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# FRM Level 2 , Nov 2012 : Post what you remember here

##### New Member
For 20, I chose Overcollateralization. Any thoughts on that
20. If I remember correctly, the question is "What amounts to overcollateralization"

By definition, it happens value of MBS issued < Value of underlying mortgate pool. But none of the answer is close to it. CCA and excess spread are correct. There is one option which is phrased other way i.e., Value of MBS issued > value of underlying mortgage pool which is wrong.

And regarding the liquidity crisis, it seems you are correct. But I donot remember reading repo, rolling over etc.. in that question. How are we supposed to know that it comes from current issue and not from credit risk. CFA is far better in that way. Atleast they ask question section wise.

#### nageshtheone

##### Member
20. If I remember correctly, the question is "What amounts to overcollateralization"

By definition, it happens value of MBS issued < Value of underlying mortgate pool. But none of the answer is close to it. CCA and excess spread are correct. There is one option which is phrased other way i.e., Value of MBS issued > value of underlying mortgage pool which is wrong.

And regarding the liquidity crisis, it seems you are correct. But I donot remember reading repo, rolling over etc.. in that question. How are we supposed to know that it comes from current issue and not from credit risk. CFA is far better in that way. Atleast they ask question section wise.
Yeah, thanks. Now I remember the question.
But dont you think that if the receivables on the asset are greater than the payables on the liability side, this could be a kind of overcollateralization. There was one option that had a similar idea.

##### New Member
Yeah, thanks. Now I remember the question.
But dont you think that if the receivables on the asset are greater than the payables on the liability side, this could be a kind of overcollateralization. There was one option that had a similar idea.
True. There was one option which states Value of MBS issued > value of underlying mortgage pool which is the opposite of the collateralization. Regarding the asset and liabilities concept, let me explain clearly. From a financial perspective, anything which generates revenue over a future period of time (in other words, provide economic benefits over the future) is an asset and the one which creates expenses over a period of time is a liability. So if a bank extends a loan to its customer, it is an asset for the bank as it will generate interest income over the future period. Similarly If it has taken a loan from other banks or central bank, then it is a liability for a bank since it has to pay interest in the future period. SPV is a separate entity and it has its own balance sheet. For a SPV, underlying mortgage pool is an asset coz it will generate income in the future and MBS or pass through securities is a liability. Your statement is correct. If assets are greater than liabilities, its a way of overcollateralizing. But in this case, underlying mortgage pool is an asset and liability is MBS/Pass-through securities. Hope I made it clear.

##### Member
There were two questions, one about the Singaporean client with its USD revenues and the other about Nasdaq. Any thoughts?

#### Frm_Indonesia

##### New Member
I also remembered:
1. Credit Risk Mitigant related with Hedge Fund with big transation : Netting, Collateral, Downgrade...
2 Related Option transaction, asked delta value for 1 week before end transaction : -0.5 , 0 , 0.5 , 1 ( I dont remember exactly)

##### New Member
I also remembered:
1. Credit Risk Mitigant related with Hedge Fund with big transation : Netting, Collateral, Downgrade...
2 Related Option transaction, asked delta value for 1 week before end transaction : -0.5 , 0 , 0.5 , 1 ( I dont remember exactly)
If I remember correctly, its about Asian option I guess. And its slightly in-the-money during the expiry I believe. And it progressed from being deep-out-of-money to slightly-in-the-money. So a 1 week before, it should be around at-the-money. Hence the answer I chose is 0.5.

#### DallasFRM

##### New Member
If I remember correctly, its about Asian option I guess. And its slightly in-the-money during the expiry I believe. And it progressed from being deep-out-of-money to slightly-in-the-money. So a 1 week before, it should be around at-the-money. Hence the answer I chose is 0.5.
Stock was at 43 with 1 week before expiration and a 1 year std. dev of 10%, with a strike of 40. This is a deep in the money call, hence 1.0.

#### nageshtheone

##### Member
Stock was at 43 with 1 week before expiration and a 1 year std. dev of 10%, with a strike of 40. This is a deep in the money call, hence 1.0.
google search term "asian option delta is zero near maturity"

www.math.umn.edu/~fhzhou/FM5022/hw5-5022.pdf
File Format: PDF/Adobe Acrobat - Quick View
Problem 22.11. In an Asian option, the payoff becomes more certain as time passes and the delta always approaches zero as the maturity date is approached .

#### matmet

##### New Member
Yes, as the value of the asian option depends on the average stock price until expiration, 5 days before expiration the payoff is pretty much fixed. Even if the stock price falls to zero on the last day, the influence on the payoff will be quite small. => delta very close to 0

#### matmet

##### New Member
28: Mortage pool is structured into two tranches A and B. Coupon payments for mortgage pool and tranch A were given in a table. And Coupon payment for Tranch B was asked. Simple Math.
Ans: LIBOR + 88bp

Does anyone has an answer LIBOR +99bp..
+99 bp as well

##### New Member
Yes, as the value of the asian option depends on the average stock price until expiration, 5 days before expiration the payoff is pretty much fixed. Even if the stock price falls to zero on the last day, the influence on the payoff will be quite small. => delta very close to 0
Ya.zero seems to make sense. Another question gone for a toss. As of now, 5 questions are wrong for sure. Getting worried...I think I should avoid discussing.....

#### matmet

##### New Member
Hi,

11. Managing tail risk: again two options are close: Ans: invest in strategy which is negatively correlated with tail risk. But I marked move off the optimal frontier which is wrong.

Thats all I remember now. I will keep updating if I remember more. Btw after I marked all the answers, I just noticed that 40% of the answers esp in the latter half are D). Did you guys also feel the same.
I really hated this one. Every answer seemed false.

