Longing correlation is to either

1. receive floating rate in a variance swap with the index as an underlying and receive fixed in a variance swap with a stock in that index as an underlying,

2. Buy call option on index and buy call option on an individual component in that index OR

3. receive realized correlation in a correlation swap

in the exam, only 1 was shown

For the CCP, to avoid being failed

CCP need to:

1. ONLY intermediate derivative transactions

2. let the clearing member to unwind the trades in case there are defaults

3. have good practice in choosing members, valuing transactions and determining initial margins and default fund contributions

In the exam, only 2 was shown

Limitation of using BSM model to value bond

The answer is the volatility will go to zero at maturity as the model assumes the volatility is constant

CLN question (sth related to minimize counterpart risk)

The counterparty risk is the lowest in issuing credit link notes given the protection sellers, i.e. investors, have already paid the price to the buyers and hence no counterparty risks in case there is a default in a reference asset.

Net Stable Funding Ratio

The bank passes the test given the ratio, ASF divided by RSF, is greater than 1 (in fact, 1.3XX)

RSF is 5X.X & ASF is 72

Standardized vs Basic Indicator

The bank is of course paying 37million more under basic indicator approach because, in the latest 3 years, there is a negative gross income and hence you will divide the capital by 2 under basic indicator approach vs by 3 under standardized approach

QQ plot

Thinner tails for sure

95% Credit Var of 100 CDS with $1000, 2% PD and LGD 100% each

The answer is 3000

At 95% level, there will be five defaults so the value is 5*1000

the expected loss is 100*0.02*1000*1

Convexity

Convexity will of course increase the bond price comparing with simply using the expected value of interest rate

Square root rule

For time varying volatility, e.g. volatility estimated via GARCH, using square root rule will overestimate the VaR whereas underestimate in case the underlying process has a jump

Policy needs to be corrected

The senior bond is only subordinated to preference share

Rule of thumb

Correlation of zero does not imply independence

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