Exam Feedback FRM Part 2 (May 2015) Exam Feedback

[Salonica]

I felt something was missing from the IRS question. The 2 year swap payed 6% fix and vas valued at par. I.e. Was worth zero. The question was the value of the floating leg with ois rates 5% for first year and 5.5% for 2 years. I think you need the current libor fixing and the forward rate from first to second year to solve this. From the information, that the swap is valued at par you can get one unknown, but you are still missing the second. Or am I missing something here.

I solved it by assuming that the current fixing and the forward rate are both 6%. Dont know if result is correct, i think other solutions are possible.

I found this tricky as well to be honest, although it seemed easy. I went for 100... A floating rate note (which can be considered as the floating leg of the swap) would be valued at 100 on reset day or at initiation of the contract. Since it mentioned that the swap was valued at par, I thought I am in one of these situations. I was able to replicate the 100.95 answer but can't remember how.

 

[hamu4ok]

Hello,
firstly, I found the exam to be fair both in terms of time to be used and difficulty of the questions, although there were again many "most appropriate" / "best practice"-questions. I find these highly irritating.

Here are a few thoughts on what has been mentioned above:

• For the OpRisk SA >> BIA question I realized you had to ignore the last column (year 2011), since both approaches only employ three years of data history. --> plus 37M
• QQ-Plot: I found it to have lighter tails and a POSITIVE mean (shifted upwards).
• I also chose the CDS-correlation graph that goes to zero, because I wouldn't pay for a protection that becomes worthless the moment the underlying defaults.

What I didn't get:

• Did anyone have any idea on the "long correlation" position? Also, there were some questions regarding the proper use of distributions that had me stumped.
• I am not quite sure what GARP's position is regarding clearinghouses.

Best luck to everyone!

Johannes

As for long correlation , Meissner in his 1st assigned reading mentions several strategies including options, variance swap and correlation swap. I chose correlation swap, but might be wrong as the question used a stock position vs index or something like that as now i don't remember the question clearly.
As for the CCP, the question was about how to prevent system risk, I chose to reduce the number of members. Other options didn't suit well.

 

[hamu4ok]

i was stumbled.. whether to consider BB- as investment grade or non investment grade when answering the risky loans question (X,Y,Z).. i used the formula Expected loss = (1-RR) * PD* Exposure and arranged the loans with respect to their Expected loss values.. did any one solve that question?

the order was AAA, BB-, and BBB, answer d

 

[xenatr]

Longing correlation is to either
1. receive floating rate in a variance swap with the index as an underlying and receive fixed in a variance swap with a stock in that index as an underlying,
2. Buy call option on index and buy call option on an individual component in that index OR
3. receive realized correlation in a correlation swap
in the exam, only 1 was shown

For the CCP, to avoid being failed
CCP need to:
1. ONLY intermediate derivative transactions
2. let the clearing member to unwind the trades in case there are defaults
3. have good practice in choosing members, valuing transactions and determining initial margins and default fund contributions
In the exam, only 2 was shown

Limitation of using BSM model to value bond
The answer is the volatility will go to zero at maturity as the model assumes the volatility is constant

CLN question (sth related to minimize counterpart risk)
The counterparty risk is the lowest in issuing credit link notes given the protection sellers, i.e. investors, have already paid the price to the buyers and hence no counterparty risks in case there is a default in a reference asset.

Net Stable Funding Ratio
The bank passes the test given the ratio, ASF divided by RSF, is greater than 1 (in fact, 1.3XX)
RSF is 5X.X & ASF is 72

Standardized vs Basic Indicator
The bank is of course paying 37million more under basic indicator approach because, in the latest 3 years, there is a negative gross income and hence you will divide the capital by 2 under basic indicator approach vs by 3 under standardized approach

QQ plot
Thinner tails for sure

95% Credit Var of 100 CDS with $1000, 2% PD and LGD 100% each
The answer is 3000
At 95% level, there will be five defaults so the value is 5*1000
the expected loss is 100*0.02*1000*1

Convexity
Convexity will of course increase the bond price comparing with simply using the expected value of interest rate

Square root rule
For time varying volatility, e.g. volatility estimated via GARCH, using square root rule will overestimate the VaR whereas underestimate in case the underlying process has a jump

Policy needs to be corrected
The senior bond is only subordinated to preference share

Rule of thumb
Correlation of zero does not imply independence

 

[Salonica]

As for long correlation , Meissner in his 1st assigned reading mentions several strategies including options, variance swap and correlation swap. I chose correlation swap, but might be wrong as the question used a stock position vs index or something like that as now i don't remember the question clearly.
As for the CCP, the question was about how to prevent system risk, I chose to reduce the number of members. Other options didn't suit well.

