Errors Found in Study Materials P1.T1. Foundations (OLD thread)

[Nicole Seaman]

Please use this thread to let David and I know about any errors, missing/broken links, etc. that you find in the materials that are published in the study planner under P1.T1. Foundations of Risk. This will keep our forum much more organized. We appreciate your cooperation!

PLEASE NOTE: Our Practice Question sets already have links to their specific forum threads where you can post about any errors that you find. The new forum threads are for any other materials (notes, spreadsheets, videos,etc.) where you might find errors.

Information needed for us to correct errors:

• Reading
• Page number
• Error

 

[kevolution]

R8.P1.T1. Amenc v5 Study Notes page 8--

What's the difference between risk free rate and riskless rate of market (7% vs 4%)? They are two different values. Also, Excess Market Return (ERP) is also two different values (5.18% vs 6.00% in the table). Could you explain this particular example?

Treynor ratio calculation result should also be 0.067 and not 0.67.

Thanks!

 

[David Harper CFA FRM]

@kevolution my apologies, there are several inconsistencies between the exhibit and the supporting text. Each of your citations is just a mistake in the text. We will fix the text immediately and update here ... Thank you for noticing

 

[kik92]

Hi David,

P1.T1.Reading 5 page 5 states that the AAA rated tranche in the ABS CDO will be expected to default if losses greater than 10 million are experienced on the mortgage portfolio backing the original ABS. With my reasoning this should be equal to 5 million. Could you kindly let me know whether there is a typo or whether my reasoning is incorrect? Thanks!

 

[David Harper CFA FRM]

Hi @kik92 I think the $10.0 million is correct as shown, although your interpretation is totally understandable. (The example is directly from Hull). There are two layers here, the ABS and the ABS CDO:

• The ABS tranches cash flows from the underlying mortgage loans:
  • Equity tranche = 5% = $5.0 mm principal / $100.0 mm mortgage loans
  • Mezzanine tranche = 20% = $20.0 mm principal / $100 mm mortgage loans
• The ABS CDO tranches the mezzanine tranche of the ABS
  • ABS (mezzanine) CDO Equity tranche = 5% * 20% Mezzanine tranche = 10% 1% * $100.0 = $1.0 million
  • ABS (mezzanine) CDO Mezzanine tranche = 20% * 20% Mezzanine tranche = 4%* $100.0 = $4.0 million

Therefore, in order to breach the senior ABS (mezzanine) CDO tranche, losses on the underlying mortgages need to exceed $5.0 (for the ABS equity tranche) plus $5.0 which is 25% of the ABS mezzinine tranche (aka, $5.0 mm of the ABS CDO). Put another way, the senior ABS CDO is subordinated by 5% ABS equity and 25% of 20% ABS mezzanine, or 5% + 25%*20% = 10% of $100.0 mm. I hope that explains!

 

[Nicole Seaman]

@David Harper CFA FRM This was sent via email from @jacobweiss2305 to point out a possible error in the study notes.

"I found a typo in one of the answer sheets that may need to be looked at. Study notes for R9.P1.T1.Amenc.

Here is the error (pg. 11): 2. C. 21.1% -- See spreadsheet here http://trtl.bz/L1-T1-27-portfolio-variance P(volatility) = SQRT[ weight_A^2*variance(A) + weight_B*variance(B) + 2*weight_A*weight_B*Covariance(A,B)] = SQRT [50%^2*20%^2 + 50%^2*30%^2 + 2*50%*50%*20*30%*0.4] = SQRT [0.0445] = 21.1%

The 20 should be 20%."

Can you let me know if this is an error, and I can get it fixed in the notes? Thanks!

Nicole

Note: This was corrected in the new version of notes.

 

[Sumeet. Mehta]

Hi David. Found this in the study notes, pg 14. The first bullet says " The AAA rated tranche in this ABS CDO will be exposed to default if losses greater than$10 million are experienced on the mortgage portfolio backing the original ABS". Since the ABS CDO Senior tranche holds $15 Mil of the overall $20Mil, it seems that the exposure to default would start at $5 Mil+. Unless, a different concept is being highlighted through this bullet point. Please comment. Thanks

 

[Nicole Seaman]

Hi David. Found this in the study notes, pg 14. The first bullet says " The AAA rated tranche in this ABS CDO will be exposed to default if losses greater than$10 million are experienced on the mortgage portfolio backing the original ABS". Since the ABS CDO Senior tranche holds $15 Mil of the overall $20Mil, it seems that the exposure to default would start at $5 Mil+. Unless, a different concept is being highlighted through this bullet point. Please comment. Thanks

Hello @Sumeet. Mehta

I've moved your post here to the Study Notes Error thread for Topic 1. As you can see, this question has already been asked in this thread. This is the reason that we created the error threads so others can read through the thread to see if their error has already been discussed, and so we can keep track of any errors that have been pointed out. Here is David's response to your question above:

Hi @kik92 I think the $10.0 million is correct as shown, although your interpretation is totally understandable. (The example is directly from Hull). There are two layers here, the ABS and the ABS CDO:

• The ABS tranches cash flows from the underlying mortgage loans:
  • Equity tranche = 5% = $5.0 mm principal / $100.0 mm mortgage loans
  • Mezzanine tranche = 20% = $20.0 mm principal / $100 mm mortgage loans
• The ABS CDO tranches the mezzanine tranche of the ABS
  • ABS (mezzanine) CDO Equity tranche = 5% * 20% Mezzanine tranche = 10%* $100.0 = $1.0 million
  • ABS (mezzanine) CDO Mezzanine tranche = 20% * 20% Mezzanine tranche = 4%* $100.0 = $4.0 million

Therefore, in order to breach the senior ABS (mezzanine) CDO tranche, losses on the underlying mortgages need to exceed $5.0 (for the ABS equity tranche) plus $5.0 which is 25% of the ABS mezzinine tranche (aka, $5.0 mm of the ABS CDO). Put another way, the senior ABS CDO is subordinated by 5% ABS equity and 25% of 20% ABS mezzanine, or 5% + 25%*20% = 10% of $100.0 mm. I hope that explains!

