5.Pillar III of the Basel II accord includes all ofthe following requirements for internationally active banks except:
A.A formal disclosure policy should be established,and supported by a bank's board of directors.
B.Banks should operate above minimum regulatory capital ratios.
C.Financial statements that fairly retlect financial condition should be Pllblished reglllarly.
D.There should be specific remedial actions in the event of nondisclosure.
6.Which ofthe following statements would be considered a drawback of Basel III?
A.Procyclicality is a concem,and no countercyclical buffer is provided.
B.It does not consider diversification effects among risk classes.
C.Level 1 diversification benefits are not acknowledged.
D.There are no detailed disclosure requirements for risk management policies conceming credit risk.
Answer:
1.B
An arbitrage opportunity is the chance to make a riskless profit with no investment.In essence,finding an arbitrage opportunity is like finding free money.As you recall,in arbitrage,you observe two identical assets with different prices.Your immediate response should be to buy the cheaper one and sell the expensive one short.You can then deliver the cheap one to cover your short position.Once you take the initial arbitrage position,your arbitrage profit is locked in.The no-investment statement referenced in the text refers to the assumption that when you short the expensive asset,you will be given access to the cash created by the short sale.With this cash,you now have the money to buy the cheaper asset.The no-investment assumption means that the first person to observe a market pricing error will have the financial resources to correct the pricing error instantaneously all by themselves.
2.B
The APT is an equilibrium model that assumes there are no arbitrage opportunities in equilibrium,that investors can create diversified portfolios,and that a factor model describes asset returns.It does NOT require that factor portfolios(nor,as in the capital asset pricing model[CAPM],the market portfolio)be efficient.In effect,the APT assumes investors simply like more money to less,while the CAPM assumes they care about expected return and standard deviation and invest in efficient portfolios.The APT makes no reference to mean-variance analysis or assumptions about efficient portfolios.This weaker set of assumptions is an advantage of the APT over the CAPM.
3.B
All the bonds described above,except for one,are types of catastrophe bonds.Parametric notes link cash flows to the magnitude of an external risk event,such as hurricane severity in a particular region.Indemnified notes offer the issuing firm debt relief based on internal events,such as a large underwriting loss for an insurance company.Indexed notes provide cash flows related to the value of an independent index,such as a weather index or an insurance underwriting loss index.Bonds with cash flows determined by parametric distributions are quixotic.
4.B
Under the advanced IRB approach,the bank uses its own intβmal measures of credit risk and exposure in capital calculations.
5.B
The requirement to operate above minimum regulatory capital ratios is a requirement laid out in Pillar II regarding the interaction of supervisors and internationally active banks.Note that Pillar III relates to market discipline and disclosure.
6.B
Basel III only considers Level 1 diversification benefits(Level 1:within specific class ofrisk,specific line ofbusiness).
Level 2a:within specific class of risk,across specific line of bussiness
Level 2b:across specific classes of risk,within a definite legal entity
Level 3:across definite classes of risk,across legal entities.
