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Hi VK95, Interest rate models are not used to predict future interest rates. They can’t tell you if interest will go up or down. What they do is providing a stochastik description of the dynamic of interest rates. I.e. they tell you which moves are possible with what probability. The BS Modell...

1. Equation From the definition Yt = e_t + theta * e_t-1 It follows that Yt - theta * e_t -1 = e_t Plug that into the first expression and you get the second expression 2. Equation Since e_t is independent of omega_t-1 it follows that also (e_t)^2 is. That means E[e_t^2 | omega_t-1] = E[e_t^2]...

Your calculation is correct, if by standard derivation you mean the standard derivation of the returns (also often called volatility). If the standard derivation of the returns is constant your conjecture is true, that with increasing prices the VaR increases. If the standard derivation is e.g...

When you look at the formula at page 13 for sigma(portfolio), be aware that the sigma(1), sigma(2) and sigma(3) in it are not the standard deviation of the risk factors r(USD), r(GBP) and S(USD/GBP). Instead they are the standard deviation of the standardized positions X1, X2 and X3. Your...

I think the trick is, that the error you made in the previous measurement bounces back in your current measurement. Assume our AR(1) process looks like X(t) = β * X(t-1) + e(t) without measurement error. Now we add an measurement error m(t) to it and call the resulting process X'(t) = X(t) +...

I did not talk about hedging, i hope that is clear with my previous post. I think a cds on yourself issued by yourself is essentially worthless. It might theoretically be worth something if your LGD is greater than zero, but I doubt that this is an instrument that is used by anybody anywhere...

If you terminate a derivative before maturity the party with negative present value has to pay the other party this value as compensation (termination fee). The present value is normally calculated with taking DVA and CVA into account. Of course the actual amount of the termination fee is...

That is a great idea, I never thought about that. Unfortunatly I think you are not allowed to bring any paper into exam room. So I guess you have to wait to official opening time of the exam booklet with the writing and than it will cost you valuable exam time. Maybe you can write on the outside...

That is exactly right. Indeed, if your credit spread increases your derivative portfolio often gains value through DVA. The same is true for issued debt. Bonds you might have issued at 100 might be worth less if your credit deteriorates, which means the absolute value of your debt is...

You need the assumption, that the drift term of u can be neglected. If u(t) is a random variable than is it's variance defined as σ(t)^2 = E( u(t)^2 ) - E( u(t) )^2 If you now assume, that the E( u(t) )^2 can be neglected against the E( u(t)^2 ) term than you get to your result. u(t) is...

Hi Anshul, If I were you, I would try to get an overall understanding of every topic from part I, but not go too deep into details. Part II is much less quantitative than part I, so don't bother with learning all the calculation details and just try to understand the overall concepts. Also a...

Hi Gavin, These are valid questions, but in my experience they do not have a clear answer. From the three market data - 3M forward curve - 1M forward curve - 1M/3M basis spread only two are independent and the third can be derived from the other two. Since 3M is the most liquid tenor you...

Hi seidu, the important fact here is, that R1 and R2 are from a multivariate standard distribution. That means their variance is 1. Since s(R2)^2 = 0.4^2 * s(R1)^2 + x^2 * s(Z)^2 and we know that s(R1) = s(R2) = s(Z) = 1 we can conclude that x = 0.92 i.e. answer A is correct.

PortoMarco79, your answer is absolutly correct and is the intended answer. Maybe a little easier way to come to the result is to count all the securities that are bonds or issued by industral firms, which are 16 (10 bonds + 6 stocks) and 16/20 = 0.8 But your way Matches the original answer...

Isn't the method to calculate Collateral most likely specified in some contract between the counterparties (e.g. CSA) and independent of any internal marking used by risk management? Also, I'm always confused by this kind of questions that talk about marking by a trading desk. From my...

Actually I changed my opinion in the course of the thread (learning is great, isn't it). Initially I thought the possibility of the delivery squeeze only affects the cds spread. Now I think, and Jayanthie just confirmed it above, that the bond spread is affected as well, so that the effects on...

Hallo Jayanthi, I agree with your great explanation above, except that I'm not clear about the last paragraph. Sorry for asking so stupidly, but do you mean that the possibility of a delivery squeeze increase/decreases the basis or has no effect at all? Following your line of thought, the...

Because they add up to the netting-set cva, which is lower than the sum of the stand-alone cva. The netting-set cva is the actual cva and it includes diversification effects that are not present in stand-alone cva. The marginal cva is just a way to distribute the netzing-set cva back on the...

Quantman2318, I don't understand the logic of here. Why would a possible future scarcity influence the current bond spread? I'm not saying that it's not true, I just don't understand the reasoning. Maybe we can argue like this: the bond spread is the compensation to the bond holder for his...

As I see it, it's not the same for cds and bonds: For both a spread is contracted at issue date. For a cds it is contracted at inception how much the protection buyer has to pay for the protection. For a bond it is defined at issue date how much spread above the riskless interest rate the bond...