I went for the variance swap

 

[Salonica]

Longing correlation is to either
1. receive floating rate in a variance swap with the index as an underlying and receive fixed in a variance swap with a stock in that index as an underlying,
2. Buy call option on index and buy call option on an individual component in that index OR
3. receive realized correlation in a correlation swap
in the exam, only 1 was shown

For the CCP, to avoid being failed
CCP need to:
1. ONLY intermediate derivative transactions
2. let the clearing member to unwind the trades in case there are defaults
3. have good practice in choosing members, valuing transactions and determining initial margins and default fund contributions
In the exam, only 2 was shown

Limitation of using BSM model to value bond
The answer is the volatility will go to zero at maturity as the model assumes the volatility is constant

CLN question (sth related to minimize counterpart risk)
The counterparty risk is the lowest in issuing credit link notes given the protection sellers, i.e. investors, have already paid the price to the buyers and hence no counterparty risks.

Net Stable Funding Ratio
The bank passes the test given the ratio, ASF divided by RSF, is greater than 1 (in fact, 1.3XX)
RSF is 5X.X & ASF is 72

Standardized vs Basic Indicator
The bank is of course paying 37million more under basic indicator approach because, in the latest 3 years, there is a negative gross income and hence the basic indicator approach divide the capital by 2 vs by 3 under standardized approach

Went also for No 2 here. Pass on the losses to other members.

 

[Salonica]

Longing correlation is to either
1. receive floating rate in a variance swap with the index as an underlying and receive fixed in a variance swap with a stock in that index as an underlying,
2. Buy call option on index and buy call option on an individual component in that index OR
3. receive realized correlation in a correlation swap
in the exam, only 1 was shown

For the CCP, to avoid being failed
CCP need to:
1. ONLY intermediate derivative transactions
2. let the clearing member to unwind the trades in case there are defaults
3. have good practice in choosing members, valuing transactions and determining initial margins and default fund contributions
In the exam, only 2 was shown

Limitation of using BSM model to value bond
The answer is the volatility will go to zero at maturity as the model assumes the volatility is constant

CLN question (sth related to minimize counterpart risk)
The counterparty risk is the lowest in issuing credit link notes given the protection sellers, i.e. investors, have already paid the price to the buyers and hence no counterparty risks in case there are defaults in a reference asset.

Net Stable Funding Ratio
The bank passes the test given the ratio, ASF divided by RSF, is greater than 1 (in fact, 1.3XX)
RSF is 5X.X & ASF is 72

Standardized vs Basic Indicator
The bank is of course paying 37million more under basic indicator approach because, in the latest 3 years, there is a negative gross income and hence you will divide the capital by 2 under basic indicator approach vs by 3 under standardized approach

QQ plot
Thinner tails for sure

Limitation of BSM to value bond option, I went for the option saying that GBM is inconsistent or something like that.

 

[hamu4ok]

Longing correlation is to either
1. receive floating rate in a variance swap with the index as an underlying and receive fixed in a variance swap with a stock in that index as an underlying,
2. Buy call option on index and buy call option on an individual component in that index OR
3. receive realized correlation in a correlation swap
in the exam, only 1 was shown

For the CCP, to avoid being failed
CCP need to:
1. ONLY intermediate derivative transactions
2. let the clearing member to unwind the trades in case there are defaults
3. have good practice in choosing members, valuing transactions and determining initial margins and default fund contributions
In the exam, only 2 was shown

Limitation of using BSM model to value bond
The answer is the volatility will go to zero at maturity as the model assumes the volatility is constant

CLN question (sth related to minimize counterpart risk)
The counterparty risk is the lowest in issuing credit link notes given the protection sellers, i.e. investors, have already paid the price to the buyers and hence no counterparty risks in case there are defaults in a reference asset.

