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# Exam FeedbackFRM Part 2 (May 2014) Exam Feedback

#### Johnson

##### New Member
Got all three wrong..hedge fund incentive fees, Basel 3 had chose option 4,and volatility weighing.i am afraid I will be in last quartile in all subjects..

#### intrepid86

##### New Member
With respect to LVar question having 80bps spread, I remember getting Var of around 26000 and for LC i remember it to around 17000. so LVar= Var+LC around 43100. Hope i got it right because i was not so sure about my LC calculation out there.

@ Johnson - Only around 30 questions would have been discussed here, still around 50 questions are left, so its like you never know. And with this kind of paper i am sure many out here would agree that it would not be 100% surety for most of the candidates.

#### mongooseny23

##### Member
With respect to LVar question having 80bps spread, I remember getting Var of around 26000 and for LC i remember it to around 17000. so LVar= Var+LC around 43100. Hope i got it right because i was not so sure about my LC calculation out there.

@ Johnson - Only around 30 questions would have been discussed here, still around 50 questions are left, so its like you never know. And with this kind of paper i am sure many out here would agree that it would not be 100% surety for most of the candidates.

i remember getting something around 36,000. i think it was something like the spread was .80 and the price of the stock was 20. does anyone know this one?

#### Johnson

##### New Member
@ Johnson - Only around 30 questions would have been discussed here, still around 50 questions are left, so its like you never know. And with this kind of paper i am sure many out here would agree that it would not be 100% surety for most of the candidates.[/quote]
@intrepid86 , I really hope so.I can't believe my luck..actually lack of it.With the questions we are discussing here, most of the questions were like we can eliminate two options but are stuck with the other remaining two options.i chose the one n thought would have 50% chance of getting those right.but apparently it's been 25% prob thus far
N now I hope noone remembers any more questions from the paper as my success rate here in this forum is horrible

#### cdbsmith

##### Member
Increase incentive fees increase the asymetrical risk. Allowing the fund manager to invest its own money is one way to counter it
There has been a lot of chatter on this particular question. So, I did more research and actually learned a lot. It turns out the high incentive fees and high water marks lead to different behavior depending on the hedge fund manager. That is, depending on whether the manager is risk-neutral or risk-averse (including high or low risk aversion) will actually determine determine how much risk they will take on. Also, the time horizon is a large factor as well. That is, if the manager has a short vs. long time horizon with the investor/client, that will impact the level of risk the manager takes on as well. If the time horizon is short (long), the manager is likely to take more (less) risk to achieve the desired payoff.

Further, a high water mark for a manager with low (high) risk aversion will cause them to take on more (less) risk to pass the minimum threshold to achieve the desired payoff. High incentive fees with low (high) water marks will lead to different risk taking behavior from the manager as well.

Therefore, the question can lead to different answers (high incentive fees vs high water marks) depending on the context, which means there are two plausible answers. This question is ambiguous at best and was poorly written by GARP, in my opinion. I would not be surprised if they end up tossing it out.

Here's a quote from a recent study ("The Incentives of Hedge Fund Fees and High-Water Marks") that I found in my search. I included only first and second conclusions as they are most relevant to this discussion.

"Our result leads to three novel implications. First, high-water marks have ambiguous risk- shifting properties, depending on managers' preferences. For a risk neutral manager and, more generally, if risk aversion is less than one (γM < 1), the high-water mark contract decreases risk- taking (γM∗ > γM). Thus, if risk aversion is low, we obtain a similar effect to that found by Panageas and Westerfeld (2009)2. They show that the optimal policy for a risk neutral manager, who maximizes the present value of performance fees, is a constant portfolio, which does not depend on the level of fees α. Thus, in their model the high-water mark contract reduces risk-taking.

However, high-water marks do increase risk-taking if the manager is more risk averse (γM > 1), leading to an effective risk aversion γM∗ lower than γM . Thus, the popular intuition that high-water marks increase risk taking because they are akin to call options, turns out to be incorrect in the risk-neutral setting where it seems most plausible, but becomes correct if risk aversion is sufficiently large.

Second, our model captures the dependence of the optimal portfolio (1) on performance fees - a natural property that has hitherto eluded existing models. We find that higher performance fees make managers more myopic, shrinking their risk aversion towards one. More myopic can mean more or less risk averse, depending on managers' own risk aversion being above or below the myopic value of one. Unlike previous studies, we consider both performance and regular fees, but we find that only performance fees affect the portfolio, suggesting that regular fees have no risk-shifting effects.

Conclusion

For those hedge fund managers who cannot, or do not, have substantial personal holdings in their funds, and have long planning horizons, high-water marked performance fees have the effect of shrinking their risk aversion toward one. This effect reduces risk-taking for risk-neutral managers, and in general for managers less risk averse than logarithmic utility. In contrast, it increases risk- taking for managers with typical levels of risk aversion, leading to more risky portfolios. In this case, higher fees lead to more volatile funds.

Performance fees alter managers' risk aversion, and are an effective agency tool for aggressive investors, and even more aggressive managers. By contrast, for conservative investors performance fees are not effective in aligning their objectives with those of managers', regardless of managers' risk aversion.
"

The link to the full study is here:

http://guasoni.com/papers/watermark.pdf

#### chouchouc

##### Member
hi

hi, i think its independent amount, minimum transfer would not mitigate collateral volatility
The question said that you had 8% CT1, but no other Tier 1 or Tier 2 Capital, and what could happen to the entity.

