With increasing EDF, UL increase at a much faster rate than EL

[qin841121]

This is a statement made by schweser study note. How can it be so since UL=sqrt (EDF.....) anything square will be reduced right?

Unless because EDF is <1 and it will be bigger if it is sqrt?

 

[David Harper CFA FRM]

It is not a correct statement (although the error starts with the source Ong). Please see this: http://forum.bionicturtle.com/threads/edf-for-ul.5803/
Spreadsheet proof is here: https://www.dropbox.com/s/0x6n82fcggd40ny/ong_figure_6.1.xlsx
i.e., UL increases faster than EL at low EDF (consistent with statement) but, at some point which is variant to the LGD assumption, then EL increases faster. Thanks,

 

[qin841121]

but can you please explain why sqrt (edf) for UL < edf for EL since edf is smaller than 1.

Actually the spreadsheet is good but we cannot use it during exam

 

[David Harper CFA FRM]

i realize you can't use the XLS during the exam, the XLS is to prove the point (as i got stuck taking the derivative of UL w.r.t EDF: lacking this mathematical proof, i resorted to empirical demonstration. most elegant would be to take the dUL/dEDF)

i don't follow your point. if EDF = 1%, then SQRT(EFD) = 10%, which is 10X. The SQRT() of an EDF < 1.0 is why the UL increases faster (initially, before eventually being overcome by the other effects and rendering the statement false). Thanks,

 

[qin841121]

Maybe when FRM (which schweser took from) set this question, they were just playing around with the formula of EL and UL, without considering that there are other effects. Thanks for being a great help.

 

[David Harper CFA FRM]

Actually, they are just quoting Ong with thinking about it critically, see http://forum.bionicturtle.com/threads/edf-for-ul.5803/

(sorry, i didn't give you this link above)