Net Stable Funding Ratio
The bank passes the test given the ratio, ASF divided by RSF, is greater than 1 (in fact, 1.3XX)
RSF is 5X.X & ASF is 72

Standardized vs Basic Indicator
The bank is of course paying 37million more under basic indicator approach because, in the latest 3 years, there is a negative gross income and hence you will divide the capital by 2 under basic indicator approach vs by 3 under standardized approach

QQ plot
Thinner tails for sure

One of the business lines had only one positive income so should it be 1 in the denominator when calculating BIA? I also chose 37 million, but only logicaly as i could't get the answer.

 

[xenatr]

for basic indicator approach, it only cares about the total gross income so even if there is 1 component showing as a negative value, it will still count as long as the total gross income is positive

 

[hamu4ok]

One of the questions that puzzled me was to find lowest MVar while having treynor ration greater than 1. Did't spend much time on this qestion in order not to sacrifice the rest.

 

[hamu4ok]

for basic indicator approach, it only cares about the total gross income so even if there is 1 component showing as a negative value, it will still count as long as the total gross income is positive

Understood, so I devided by 2 and 1 to check but neither showed the desired difference between the 2 approaches, so logicaly opted for higher amount and 37.

 

[xenatr]

One of the questions that puzzled me was to find lowest MVar while having treynor ration greater than 1. Did't spend much time on this qestion in order not to sacrifice the rest.

choose the highest Treynor ratio and use the index Beta

 

[hamu4ok]

There were some theortical qestions related to RAF, Capital planning and Op. risk framework And how did you takcle the question related to fat fingers: stop loss functionality or limit orders?

 

[xenatr]

There were some theortical qestions related to RAF, Capital planning and Op. risk framework And how did you takcle the question related to fat fingers: stop loss functionality or limit orders?

Operational Risk Gain Event
Surely not near miss
Near miss is a scenario that a bank has made a loss but is able to recover the loss (excluding the recoveries from insurance)
Stop Logic = kill button
Regarding the exchange's action, cancel on disconnect, message limit and order limit, i.e. number of orders, are irrelevant

 

[hamu4ok]

Operational Risk Gain Event
Stop Logic = kill button

Stop logic would have been fine, but the made money from this transaction, so if it was profitable there was no harm to the exchange.

 

[xenatr]

Stop logic would have been fine, but the made money from this transaction, so if it was profitable there was no harm to the exchange.

This question only asks categorization and action to prevent from happening
Even if profit is made, it still needs to be categorized in operational risk database as operational risk gain event
Near miss is a scenario losses are made but a bank is able to recover the loss (excluding recoveries from insurance)

 

[berimbolo]

Limitation of BSM to value bond option, I went for the option saying that GBM is inconsistent or something like that.

Yes that was a very tricky question. I first chose the zero volatility answer, but when I reread I saw about the BSM assumption that was violated, which is the lognormal assumption.
What do you guys think the cutoff score is for a pass. With all the discussion here I think I won't make 50.

 

[vamsib555]

I gave the same answer, but i'm not so sure, that it is correct. Essentially you valued the fixed leg with ois discounting. Its not clear to me, why that should be the same as the floating leg. They are valued at par with libor discounting, that might be different under ois discounting, right?

Any derivative contacts value at initiation is 0 either it is swap, forward, future etc.. neither long nor short will be at advantage during the contact initiation because arbitrage neutralizes the advantage. Later one party may gain and other may loose because of change in market rates (Libor in case of swap) changing the value of contract. So value delivered to fixed leg party = value delivered to floating leg party only at the initiation of swap

 

[ami44]

Any derivative contacts value at initiation is 0 either it is swap, forward, future etc.. neither long nor short will be at advantage during the contact initiation because arbitrage neutralizes the advantage. Later one party may gain and other may loose because of change in market rates (Libor in case of swap) changing the value of contract. So value delivered to fixed leg party = value delivered to floating leg party only at the initiation of swap

It was stated in the question that the swap was valued at par. I think that means, that the value of floating and fixed leg cancel each other out, independent of the age if the swap.

 

[MLago]

It was stated in the question that the swap was valued at par. I think that means, that the value of floating and fixed leg cancel each other out, independent of the age if the swap.

I guessed on this one and went with the one selection below 100 (I recall something like 98.xx) as I thought the question was asking for the side that was required to make net payment therefore NPV below 100! Again I could have misinterpreted the question all along