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Which of the following are conclusions that could be drawn from the shape of the statistical distribution of losses that a bank might incur over a future time period? I. In most years a bank would look more profitable than it will be on average. II. Most of the time a sufficiently well capitalized bank will appear over-capitalized. III. Bad years do not come along very often, but when they do they lead to enormous losses.
Correct Answer: D
From the statistical distribution of bank losses over a future period, several conclusions can be drawn: * I. In most years a bank would look more profitable than it will be on average: This indicates that most years will show better-than-average profitability because the distribution of losses includes infrequent but severe loss events. * II. Most of the time a sufficiently well-capitalized bank will appear over-capitalized: Because banks prepare for rare but significant losses, in normal years, their capital reserves may seem excessive. * III. Bad years do not come along very often, but when they do they lead to enormous losses: This reflects the heavy-tailed nature of the loss distribution, where extreme losses are rare but severe. All three statements correctly reflect the characteristics of the loss distribution for banks.References: How Finance Works, sections covering statistical analysis of losses and capital adequacy.