Exam Feedback May 2018 Part 1 Exam Feedback

[dahoang92]

1. Won’t rising rates make it easier to fund the pension plan? As for the impact on the shareholders fund (i.e. shareholders equity), I am not too sure. I selected that it decreases. My logic was that when rates rise, fixed income asset prices drop but the pension plan's liability remains constant...hence a net negative impact to shareholders equity. This question was referring to a defined benefit plan. Somebody please let me know if my understanding of this is correct.

Read here more for information on this:

3. I also chose variation margin of 54000. Only sensible answer in my opinion.

4. Wasn’t it asking for the price of the warrant given the price of a call? Answer is N/(N+M) * Price of call

5. I don’t remember this. Par rate? Or you mean discount rate (the question in a table format where you were asked to find the spot rate of the bottom row)? There was also a question where you given semi annual compounding rate and asked to find the monthly compound rate.

6. I applied standard formula and got an answer.

7. I can’t recall my answer now, but won’t rising futures prices hurt a stack and roll strategy?

8. How was this question framed again? Can’t recall it!

5. I remember a table with par rate and discount factor. I was eager to just use the discount factor to calculate the spot rate. But I realize those discount factor are just calculated from the par rate given. So I think the spot rate should be calculated from the par rate. I don't have enough time to finish this question.

7.

From what I understand, a long position in future contract as the MG case: they have long position in future and expect to be profitable in backwardation, but when price shift to contango they lose.
In the investopia page:
Benefits of Backwardation
The primary cause of backwardation in the commodities' futures market is a shortage of the commodity in the spot market. Since futures prices are below spot prices, investors who are net long the commodity benefit from the increase in futures prices over time as the futures price and spot price converge. Additionally, a futures market experiencing backwardation is beneficial to speculators and short-term traders who wish to gain from arbitrage.

So I think in backwardation, future prices rise and it is beneficial for long position.

8. The question on volatility term structure, the first 2 choices was about strike prices as the x-axis, which is irrelevant.
I choose: if volatility term structure is decreasing, it mean volatility is above it long-run volatility.

 

[nikic]

5. I remember a table with par rate and discount factor. I was eager to just use the discount factor to calculate the spot rate. But I realize those discount factor are just calculated from the par rate given. So I think the spot rate should be calculated from the par rate. I don't have enough time to finish this question.

7.

From what I understand, a long position in future contract as the MG case: they have long position in future and expect to be profitable in backwardation, but when price shift to contango they lose.
In the investopia page:
Benefits of Backwardation
The primary cause of backwardation in the commodities' futures market is a shortage of the commodity in the spot market. Since futures prices are below spot prices, investors who are net long the commodity benefit from the increase in futures prices over time as the futures price and spot price converge. Additionally, a futures market experiencing backwardation is beneficial to speculators and short-term traders who wish to gain from arbitrage.

So I think in backwardation, future prices rise and it is beneficial for long position.

8. The question on volatility term structure, the first 2 choices was about strike prices as the x-axis, which is irrelevant.
I choose: if volatility term structure is decreasing, it mean volatility is above it long-run volatility.

5. Why can't calculate spot rate from discount rate?

7. I might be wrong here then.

8. Honestly can't remember this question.

 

[nikic]

There was a question about country default risk, and the answer I had selected was that sovereign credit rating in local currency is at least or more than the sovereign credit rating in foreign currency.

Anyone recall this?

 

[nikic]

I'm trying to recall question from Foundations of Risk Management. There should be 20 questions in all, but I can only recall 10. Can someone see what I'm missing out on? I've got 18/25/25 questions for Books 2/3/4 respectively.

1. IR/Sharpe ratio
2. Impact of Beta/volatility on Jensen/Sharpe/Sortino/Treynor
3. Theory question on CAPM
4. Barings failure
5. Metallgesellschaft
6. Multifactor model
7. GARP Code of Conduct - (Employee uses model from previous employer)
8. ERM Framework - (One of the answers spoke about line management)
9. Operational risk - Which of the following is an operational risk (Answer was rogue trading or something)
10. Some question about Data Aggregation

What am I missing out on? Appreciate all your help.

 

[nikic]

There was a question on the quants side. It said in the past 250 days, at 99% VAR there were 3 exceedences observed. Question then asked for the probability of exactly 3 exceedences occurring at 99% VAR.

How did you guys do this? Did the question ask to assume binomial distribution? Or were you supposed to use another distribution?

