.

Question 46Advanced Bank Management (ABM)

A bank's foreign exchange dealer quotes a spot rate of 83.20 and a three-month forward rate of 84.10 for the US dollar. What does this quotation indicate?

  1. The rupee is expected to appreciate against the dollar
  2. The dollar is at a forward discount, reflecting lower forward points
  3. The forward market is quoting a cross rate rather than a forward rate
  4. The dollar is at a forward premium, reflecting higher implied forward points Correct answer.

Explanation

The forward rate exceeds the spot rate, so the dollar is at a forward premium of 0.90 rupees. Forward points typically reflect the interest rate differential between the two currencies.

Question 47Advanced Bank Management (ABM)

Which of the following best describes the role of the Basel Committee's Principles for the Management of Credit Risk?

  1. Providing supervisory guidance on establishing a sound credit risk management framework Correct answer.
  2. Setting the interest rates that banks must charge on loans
  3. Prescribing the maximum permissible leverage ratio for banks
  4. Determining the accounting treatment for loan loss provisions

Explanation

The Basel credit risk principles set out supervisory expectations for a bank's credit risk strategy, origination, monitoring and control. They are guidance rather than price or accounting rules.

Question 48Advanced Bank Management (ABM)

A bank has a portfolio of 100 loans, each with a 1 percent probability of default, and assumes defaults are independent. What is the approximate probability that at least one loan defaults?

  1. About 10 percent
  2. About 1 percent
  3. About 100 percent
  4. About 63 percent Correct answer.

Explanation

The probability that no loan defaults is 0.99 raised to the power 100, which is approximately 0.366. Therefore the probability of at least one default is about 1 minus 0.366, or 63 percent.

Question 49Advanced Bank Management (ABM)

Which of the following statements about the standardised approach to credit risk under Basel is correct?

  1. The approach eliminates the need for collateral recognition
  2. The approach applies only to trading book exposures
  3. Risk weights are derived entirely from the bank's internal rating models
  4. Risk weights are assigned to exposures based on external credit assessments and exposure class Correct answer.

Explanation

Under the standardised approach, exposures are mapped to broad asset classes and risk weights are assigned using prescribed criteria, often referencing external credit ratings. The internal ratings-based approach, by contrast, relies on the bank's own models.

Question 50Advanced Bank Management (ABM)

A bank's operational risk loss data show recurring small losses from processing errors and occasional large losses from fraud. Which statement best reflects the capital treatment under the standardised approach for operational risk?

  1. The capital charge is calculated using the bank's own internal loss distribution model
  2. The capital charge is based on a business indicator component applied to a prescribed formula Correct answer.
  3. The capital charge is based solely on the largest single loss event
  4. The capital charge is zero if losses are below the deductible

Explanation

Under the Basel III standardised approach, the operational risk capital charge is derived from a business indicator component multiplied by a marginal coefficient, with possible adjustment for internal loss experience. It does not rely on a single loss event or a full internal model.