 

[David Harper CFA FRM]

Thank you @Nicole Seaman ! @Sumeet. Mehta I do think my previous reply does already address this (although I just fixed a minor typo: the ABS mezz CDO tranche = 5% * 20% = 1%, not 10%). So the key part of your quoted phrase is "experienced on the mortgage portfolio backing the original ABS." You are correct that the ABS CDO Senior tranche becomes exposed after $5.0 million in defaults associated with the other two ABS CDO tranches ($1 + $5); however, this can only happen after the first $5.0 million in defaults in the ABS (from which the CDO is structured, where the two $5.0 values are coincident.) Thanks!

 

[QuantFFM]

Study Notes APT page 9:

"Let the factor exposures of a well-diversified portfolio, P, be given by its betas, BetaSubp1 and BetaSubp1"

Should it be: Let the factor exposures of a well-diversified portfolio, P, be given by its betas, BetaSubp1 and BetaSubp2"?

Regards

 

[David Harper CFA FRM]

@QuantFFM Yes, good catch. Our mistake. Thank you!

 

[QuantFFM]

Question set Miller Probability 201.4
"The simplified standard deviation = ..."

I assume the sqrt is missing here to get to a result of 4.0?

Regards

 

[Shikhar_Pachori]

Hi David,

Please see and correct the following:

• Reading: R10.P1.T1.Bodie
• Page number : 5
• Error : In example 10.1 solution, it was given as = 10% + 1.2 × (3% − 4%) = 10% − 1.2% = 9.2% whereas it should be 10 % -1.2 % = 8.8%

Thanks,
Shikhar

 

[David Harper CFA FRM]

HI @QuantFFM Yes, you are correct, our typo. I have edited the line to read "The simplified standard deviation = SQRT[(5^2 + -3^2 + 6^2 + -1^2 + 3^2)/5] = 4.0" at https://forum.bionicturtle.com/threads/p1-t2-201-random-variables-stock-watson.4951/ (and we will fix the PDF but given this is minor, not immediately, but rather at the next "batch interval" cc @Nicole Seaman ). Thank you!

Hi @Shikhar_Pachori Yes, absolutely, this too is our mistake in the calculation. Exactly as you say, on page 5 rather than "r = 10% + 1.2 × (3% − 4%) = 10% − 1.2% = 9.2%" it should have course read "r = 10% + 1.2 × (3% − 4%) = 10% − 1.2% = 8.8%". This is noted for revision. Thank you!

 

[Sumeet. Mehta]

Thank you @Nicole Seaman ! @Sumeet. Mehta I do think my previous reply does already address this (although I just fixed a minor typo: the ABS mezz CDO tranche = 5% * 20% = 1%, not 10%). So the key part of your quoted phrase is "experienced on the mortgage portfolio backing the original ABS." You are correct that the ABS CDO Senior tranche becomes exposed after $5.0 million in defaults associated with the other two ABS CDO tranches ($1 + $5); however, this can only happen after the first $5.0 million in defaults in the ABS (from which the CDO is structured, where the two $5.0 values are coincident.) Thanks!

Thanks David.

 

[gaurav_ry]

foundation of risk management review video,

i believe the attached slide is wrong, please advise.

regards
Gaurav N

 

[David Harper CFA FRM]

Hi @gaurav_ry if it were a correlation matrix, then the diagonals must be 1.0. But this is a covariance matrix such that covariance (A,A) = variance (A) = 0.010 and covariance (B, B) = variance (B) = 0.040. So σ(A) = 10.0% and σ(B) = 20.0%. Thanks!

 

[gaurav_ry]

Thanks David, it clear for life now

 

[Charlymanlangit]

HI @QuantFFM Yes, you are correct, our typo. I have edited the line to read "The simplified standard deviation = SQRT[(5^2 + -3^2 + 6^2 + -1^2 + 3^2)/5] = 4.0" at https://forum.bionicturtle.com/threads/p1-t2-201-random-variables-stock-watson.4951/ (and we will fix the PDF but given this is minor, not immediately, but rather at the next "batch interval" cc @Nicole Seaman ). Thank you!

Hi @Shikhar_Pachori Yes, absolutely, this too is our mistake in the calculation. Exactly as you say, on page 5 rather than "r = 10% + 1.2 × (3% − 4%) = 10% − 1.2% = 9.2%" it should have course read "r = 10% + 1.2 × (3% − 4%) = 10% − 1.2% = 8.8%". This is noted for revision. Thank you!

Hi David/Nicole,

Just want to note that this portion is still not updated . Thanks

 

[Nicole Seaman]

Hi David/Nicole,

Just want to note that this portion is still not updated . Thanks

@Charlymanlangit

We do not update the errors immediately. When we update a set of notes to the next version, we check this forum thread to see if there are errors that need to be corrected, and they are updated in the study planner at that time. These error threads are an easy way for us to quickly reference errors when we are updating notes to a new version.

Thank you,

Nicole