I picked option A), because I considered that it did not meet the countercyclical bufer and thus its dividend policy was restricted. I discarded the 9,5% because it fell in between of the 8% and 10.5%, although I cannot remember the comple text.

In any case, this was one of the questions I was not confident about.
Picked this one too, but I am really not sure.

#### cdbsmith

##### Member
Yes, I agree with the ES 95% is approx equal to VaR 97.5% although after the exam I though that perhaps there were no decimal vars in the HS so it was not that simple, anyway I decided for the 97.5%

The var after 10 days, I think you got rid of 3 returns and one return with 90 days became 100 days old and just get the 95% var

What about the stress var? first table 99 var as opposed to 99.9 table, and then just add max of last day var or 3 x 60 day average plus max of the last stress var or 3 x 60 day average, i think it was 410
I do not agree that the ES 95% was the same as the VaR 97.5%. My calculation resulted in the VaR 99%. The reason is when using percentages for ES (for continuous distributions) the denominator is always n-1. If we were using (discrete) values, the denominator would be n. I could be wrong, but that is my understanding.

#### Johnson

##### New Member
@cdbsmith,gd research...n yes it was quite ambiguous question for sure like few others..

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#### Diranim

##### New Member
There was a question related to the difference between a pass through MBS and a CDO

#### Juan B.

##### Member
Hi guys, the daily quiz..., do you remember the question asking for the 2 year HS Var where you had only 1 year of returns?
I remember 3 options in relation to getting the missing data:

1. getting the returns from one of the CDS index: perhaps
2. getting the 1 year HS Var and multiply for sqrt 2: no, as you might miss some important event that occur during the 1st year
3. getting the return from a similiar company with similar rating and same industry: i think it was this one as I thought it was a better choice than the index as you narrow down the industry factor.
4. do not remember but I hope it was not relevant.

#### Juan B.

##### Member
i remember getting something around 36,000. i think it was something like the spread was .80 and the price of the stock was 20. does anyone know this one?

yes, i think it was spread 0.80 on a 20 stock, so 4%, and then 50.000 shares portfolio

they asked for the log normal var (but there was no answer available if you calculated using normal). I think I got something like 16316 plus half of the 4% spread, so around 36316, same as you I believe

#### chouchouc

##### Member
yes, i think it was spread 0.80 on a 20 stock, so 4%, and then 50.000 shares portfolio

they asked for the log normal var (but there was no answer available if you calculated using normal). I think I got something like 16316 plus half of the 4% spread, so around 36316, same as you I believe
I dont remember the answer but do you remember that you had to divide the spread by the price of the stock to arrive to the result ?

#### mongooseny23

##### Member
I dont remember the answer but do you remember that you had to divide the spread by the price of the stock to arrive to the result ?

yeh when you divide it you should get 20,000 for the 2nd part

#### chouchouc

##### Member
yeh when you divide it you should get 20,000 for the 2nd part
ok but I kind of remembered that the price of the stock was 90..

#### mongooseny23

##### Member
ok but I kind of remembered that the price of the stock was 90..

it was definitely 80 on my paper ... any chance people had different papers to prevent cheating? does GARP do that?

#### chouchouc

##### Member
it was definitely 80 on my paper ... any chance people had different papers to prevent cheating? does GARP do that?
so was it 80 or 20 ?

#### mongooseny23

##### Member
so was it 80 or 20 ?

spread was 80 and stock price was 20 ... so I did 1/2(.80/20)*($20 *50,000 shares) = 20,000 for the liquidity portion of the VaR #### chouchouc ##### Member spread was 80 and stock price was 20 ... so I did 1/2(.80/20)*($20 *50,000 shares) = 20,000 for the liquidity portion of the VaR
spread was 80 and stock price was 20 ... so I did 1/2(.80/20)*(\$20 *50,000 shares) = 20,000 for the liquidity portion of the VaR
anyway, I remember that I found exactly one of the result and it was indeed around 36 000, so we will see...

#### joacogimeno

##### Member
I do not agree that the ES 95% was the same as the VaR 97.5%. My calculation resulted in the VaR 99%. The reason is when using percentages for ES (for continuous distributions) the denominator is always n-1. If we were using (discrete) values, the denominator would be n. I could be wrong, but that is my understanding.

One can consider that ES is the conditional average of tail VaRs, and we could say that 95 ES can be approximated by a 97,5 VaR (in this case we take the median as average). In any case, this is just an approximation (but this word was indeed in the answer). What I can't really understand is why you would consider a 99% VaR as an approximation of 95 ES when no actual distribution or historical losses were provided.

#### joacogimeno

##### Member
Hi guys, the daily quiz..., do you remember the question asking for the 2 year HS Var where you had only 1 year of returns?
I remember 3 options in relation to getting the missing data:

1. getting the returns from one of the CDS index: perhaps
2. getting the 1 year HS Var and multiply for sqrt 2: no, as you might miss some important event that occur during the 1st year
3. getting the return from a similiar company with similar rating and same industry: i think it was this one as I thought it was a better choice than the index as you narrow down the industry factor.
4. do not remember but I hope it was not relevant.

I marked the same answer, although, as you, it was just an educated guess.

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