Exam Feedback November 2016 Part 2 Exam Feedback

[Eternity]

One question I vaguely recall was the asset/liability pension fund question where they described risks: 1. manager changed the expected asset allocation based on expectations and lost money, 2. and the sponser was concerned about liabilities exceeding assets, etc.,

The question was: which relevant risk was not described? active management risk, sponser risk, counter party risk, liquidity risk.

I was thrown off not by the paragraph/description but the wording of the question. i.e., the only risk not mentioned (imo) was counter party risk, but that seemed like kind of a stretch.

I chose counterparty risk

 

[Siqueue]

Ok, things I recall:

• There was a question on CCP: A country has three dealers (X, Y, Z) and a set of collateralised exposures are listed. The dealers have bilateral netting agreements but the govt is investigating setting up a CCP. How much collateral would be freed up? (I got that the total collateral in use, after bilat netting was 9, and the options were 2, 7, 9, 10. So concluded 10 and 9 weren't likely but couldn't see the netting benefit without a correlation assumption so just guessed 2).
• One of the essay questions described a bank with loans to customers and some derivative exposures. The bank has securitised some of the loans. It retained the equity portion and sold the senior risk to, inter alia, a named investor. This investor who has a substantial exposure bought some credit protection from the original bank. If correlation increased (?? i think) what is the effect. I can''t remember the exact details of the question but it was clearly getting at the effect of correlation increasing on securitised risk (good for the equity, bad for the senior) and wrong-way risk on the derivative.
• Another essay style question about an asset manager with three sub funds (global macro hf, commodity hf and real estate). Long and meandering description but one question I recalled was on risk budgeting. Options were to allocate new capital equally, allocate it in proportion to the funds' respective information ratios and something else. Then the question was if option A was taken, would fund 1 get more capital than fund 2, if option b was taken would fund 3 get more than fund 1 and is equally weighting a better hedge, etc. I think I picked the one on IR, even though I think the fund with the negative return had the better IR. Another question on this one was that the CIO thinks that equity markets and commodities will both outperform. A correlation matrix is given and the CIO goes long a correlation swap struck at 41%. What is the effect if the correlation is lower? The options were the fund has to pay more than x, fund has to receive less than x, fund has to pay less than x and fund has to receive more than x. As I recall the average correlation in the given matrix was .4 and so (.41-.4)*Notional did give the X. I think I decided that given the way the question was phrased the CIO was long correlation risk so underperforming correlation was bad but then had to guess whether that meant paying more or receiving less.
• There was a question on binary tree pricing of a bond.
• One on empirical hedge ratio.
• There was an incredibly tough essay style question on a bank's balance sheet. The bank funded non-US exposure using FX swaps. At the start of the year interest rates in the US increase unexpectedly right after the bank has sold its JGBs and used the proceeds to make "new margin loans" (which I took to mean that the loans were at an on-market rate and that the loans were in JPY): what is the effect? The options were to do with increased exposure I think. I can't recall the details but I do recall that I didn't get it right.
• There was a question on working out the CVA that went along the lines of the exposure for the next two years is X, spread is Y, LGD is Z and OIS rate is 2.5% (I think), what is the CVA.
• Question on a pension fund where the manager deviates from his mandate, going overweight foreign equity which subsequently underperforms. The plan sponsor is concerned about which risk which wasn't discussed: active management risk, counterparty risk, funding risk and maybe sponsor risk. The question seemed to be getting at Surplus at Risk but it wasn't explicitly mentioned. I chose funding risk - thinking this was the risk of having to additionally fund the plan but I am not sure that was right.
• There was a question on working out a Libor forward using OIS discounting that I couldn't recall how to do, which was very annoying as I don't think there was any trick to it.
• There was a question on Ho-Lee that required you to work out the lowest level of sigma which would lead to a negative rate at node 0,2 given a certain set of parameters.

That is all I can recall right now...

 

[Eternity]

Ok, things I recall:

