Exam Feedback May 2018 Part 2 Exam Feedback

[Kullado]

Thanks for clearing things up David. I was a bit confused when I read some people went with a frown.

 

[jamietay]

Honestly, I can't remember the exact question on the "jump" nor the options given.

But there was a question on which one will have a higher price than OTM Call something to that effect....

 

[Bilal Ehsan]

But David text on volatility smile topic suggest that it will be bimodal or frown for price jump.

The word they use in the paper was that there is infrequent price jump

 

[David Harper CFA FRM]

thank you @Bilal Ehsan the problem is that "jump" by itself is ambiguous and can support either a frown (per the jump due to a binomial) or a smile (per the more typical meaning of "jump risk" this is consistent with Hull's EOC Question 20.3 that I cited above). But the adjective "infrequent" suggests strongly to me they were looking for a frown à la Hull's "single (aka, binomial) large jump" but if the only assumption was "infrequent jump" without further qualification, then I can certainly empathize with those who selected smile. In fact, I think most quants would agree that jump-diffusion models are used precisely because they explain the implied volatility skew. So, IMO, the most natural response to the word "jump" is skew; i.e., heavy left-tail, at least. I'm not sure the mere use of "infrequent" can be expected to convincingly switch the answer to frown: the specifics are nuanced, at the end of the day, "jumps" can reconcile with either smile or frown simply depending on our definition of jump (as I said above, a binomial has jumps, but for p in the range of 0.40 to 0.60, the binomial is slightly light tailed). I'll share this with GARP ....

 

[Nirushan1990]

Hi David,

Since the volatility smile curve is different for currency and equity options, would it be possible to have a common (same) volatility frown curve for both type of options? I think the question was on stock options with a large price move and they didn't mention if it's a up move or a down move. I am just wondering what's the correct answer for that question

 

[schumi_frm]

If I remember correctly, the question was about a merging of a company taking place in a few days. The price of the stock was expected to either increase by X% or decrease by Y%.

 

[Navneet02]

The wording is important. In general, jumps suggest an volatility smile; this is hopefully intuitive, a greater probability of big move suggests heavier-than-lognormal tails. However, the confusion arises because a binomial (e.g., bimodal) distribution tends to have lighter tails and therefore suggests a frown; this is per Hulls 20.8, but his example is a bimodal distribution (his bimodal example concerns a "single large jump" which is different than a general jump risk model), not the situation when there are jumps in the underlying asset price (a binomial distribution with p in the neighborhood of 0.50 +/- 0.10 has kurtosis < 3).

In this way, "jump risk" suggests a volatility smile (not frown). See https://forum.bionicturtle.com/threads/vol-frown-jumps-in-underlying-asset.10256/#post-59508 but also Hull's EOC question 20.3:


Bottom line (in my humble opinion): "jumps" is far more likely to suggest smile than frown because for a frown (i) the question would need to be explicit about the bimodial/mixture nature of the distribution and (ii) the smile should be more intuitive, anyway, right? Jump risk suggests heavier tails and therefore smile.

The question was on a large price move in a merger of tageted and acquirer firm. That leads to a frown not smile.

 

[Navneet02]

Thanks for clearing things up David. I was a bit confused when I read some people went with a frown.

It was frown not smile as the question stated big price moves in a merger

 

[jamietay]

I'm not sure if anybody remembers this but there's a question similar to the above topic on left heavier tail and asking us to choose the right answer in terms of pricing. 2 options out of 4 are on the ATM price being either higher or lower than the OTM call option I think.

 

[Bilal Ehsan]

I remember this question and ans for this question was that ATM call option has more volatility than OTM call option.

 

[jamietay]

Hi David,

Regardless of whether or not there were mistakes on previous GARP practice tests/exams, I simply meant that BT did not have us practice how to calculate CVA charges [(1-RR)(EE)(PD)(DF)] on any of the BT practice tests. and the only place I had seen or practiced the question setup was from previous GARP practice exams (2012-2015, I can’t remember) So regardless of whether their calcs in practice exams were correct, GARP seems to have demonstrated an importance on the concepts —> and maybe something to add to BT going forward. This is the 2nd GARP exam I’ve taken (after FRM 1) where they have re asked questions that look VERY SIMILAR to the practice questions they release over the years

While thinking of it, GARP also asked some convuluted exposure type questions where several counter parties are involved facing each other with different credit exposures, and it was asked to identify the risks and/or how to hedge. I think questions of this nature would be a huge benefit for understanding to future FRM 2 test takers

Hi @drewmanfsu, I remember there's a question on hedging and asking us to identify the risks. I can't remember all the options clearly. There was one on basis risk and counterparty credit risk, lending risk and market risk, funding risk and market risk and...... Wonder what is the right answer.

 

[schumi_frm]

I went for funding risk and counterparty credit risk.

 

[jamietay]

I went for funding risk and counterparty credit risk.

Is that the fourth option? Or no such thing as basis risk and counterparty credit risk. I recall seeing counterparty credit risk once. My memory must have failed me....

 

[Bilal Ehsan]

I believe right option was funding and liquidity risk... Were there two option with funding risk....1. Funding and Counterparty and 2 Funding and liquidity? I went with funding and liquidyt.

 

[Stella G]

I was under the same impression and this was what happened in London but then how is it possible for other countries to have had a wall clock in the actual exam room?? I think this is not fair game so was wondering if anyone could advise on any formal policy that GARP might have released regarding this. Maybe @David Harper CFA FRM or @Nicole Seaman would be the best persons to assist.

@David Harper CFA FRM Any ideas on this?

 

[Maiyaa]

It was frown not smile as the question stated big price moves in a merger

Big price move on either side ( price of the stock either increase by X% or decrease by Y% ) would effect the TAIL more -- hence will pull up the implied Volas for the tails. So writers would expect a higher premium on the OTM Calls/Puts -- Smile curve IMHO would capture that move.

 

[hana1563]

I believe right option was funding and liquidity risk... Were there two option with funding risk....1. Funding and Counterparty and 2 Funding and liquidity? I went with funding and liquidyt.

there was funding liquidity risk. they were not separated.. so you should have chosen another risk option. i chose funding liquidity and market

 

[Maiyaa]

What were the options? I already forgot. One of the answers was something about different bank sizes, right? I know I did not chose this one.

Does someone remember about the EL from a PIT model question? I went that it was not suitable for Stress test, but was very unsure.

IMHO focus of question was drawback of SMA approach. In SMA approach risk exposure is one the factors. This might encourage Banks to take risky exposures(high risk high reward) which means Banks might go unpunished for more risk exposures. Did anyone remember the options for the answers on this line?

 

[Bilal Ehsan]

You are right . I got confuse . Funding liqduity is one risk .
I believe I went with funding liquidity and market risk as well or if I can get to know other funding liquiity option

 

[schumi_frm]

I believe right option was funding and liquidity risk... Were there two option with funding risk....1. Funding and Counterparty and 2 Funding and liquidity? I went with funding and liquidyt.

I am almost 100% sure that 3 of the 4 answers contained "market risk", so no answer such as "funding and liquidity" if my memory serves me right. The answers were something like:

- Market and basis risk
- Market and funding risk
- Funding risk and counterparty credit risk
- Market risk and liquidity risk