"Invest in strategy which is negatively correlated with tail risk" sounded right. But it was something like

"Invest in strategy which is negatively correlated with tail risk like call options on S&P 500".

But as the portfolio was long only, i guess tail risk is the risk of dramatically falling prices. I think there's no point in investing in call options as the payoff of call options is positively correlated to the porfolio's value.
Buying put options, however, would make sense.

"move off the optimal frontier" was something like "move off the optimal frontier to a less risk averse portfolio", which, if I'm right, implies taking more risk ?!?

#### roierez@gmail.com

I did the same - as I had no idea about which formula to use I just guessed that the same amount of $that's generated by the mortgage pool (-fees) has to be shared by the tranches. The resulting formula was something like: (LIBOR + 90 -12)*200=75*(LIBOR+45)+125*(LIBOR+X) #### roierez@gmail.com ##### New Member Exactly. I think the spread on the senior trache was Libor + 43 and then you get 99 I believe. #### fnctkaa ##### New Member Hi, anyone can recall questions asking for VaRs? I almost could not get the answer for all VaR calculations I thought i remember the formula correctly but my calculated answers were never a choice. 1) i recall one question given u annualized return and vol (assuming trade day 250), asking you 10-day VAR 2) stock px 700, 100 in-the money call and 300 forward and some out of money call, asking VaR again (i got the formula but cant get the answer) 3) binomal model? a fairly complex formula given.....asking you maximum value of x? i just know p = 0.5 to get the max. value,,,,,choices are 4 16 49 64 ? i chose 49 4) component VaR? needa est beta? portfolio vol 19%, asset A vol 12%, port$110, asset A $10 correlation 0.5 (sooooo sad i COULD not get the answer, i know the formula !!!!!) 5) stressed VaR? 6) liquidity VaR? 7) one question asking you nomial spread, z spread, given two yield curve 8) one question choices are lognormal / log gamma / generalized pareto / ????? ,,,,seemed asking frequecny of sth..... #### klartxt ##### New Member Hi, anyone can recall questions asking for VaRs? I almost could not get the answer for all VaR calculations I thought i remember the formula correctly but my calculated answers were never a choice. 1) i recall one question given u annualized return and vol (assuming trade day 250), asking you 10-day VAR 2) stock px 700, 100 in-the money call and 300 forward and some out of money call, asking VaR again (i got the formula but cant get the answer) 3) binomal model? a fairly complex formula given.....asking you maximum value of x? i just know p = 0.5 to get the max. value,,,,,choices are 4 16 49 64 ? i chose 49 4) component VaR? needa est beta? portfolio vol 19%, asset A vol 12%, port$110, asset A \$10 correlation 0.5 (sooooo sad i COULD not get the answer, i know the formula !!!!!)
5) stressed VaR?
6) liquidity VaR?
8) one question choices are lognormal / log gamma / generalized pareto / ????? ,,,,seemed asking frequecny of sth.....
for 1), which actually asked to assume 252 days/yr (not 250), if i recall correctly, you divide by square rt of 252 to get one-day, then multiply by sq rt of 10.
for 8) the lognormal,loggamma and GPD are for severity, not frequency. Typical for frequency distributions are Poisson and neg. binomial. I think one of those was a possible and the right answer.

#### klartxt

##### New Member
There was a question where i think GARP made a mistake: they asked whether one wanted to add A or B to a portfolio. Choices were
a) Asset A because highest excess return
b) Asset A because highest Sharpe Ratio (this not a correct choice because Asset B Sharpe-Ratio was higher)
c) Asset ? because highest Info Ratio (also incorrect because the other asset had the higher Info Ratio)
d) Asset B because lower volatility
This left me with choosing A for its higher return or B for its lower volatility - but Garp gave no indication whether we have a risk averse investor or any other hint whether one should prefer return or lower volatility.
The only 3 ways I could think of to answer this question correctly (assuming Garp made no mistake) are:

1) Notice that the benchmarks return was given as 7% OVER THE PAST YEAR while the returns given in the table were EXPECTED RETURNS FOR THE NEXT YEAR. That being the case, you could not really compute an excess return (or an information ratio - but that was the wrong way around anyway), so choice d) was the only choice you could be left with (choosing asset B for the lower volatility).

2) Also possible would be that Garp expected you to remember that excess returns / Beta for each asset should be the same to optimize a portfolio (usually its excess return / MVAR. Excess return / Beta is a step before and also valid). Hence, even when you cannot calculate excess return, you can use the (return minus risk free) over beta as a proxy and you would choose the asset with the higher ratio - not sure which one of the two assets would have benn the right one then.

3) one could possibly calculate excess return by finding the return of the benchmark by knowing that the betas were 0.8 and 0.9. Don't those Betas imply that in risking markets the returns of A and B are lower than the benchmark?

However, I think that is asking for way too much interpretation and around-the-corner thinking than Garp would intend. Therefore, I think they made a mistake. They probably wanted you to calculate the Sharpe Ratio and choose Asset B for having the higher ratio but did not properly give that as an answer choice.

#### roierez@gmail.com

##### New Member
I remember this questions. I actually got a higher sharp ratio for asset A but was in a real hurry. I remember something like 0.33 for A vs. 0.28 to B. Didn't have much time to spend on this one...

#### Level2WaitingForResults

##### New Member
There was a question on finding a min variance position. corr coeff , and standard deviations were given. I tried using -(Corr*SD1/SDP) . Got an answer of -30? Anyone remembers this?

Also, for 28, i got the answer as LIBOR+118. Anyone got the same answer?