The way I did it was as such:

250C3 * (0.01)^3 * (0.99)^247 = 21.5%

Anyone managed this question?

 

[flex]

There was a question on the quants side. It said in the past 250 days, at 99% VAR there were 3 exceedences observed. Question then asked for the probability of exactly 3 exceedences occurring at 99% VAR.

How did you guys do this? Did the question ask to assume binomial distribution? Or were you supposed to use another distribution?

The way I did it was as such:

250C3 * (0.01)^3 * (0.99)^247 = 21.5%

Anyone managed this question?

i answered u early, when it's 1st mentioned at the thread

 

[flex]

5. I remember a table with par rate and discount factor. I was eager to just use the discount factor to calculate the spot rate. But I realize those discount factor are just calculated from the par rate given. So I think the spot rate should be calculated from the par rate. I don't have enough time to finish this question.

In this qstn 'par' was named as 'SWAP' int. rates, and, IMHO, it was dummy info

 

[flex]

5. I remember a table with par rate and discount factor. I was eager to just use the discount factor to calculate the spot rate. But I realize those discount factor are just calculated from the par rate given. So I think the spot rate should be calculated from the par rate. I don't have enough time to finish this question.

In this qstn 'par' was named as 'SWAP' int. rates, and, IMHO, it was dummy info

 

[krystynkatt]

8. The question on volatility term structure, the first 2 choices was about strike prices as the x-axis, which is irrelevant.
I choose: if volatility term structure is decreasing, it mean volatility is above it long-run volatility.

it was a question about garch model and flat term structure was among the answers, wasn't it? or am i mixing two questions?
for the question with pension fund and equity, same as one of the posters here, i chose pension funding status to improve and equity to deteriorate, as i reasoned that with increasing interest rate fixed income instruments would be preferred; i'm not sure of this one though. I guess pension funding status should improve, as it can be treated as liability funded when interest rate was lower.

 

[dahoang92]

it was a question about garch model and flat term structure was among the answers, wasn't it? or am i mixing two questions?
for the question with pension fund and equity, same as one of the posters here, i chose pension funding status to improve and equity to deteriorate, as i reasoned that with increasing interest rate fixed income instruments would be preferred; i'm not sure of this one though. I guess pension funding status should improve, as it can be treated as liability funded when interest rate was lower.

You are right. Among the answer is: If term structure is not flat then the GARCH model is wrong or something like that. But it is not true.

 

[krystynkatt]

You are right. Among the answer is: If term structure is not flat then the GARCH model is wrong or something like that. But it is not true.

And are you sure that the other two answers were with strike price? I remember i chose an answer with increasing/decreasing term structure and long run volatility, but not sure about the directions (increasing/decreasing and lower/higher)

 

[dahoang92]

And are you sure that the other two answers were with strike price? I remember i chose an answer with increasing/decreasing term structure and long run volatility, but not sure about the directions (increasing/decreasing and lower/higher)

I pretty sure this is the right answer. Decreasing term structure means long-run vol is lower than current vol.
I was tried to remember what is term structure of vol and then decide that it does not involve strike prices.

 

[krystynkatt]

I pretty sure this is the right answer. Decreasing term structure means long-run vol is lower than current vol.
I was tried to remember what is term structure of vol and then decide that it does not involve strike prices.

agreed, in garch model volatility does not depend on strike prices. Thank you!

 

[Albertikos]

There was a question about country default risk, and the answer I had selected was that sovereign credit rating in local currency is at least or more than the sovereign credit rating in foreign currency.

Anyone recall this?

Me too! i put the same! Someone has choose a different answer?

 

[krystynkatt]

Me too! i put the same! Someone has choose a different answer?

I believe i have chosen same answer, unless the stress got me confused. This is the correct one obviously (its stated explicitly in damodaran paper).

