High price - 2014 GARP Practice Exam

[tosuhn]

Hi @David Harper CFA FRM CIPM I just did the 2014 GARP Practice Exam and came across the question below.
I can't remember reading anything on high price. Appreciate that you can advise me please on this.

An experienced commodities risk manager is examining corn futures quotes from the CME Group. Which of the following observations would the risk manager most likely view as a potential problem with the quotation data?
a. The volume in a specific contract is greater than the open interest.
b. The prices indicate a mixture of normal and inverted markets.
c. The settlement price for a specific contract is above the high price.
d. There is no contract with maturity in a particular month.

Regards,
Sun

 

[David Harper CFA FRM]

Hi @tosuhn I agree, that option (c) is frankly new to me, too. I don't like (c) at all. The first CME page I happen to look at contradicts the assertion, see http://www.cmegroup.com/trading/agricultural/grain-and-oilseed/corn.html
For Dec 2015 corn contract, we currently have:
Last 413,4, Change -1'4, Prior Settle 419'2, Open 413'0, High 417'0, Low 413'0, Close 413'4
i.e., the "Prior Settlement" is greater than the "High"

I'm sheer guessing that maybe (?) they meant to suggest the most recent trade ("last") of the current trading day should not be higher than the "high" price of the current trading day. The issue is that "settlement" in the CME quote refers to the prior day's settlement price (i.e., the price used to mark to market the contract based on the day, so it's the prior day's settlement; I suppose the prior day's settlement should not exceed the prior day's high but that's too precise for the question). I'm not sure this question is not confusing the prior day with the current trading day ... I have no problem seeing how the prior settle (419'2) is greater than the current high (417'0). I don't think this is really covered in the readings to my knowledge. Here is Hull:

Prices
The first three numbers in each row of Table 2.2 show the opening price, the highest price in trading so far during the day, and the lowest price in trading so far during the day. The opening price is representative of the prices at which contracts were trading immediately after the start of trading on May 14, 2013. For the June 2013 gold contract, the opening price on May 14, 2013, was $1,429.5 per ounce. The highest price during the day was $1,444.9 per ounce and the lowest price during the day was $1,419.7 per ounce.
Settlement Price
The settlement price is the price used for calculating daily gains and losses and margin requirements. It is usually calculated as the price at which the contract traded immediately before the end of a day’s trading session. The fourth number in Table 2.2 shows the settlement price the previous day (i.e., May 13, 2013). The fifth number shows the most recent trading price, and the sixth number shows the price change from the previous day’s settlement price. In the case of the June 2013 gold contract, the
previous day’s settlement price was $1,434.3. The most recent trade was at $1,425.3, $9.0 lower than the previous day’s settlement price. If $1,425.3 proved to be the settlement price on May 14, 2013, the margin account of a trader with a long position in one contract would lose $900 on May 14 and the margin account of a trader with a short position would gain this amount on May 14."-- Hull, John C (2014-02-19). Options, Futures, and Other Derivatives (9th Edition) (Page 37). Prentice Hall. Kindle Edition.

Please note the chart to which Hull refers is labeled "Prior Settle" consistent with the CME definitions http://www.cmegroup.com/trading/about-quotes.html so I *think* it's okay to insist that for a given (e.g., previous) day the settlement price must (should) be within the same day's low and high prices, but the problem in my opinion, is that the quotes mix a prior settlement with a current day's high/low/close so I'm *thinking* this question is a little imprecise.

 

[prebhan27]

Hi, I am currently practicing with the FRM 2014 Practice Exam Part II and I just did the question 4. regarding Backtesting VaR. My question is the following:
How do they get to the statistic lookup value of 1.96? I get to the 1.96 as well, if we this is a t-test and we are looking at the students t-distribution table with unlimited df and level of significance of ONE-TAILED test of 0.025 (as we have a VaR (98%) significance level would be 2%.
For Backtesting VaR do you use a t-test ?
Why do they mention in the explanation that 1.96 ist derived from a TWO-TAILED confidence level quantile?
Thanks in advance,
Peter

 

[ami44]

The t-distribution with unlimited df is identical to the normal distribution i.e. Z-table. The 1.96 is valid for a two tailed z-test with 5% confidence level.
I guess the rationale for using the z-test here is, that the variance is known. Because we actually deal with a binominal distribution with n = 252 and p = 0.02 we know that the variance is p*(1-p) * n.
To use the z-test we have to assume, that the binominal distribution approximates a normal distribution good enough.

I agree with you, that the use of the two tailed test seems a bit suspicious here. The question clearly describes a one tailed test: "what is the maximum number of daily losses exceeding the 98% VaR that is acceptable to conclude, at a 95% confidence level, that the model is calibrated correctly?" Since a minimum number of losses is not mentioned, its a one tailed test and 1.64 instead of 1.96 should be used in my opinion. If I calculated correctly the result will then be 8.6, which means 9 is still the correct answer.

 

[prebhan27]

Thank you for your answer ami44. I was unsure which test to use and confused about the information with the two-tailed test.