• There was a question on CCP: A country has three dealers (X, Y, Z) and a set of collateralised exposures are listed. The dealers have bilateral netting agreements but the govt is investigating setting up a CCP. How much collateral would be freed up? (I got that the total collateral in use, after bilat netting was 9, and the options were 2, 7, 9, 10. So concluded 10 and 9 weren't likely but couldn't see the netting benefit without a correlation assumption so just guessed 2).
• One of the essay questions described a bank with loans to customers and some derivative exposures. The bank has securitised some of the loans. It retained the equity portion and sold the senior risk to, inter alia, a named investor. This investor who has a substantial exposure bought some credit protection from the original bank. If correlation increased (?? i think) what is the effect. I can''t remember the exact details of the question but it was clearly getting at the effect of correlation increasing on securitised risk (good for the equity, bad for the senior) and wrong-way risk on the derivative.
• Another essay style question about an asset manager with three sub funds (global macro hf, commodity hf and real estate). Long and meandering description but one question I recalled was on risk budgeting. Options were to allocate new capital equally, allocate it in proportion to the funds' respective information ratios and something else. Then the question was if option A was taken, would fund 1 get more capital than fund 2, if option b was taken would fund 3 get more than fund 1 and is equally weighting a better hedge, etc. I think I picked the one on IR, even though I think the fund with the negative return had the better IR. Another question on this one was that the CIO thinks that equity markets and commodities will both outperform. A correlation matrix is given and the CIO goes long a correlation swap struck at 41%. What is the effect if the correlation is lower? The options were the fund has to pay more than x, fund has to receive less than x, fund has to pay less than x and fund has to receive more than x. As I recall the average correlation in the given matrix was .4 and so (.41-.4)*Notional did give the X. I think I decided that given the way the question was phrased the CIO was long correlation risk so underperforming correlation was bad but then had to guess whether that meant paying more or receiving less.
• There was a question on binary tree pricing of a bond.
• One on empirical hedge ratio.
• There was an incredibly tough essay style question on a bank's balance sheet. The bank funded non-US exposure using FX swaps. At the start of the year interest rates in the US increase unexpectedly right after the bank has sold its JGBs and used the proceeds to make "new margin loans" (which I took to mean that the loans were at an on-market rate and that the loans were in JPY): what is the effect? The options were to do with increased exposure I think. I can't recall the details but I do recall that I didn't get it right.
• There was a question on working out the CVA that went along the lines of the exposure for the next two years is X, spread is Y, LGD is Z and OIS rate is 2.5% (I think), what is the CVA.
• Question on a pension fund where the manager deviates from his mandate, going overweight foreign equity which subsequently underperforms. The plan sponsor is concerned about which risk which wasn't discussed: active management risk, counterparty risk, funding risk and maybe sponsor risk. The question seemed to be getting at Surplus at Risk but it wasn't explicitly mentioned. I chose funding risk - thinking this was the risk of having to additionally fund the plan but I am not sure that was right.
• There was a question on working out a Libor forward using OIS discounting that I couldn't recall how to do, which was very annoying as I don't think there was any trick to it.
• There was a question on Ho-Lee that required you to work out the lowest level of sigma which would lead to a negative rate at node 0,2 given a certain set of parameters.

That is all I can recall right now...

The netting qns I picked 10, because I think it was asking the collaterals can be reduced. For example if A posts 7 collateral and B posts 5 collateral, then the total collaterals can be reduced is 5.

Correlation qns I went for receive more than 0.4 million because the firm is the buyer and the actual corr > forecasted and (forecasted - fixed) * notional = 0.4 million alr, so the buyer should receive more.

For the risk that is not mentioned I chose counterparty risk. Funding risk is related to obligation coverage which was mentioned I think, it said the investor worried that the fund cannot cover the liability.

Binary tree pricing is 945 usd smth.

Ho lee model is 5.1%

 

[Siqueue]

The netting qns I picked 10, because I think it was asking the collaterals can be reduced. For example if A posts 7 collateral and B posts 5 collateral, then the total collaterals can be reduced is 5.

But that is bilateral netting, no? Which they already did.

 

[Eternity]

But that is bilateral netting, no? Which they already did.

Omg I misunderstood the qns. Then should be 2

 

[FRMPART2]

Answer for CVA was LGD*Discount factor* EE* PD .Actually marginal default probability was required.but in question only PD was given.hence for answer PD was used

 

[FRMPART2]

Question was change in collateral when billateral netting was changed to CCP.

 

[FRMPART2]

For liquidity Var they have given the VAR for one day other information for spread was not given and question was to xalculate LVAR for tweleve days .hence answer was calculated by VAR *squareroot of 12

 

[Eternity]

For liquidity Var they have given the VAR for one day other information for spread was not given and question was to xalculate LVAR for tweleve days .hence answer was calculated by VAR *squareroot of 12

I got same answers for CVaR and LVaR as yours, so your collaterals qns answer?

 

[Moey]

For liquidity Var they have given the VAR for one day other information for spread was not given and question was to xalculate LVAR for tweleve days .hence answer was calculated by VAR *squareroot of 12

Hm, pretty sure that was a liquidated var question *= SQRT((1+t)(1+2t)/6t). There were two 4s, a 6, and a 10 or something... I chose 6-something.

 

[Moey]

Omg I misunderstood the qns. Then should be 2

This should've been a cake walk but my multi-netted answer was 1 which wasn't a choice. Maybe I misread the question or messed up the simple math, but unfortunately I didn't have time to review it. Does anyone remember the numbers here?

 

[Diep Anh Ngo]

The netting qns I picked 10, because I think it was asking the collaterals can be reduced. For example if A posts 7 collateral and B posts 5 collateral, then the total collaterals can be reduced is 5.