 

[BoobyMiles]

So what was the answer provided in the exam? I thought I chose an obvious answer but can’t seem to recall it. Did the answer speak about the clients right to cancel contracts? Was there one or multiple answers that talked about the cash flow problem? Cause I remember choosing an answer which addressed the cash flow problems, but not sure about the cancellation of contracts part.

the answer indeed referenced cash flow problems, and it was linking the cash flow problems to the clients (not explicitly saying clients cancelled but i believe it referenced client "contracts" or "agreements". if i recall correctly, and it's been a week now, the wrong answer choice that mentioned cashflow i believe gave the reason as MG using an incorrect/invalid/theoretically unsound/model-errored strategy, which was a point explicitly debunked in the text (the overall strategy was sound)

 

[BoobyMiles]

1. Won’t rising rates make it easier to fund the pension plan? As for the impact on the shareholders fund (i.e. shareholders equity), I am not too sure. I selected that it decreases. My logic was that when rates rise, fixed income asset prices drop but the pension plan's liability remains constant...hence a net negative impact to shareholders equity. This question was referring to a defined benefit plan. Somebody please let me know if my understanding of this is correct.

Read here more for information on this: https://www.brookings.edu/research/...erest-rate-for-defined-benefit-pension-plans/

3. I also chose variation margin of 54000. Only sensible answer in my opinion.

4. Wasn’t it asking for the price of the warrant given the price of a call? Answer is N/(N+M) * Price of call

5. I don’t remember this. Par rate? Or you mean discount rate (the question in a table format where you were asked to find the spot rate of the bottom row)? There was also a question where you given semi annual compounding rate and asked to find the monthly compound rate.

6. I applied standard formula and got an answer.

7. I can’t recall my answer now, but won’t rising futures prices hurt a stack and roll strategy?

8. How was this question framed again? Can’t recall it!

for # 4, whether you used n/(n+m)* price of call or (n-m)/n*price of call you got a number like 97% of the call price, and using either calculation there was only one answer choice in the ball park (D if i recall correctly).

 

[BoobyMiles]

I can't recall that. But for unexpected loss, bank should use it for economic capital. Expected loss are already accounted in pricing of product.

Some of the question I remember and not very sure of the answer.

1. For a pension plan, what is the effect of rising interest rate when the assets of the plan is stable. I choose the plan is deteriorating and negative for investor, because if interest rise and asset stable then present value will decrease?

2. The question give the term of 2 zero-coupon bond, the weight of investment and ask to calculate the portfolio duration and convexity. I remember something like duration is the term of the bond and convexity is the term^2. The portfolio duration and convexity is the weighted sum of the two. Not quite sure.

3. The margin call of future contract. The price of gold is decreasing for day 1 and stay the same for day 2. All of the answer is incorrect to me. I choose the answer that variation margin is 55000 for day 2 or something, but if price of day 2 is the same, the holder of future should not post variation margin because it must be fulfill for day 1 already, right?

4. Question on warrant and price of stock after announcement of warrant. Not quite sure about the solution? Anyone remember that question and how to calculate that? I think the price will reduce by n/(n+m) (%) but it not in the answer in my first try.

5. Question give the par rate and calculate the spot rate.

6. Question on calculation of EWMA correlation.

7. The stack and roll strategy question. I choose something like the strategy will profitable if future price increasing, right? Because it means it is in backwardation: future price is smaller than spot price and future price will increase in the future. If future price increasing then you can buy at lower price and sell at better price in the future, is that correct?

8. Question on volatility term structure. Lucky to get it right.

and for #7, i thought that stack-and-roll profits when they generate positive roll return, which happens in backwardation, and backwardation is when futures prices are decreasing isnt it?

EDIT: i just looked online, and found this: "contango indicates that futures prices are falling over time to converge to the future spot price." i think you're right

 

[nikic]

the answer indeed referenced cash flow problems, and it was linking the cash flow problems to the clients (not explicitly saying clients cancelled but i believe it referenced client "contracts" or "agreements". if i recall correctly, and it's been a week now, the wrong answer choice that mentioned cashflow i believe gave the reason as MG using an incorrect/invalid/theoretically unsound/model-errored strategy, which was a point explicitly debunked in the text (the overall strategy was sound)

I'd definitely not have selected an answer referencing an incorrect/unsound model. So yeah, I think I should have selected the correct answer here.

 

[BoobyMiles]

Me too! i put the same! Someone has choose a different answer?

i actually double-checked one right after the exam and the material clearly states that due to local gov'ts control of monetary policy (and ability to more effectively respond to changes in their own domestic economy), local currency ratings are generally at least as high the foreign currency rating, BUT it is possible that the local currency rating is lower, as was the case with India in March 2010. even looking at this right after the exam, i couldnt remember if the answer choice made a definitive statement (local currency is always at least equal to or greater than foreign currency rating) or gave wiggle room ("it's generally greater", "or almost always higher", etc.).

Do you guys recall?