PRMIA 8020 Practice Test Questions Answers

Background of the Barings Case Study

TheBarings Bank collapseoccurred due to unauthorized derivatives trading byNick LeesoninSingapore.

Leeson concealed losses, and his trading positions became unmanageable.

How the Kobe Earthquake Affected Barings

OnJanuary 17, 1995, theKobe earthquakecaused extreme market volatility.

Leeson's unauthorized trades were highly exposed to the Nikkei 225 index, and the earthquake triggeredheavy losses.

The eventaccelerated the exposure of Leeson’s fraudulent activities, leading toBarings' collapse.

Why Answer D is Correct

TheKobe earthquake created market turmoil, forcing Barings toconfront its financial position, ultimately revealing the hidden losses.

Why Other Answers Are Incorrect

Option

Explanation

A. The collapse of Lehman Brothers into bankruptcy in 2002.

Incorrect–Lehman Brothers collapsed in 2008, not 2002.

B. The Singapore earthquake of January 17th, 1995.

Incorrect– No significant earthquake occurred in Singapore on that date.

C. The collapse of Lehman Brothers into bankruptcy in 2008.

Incorrect–Barings collapsed in 1995, not related to Lehman Brothers' 2008 failure.

PRMIA Case Study on Barings Bank Collapse

Basel Committee Principles on Risk Oversight and Fraud Prevention

PRMIA References for Verification

TheThree Lines of Defense (3LoD) modelensures thatrisk management responsibilities are properly segregated:

First Line: Business units (own and manage risk).

Second Line: Compliance and risk management (independent oversight).

Third Line: Internal audit (provides assurance).

PRMIA andBasel Compliance Principlesstate that compliance shouldnot report to business units, as this creates aconflict of interest.

Compliance must beindependent to ensure objective oversightof regulatory adherence.

Option A ("Report to the business")→ Incorrect becausecompliance must provide independent oversight, not report to business units.

Option C ("Outsource compliance if risk function exists")→ Incorrect becausecompliance and risk functions have distinct roles.

Option D ("Outsource risk if compliance exists")→ Incorrect becauserisk management is a core function, not an outsourcing candidate.

Step 1: Compliance Function and the Three Lines of Defense ModelStep 2: Why Compliance Must Be IndependentStep 3: Why the Other Options Are Incorrect

PRMIA Compliance Risk Governance– States compliance must beindependentunder the Three Lines of Defense model.

Basel Compliance Principles– Recommends separate reporting structures for compliance and business units.

PRMIA Risk References Used:

Final Conclusion:Compliance must be independent from the business to avoid conflicts of interest, makingOption B the correct answer.

Near Misses in Operational Risk

Anear missis an event that could have led to a loss but wasavoided or mitigatedbefore actual financial impact occurred.

PRMIA emphasizes that near misses should bereported, recorded, and analyzedbecause they provide valuable insights intopotential vulnerabilitiesin risk controls.

However, since they did not result in actual financial losses,they are not included in the calculation of Operational Risk Capital.

Opportunity Costs in Operational Risk

Opportunity costsrefer to theloss of potential gainsdue to missed strategic opportunities.

These arenot directly quantifiable as operational risk lossesand are not included in Operational Risk Capital calculations.

PRMIA’sOperational Risk Frameworkstates thatoperational risk is about actual lossesrather than theoretical costs.

Why Other Answers Are Incorrect

Option

Explanation

A. Ignored.

Incorrect– Near misses and opportunity costs provide valuable insights into operational risk, so they should never be ignored.

B. Recorded and Analyzed. Used in calculation of Operational Risk Capital.

Incorrect– While they should be recorded and analyzed, they arenot included in Operational Risk Capital calculationsbecause they do not result in actual losses.

D. Reported, Recorded, and Analyzed, Used in calculation of Operational Risk Capital.

Incorrect– Reporting, recording, and analysis are correct, but theyshould not be included in capital calculations.

PRMIA Operational Risk Management Standards– Defines near misses and opportunity costs.

Basel II & III Operational Risk Framework– Outlines the principles of operational risk capital calculations.

PRMIA References for Verification

TheTSB outagein 2018 was caused by afailed IT migrationfrom its old banking system to a new one.

The transitionlocked millions of customers out of their accounts for weeks, resulting infinancial losses and reputational damage.

TSB attempted tomove customer data to a new banking platform, butserious defects in the migration processled to service failures.

PRMIA andUK Financial Conduct Authority (FCA) reportsconfirmed thatpoor IT risk managementwas a key failure.

Option A ("Liquidity squeeze by hedge-fund")

Incorrect because TSB's failure was due toIT migration issues, not a liquidity crisis.

Option B ("Sub-standard risk pricing and risk management")

Incorrect becausepricing models were not the cause—it was anIT system failure.

Option D ("IT models did not work if prices were discontinuous")

Incorrect as this issue ismore common in high-frequency trading failures, not banking system outages.

Step 1: Understanding the TSB CaseStep 2: Why Option C Is CorrectStep 3: Why the Other Options Are Incorrect

UK FCA Investigation on TSB Incident– Confirms IT migration failure as root cause.

PRMIA IT Risk Management Framework– Highlights risks of major IT transitions.

PRMIA Risk References Used:

Final Conclusion:TheTSB outage was caused by a failed IT migration, makingOption C the correct answer.

Definition of Key Risk Indicators (KRIs)

KRIs arequantitative metricsused to monitor risk levels and detect early warning signs of potential risk events.

Top-down KRIsare identified at thesenior management leveland focus onenterprise-wide risk exposure.

Key Properties of Top-Down KRIs

Selected by senior managementto ensure alignment with strategic objectives.

Tied to material external and internal loss exposuresto capture critical financial, operational, and strategic risks.

Used to manage changes in the business environmentto ensure proactive risk response, especially under stress conditions.

Why Other Answers Are Incorrect

Option

Explanation

B. Selected by senior management, used to manage changes in the business environment, especially under periods of stress, and reported on a daily basis.

Incorrect– Top-down KRIs arenot reported daily; they are monitored periodically (e.g., quarterly).

C. Selected by junior management, used to manage changes in the business environment, especially under periods of stress, and reported on an annual basis.

Incorrect– Junior management does not definetop-down KRIs; senior management does. Also, annual reporting is too infrequent.

D. Can only be selected by the board in line with risk ratings.

Incorrect– The board provides oversight, butsenior risk management selects KRIs, not just the board.

PRMIA Risk Indicator Guidelines

Basel Committee on Banking Supervision (BCBS) Principles for Effective Risk Data Aggregation

PRMIA References for Verification