Financial Risk Manager

Procyclicity

2008-11-14T08:58:48-08:00

Hi.

both at-the-point and through-the-cycle have procyclicity effect??

suk

PD & expected loss

2008-10-06T09:31:49-08:00

Hi David,

I have taken this Q from the practice set 2007…

A company has been offered a USD 5 million term loan to be fully repaid only at maturity
2 years later. The bank estimates that it will recover only 55% of its exposure if the
borrower defaults and that the likelihood of that happening is 0.1%. What is the bank’s
expected loss one year later?
a. USD 2,750
b. USD 2,250 (answer)
c. USD 1,375
d. USD 1,125

here it mentions that maturity is at end therefor period doesn’t matter, I am little confused...as in our credit risk portion, we have not used the same method for zero coupon bonds..and calculated the marginal PD at the end of the year. I was getting C as I calculated marginal PD

Rgrds,
OM

What is Liquidity Put?

2008-11-09T15:17:24-08:00

hi David,

i tried to find out what it is, but still wondering

money back guarantee anytime on MBS ?

could you explain it please?

suk

Credit Loss

2008-11-12T18:41:06-08:00

Hi,

this is a question from 06 practice exam part II

79.Which of these transactions will NOT result in a credit loss for Bank A in the event of
default before maturity by Bank A’s counterparty?

I. Bank A buys an ATM (at-the-money) call option on the USD/CHF and the
CHF subsequently depreciates against the USD.
II. Bank A buys an interest rate cap and interest rates are below the cap level.
III. Bank A goes long AUD through an OTC forward contract on the AUD/YEN
and the AUD subsequently appreciates against the YEN.
IV. Bank A receives fixed in an interest rate swap and interest rates have risen.

II and IV is the right answer, but i’m wondering about I and III

first, in terms of choice I,
it says CHF depreciation against USD, which makes USD/CHF go down
so call option is gonna be OTM. this is my thought
however, this is what solution gives -> It would result in a credit exposure as the option has moved in-themoney
and has a positive value to Bank A.

next one, choice III
it says long AUD through forward on the AUD/YEN
I thought forward price in this contract is AUD/YEN
so that there will be a loss (but not credit loss) if AUD appreciates against yen ; AUD/YEN goes down

It would result in a loss as the contract has a positive value to Bank A -> this is explanation by garp
how does contract have positive value??

thanks a lot

suk

CDS

2008-11-12T03:32:39-08:00

Hi David,

I am not clear how C is the hedge, now here we need to create the synthetic returns as good as selling the corporate bond. So Buy government bond and buy CDS (as we pass on the premium for the default risk). In such a way profit is locked for Wallace. But ans C mentions to Short the CDS. Please correct my understanding, if I am not right here. Thnks.

Practice set III
Q31. Wallace, an emerging market bond trader, is holding a USD 5 year Malaysian corporate bond in his book.
He has made enough profit from this bond position and wishes to lock in the profit (full hedge) without
selling it. Which is the best option for Wallace below?
a. Buy protection with a USD 5 year Malaysian bond.
b. Buy protection with a USD credit default swap on the Malaysian corporate bond.
c. Buy protection with a USD 5 year US Treasury government bond and short a USD credit default swap
on the Malaysian corporate bond.
d. Buy protection with a USD 5 year Ringgit Malaysia government bond and USD short a credit default
swap on the Malaysian corporate bond.

Rgrds
OM

FRM exam 2008 Practice

2008-11-12T08:48:01-08:00

Hi David,

Just would like to tell you that your FRM material has been excellent, and all the Q’s are answered in such a simple way. It is commendable.

Could you pls also help me out with a practice exam 2008 Q.

Your firm is holding a short position in Argentian bond with a notional value of ARS 5000000 & a coupon yield of 5.5%, Your model predicts the bonds yield to decrease over the coming yr. U r asked to hedge the position. Ur recommendation is

a) Buy a credit default swap
b) Sell a credit-spread put option
c) Short a credit spread forward
d) Buy a total rate of return swap.

Mini

Credit risk: Flash quiz - Round 2 question 1

2008-11-12T07:43:50-08:00

Hi David,

Can you please confirm the use of the formula in the calculation of the PD? I know there are 2 different ones and they both come down to the same thing but for some reason I cannot get the correct answer. Thanks.

Value of junior bond

2008-11-11T22:45:28-08:00

Hi David,

This Qustion is frm 2008 practice set and i am not able to understand the question itself..what is it asking us to achieve ..pls help

A junior bond with a face value of 200 matures in 5 years. A senior bond on the same firms also matures
in 5 years, and has a face value of 100. Assume -A = .5 and the riskfree rate=.04. Firm value is equal to
400. Using the Merton model, what is the value of the junior bond? (The following table includes figures
that will reduce the time required to answer this but it also includes figures that are irrelevant to the
problem and some that are strictly wrong).
d1 d2 N(d1) N(d2)
1.978 0.860 .9761 .8051
1.978 0.860 .8051 .9761
0.9952 -.1228 .8413 .5478
0.9952 -1.505 .8413 .0661
0.9952 -.1228 .8413 .4522

TBDS

2008-11-11T22:52:18-08:00

Hi David,

In this Q - I am not able to understand that if default correlation is negative then that will mean that we have perfect hedge ..i.e for every one asset defaulting one will not default ...then how is it increases the investment risk..I am not clear, may be missing some conceptual link..pls help

You are considering an investment in the mezzanine tranche of a tranched basket default swap (TBDS)
constructed from a basket of N assets. The TBDS is structured such that the junior tranche is exposed to
the first four defaults, the mezzanine tranche to the fifth, sixth, seventh and eighth defaults, and the
senior tranche to the ninth and higher defaults. The risk of this investment increases as

Rgrds
OM

question about marginal prob of default

2008-11-11T19:16:57-08:00

Hi,

practice exam 08 part I number 38.

I dont understand the solution intuitively

Conditional Probability (24 months / not defaulted during first 12 months) =

(45.6% - 21.5% ) / (1-21.5%)

is it bayes theorem?

denominator is probability of nondefault in first year

and what is numerator?