Correlation qns I went for receive more than 0.4 million because the firm is the buyer and the actual corr > forecasted and (forecasted - fixed) * notional = 0.4 million alr, so the buyer should receive more.

For the risk that is not mentioned I chose counterparty risk. Funding risk is related to obligation coverage which was mentioned I think, it said the investor worried that the fund cannot cover the liability.

Binary tree pricing is 945 usd smth.

Ho lee model is 5.1%

For the netting question I picked 9 because net exposure after bilateral netting is 9
Correlation swap i picked answer C: the bank receive less than 0.4 because correlation realized is >0.41 and the amt that the bank receive is 0.3 mil (that less than 0.4 mil). Bank receiving instead of paying because in the beginning of question quoted CIO expect correlation will increasing --> bet in floating correlation against fixed (0.4)
Fund's risk question I chose counterparty risk, too
LVaR question you should use formula: VaR*sqrt{(T+1)*(2T+1)/6T} with VaR and T(12 days) that given in the question
For CVA, you should derive PD from formula: 1-e^(-lamda*t), and then calculate PD for second period= cumulative PD for 2 years - cumulative PD in 1st year. Then put it in the formula CVA= Sum{LGDi.EEi.Discount factor i.PDi}

anyone remember exactly answer for Hoo Lee model? (question 1st in red booklet qust)

 

[JVE]

Question on pension fund not being able to cover liabilities with assets - I choose sponsor risk. If L > A, then the plan's sponsor would be expected (by participants as well as regulators) to make up the difference. Sponsor's willingness/ability to do this = sponsor risk. Question was strangely phrased, asking for which risk was not discussed but relevant.

Question on the 3 counterparties X, Y and Z with 6 bilateral transactions between them who move to a CCP - the question asked for the reduction in collateral after CCP novation. I got 8, which wasn't any of the possible answers. Still puzzled by that one, suspect there must be some kind of assumption there is rehypothecation going on.

Question on the correlation swap - the realised correlation with higher-than-expected correlation > fixed correlation of 40. Hence the variable (realised) leg of the swap has a greater cash flow than the fixed leg. Now, I found it ambiguous whether the firm was on the receiving or paying end on of the variable leg, since the question said the firm 'went long' on the correlation swap. The study material seems to suggest that the 'buyer' (i.e. long?) of a corr swap receives fixed and pays realised (variable). If so, then the answer would be that the firm would be paying more than 4m. Still seems counterintuitive, because this would mean a long position in a correlation swap expresses a short view on correlation.

 

[JVE]

Question on the Ho Lee model and the (non)negative interest rate at the lowest (0,2) node - I don't know if I did it right, but I seem to remember I got to 5.4.

 

[FRMPART2]

I choose funding liquidity risk as liabilities are greater than assests and pensions funds will face problems to fund their pensions

 

[JVE]

There was also a question on the shape of the implied volatility curve for options on a stock which is in an M&A process and is therefore expected to either go up by 25% or go down by 20%. This puzzled me for a while. Price jumps cause volatility frowns... but how about expected price jumps? I figured they do, because logically all known information should already be incorporated in the curve. But not sure.

 

[Eternity]

Question on pension fund not being able to cover liabilities with assets - I choose sponsor risk. If L > A, then the plan's sponsor would be expected (by participants as well as regulators) to make up the difference. Sponsor's willingness/ability to do this = sponsor risk. Question was strangely phrased, asking for which risk was not discussed but relevant.

Question on the 3 counterparties X, Y and Z with 6 bilateral transactions between them who move to a CCP - the question asked for the reduction in collateral after CCP novation. I got 8, which wasn't any of the possible answers. Still puzzled by that one, suspect there must be some kind of assumption there is rehypothecation going on.

Question on the correlation swap - the realised correlation with higher-than-expected correlation > fixed correlation of 40. Hence the variable (realised) leg of the swap has a greater cash flow than the fixed leg. Now, I found it ambiguous whether the firm was on the receiving or paying end on of the variable leg, since the question said the firm 'went long' on the correlation swap. The study material seems to suggest that the 'buyer' (i.e. long?) of a corr swap receives fixed and pays realised (variable). If so, then the answer would be that the firm would be paying more than 4m. Still seems counterintuitive, because this would mean a long position in a correlation swap expresses a short view on correlation.

From Kaplan's book 1, page 65, the buyer of correlation swap pays fixed and receives realized..

 

[Johnkrause1]

From Kaplan's book 1, page 65, the buyer of correlation swap pays fixed and receives realized..

If so, that means that the he will be receiving 0.4 mil more?

 

[FRMPART2]

What u think will be the safe score to pass FRM part 2 .50% or more than that

 

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Should we include recovery from insurance in calculating op loss?