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Financial Risk Manager Handbook 6th Edition Philippe Jorion - Solutions
When evaluating asset-backed securitization issues, which of following would be least important during the investor’s analysis process?a. The liability concentration levels of the asset originatorb. The structure of the underlying securitization transactionc. The quality of the loan servicer for
A CLO is generallya. A set of loans that can be traded individually in the marketb. A pass-throughc. A set of bonds backed by a loan portfoliod. None of the above
Many observers have blamed the originate-to-distribute model of banks for having aggravated or even caused the credit crisis. Which of the following statements about the performance of the originate-to-distribute model of banks during the credit crisis is incorrect?a. The originate-to-distribute
The nominal spread on the comparable option-free bonds in the market is 100 basis points. Which of the following statements is correct?a. X only is undervalued.b. Y only is undervalued.c. X and Y both are undervalued.d. Neither X nor Y is undervalued
You are analyzing two comparable (same credit rating, maturity, liquidity, rate) U.S. callable corporate bonds. The following data is available for the nominal spread over the U.S. Treasury yield curve and Z spread and optionadjusted spread (OAS) relative to the U.S. Treasury spot curve:X Y Nominal
What bond type does the following price-yield curve represent and at which yield level is convexity equal to zero?Yield Price Y1 Y2 Y3a. Puttable bond with convexity close to zero at Y2.b. Puttable bond with convexity close to zero at Y1 and Y3.c. Callable bond with convexity close to zero at Y2.d.
Suppose the annual conditional prepayment rate (CPR) for a mortgagebacked security is 6%. What is the corresponding single monthly mortality(SMM) rate?a. 0.514%b. 0.334%c. 0.5%d. 1.355%
MBSs are a class of securities where the underlying is a pool of mortgages. In addition to the credit risk of a borrower defaulting on the loan, mortgages also have prepayment risk because the borrower has the option to repay the loan early (at any time) usually due to favorable interest rate
What is the effect on the value of a callable convertible bond of a decrease in interest rate volatility and stock price volatility?a. An increase in value due to both interest rate volatility and stock price volatilityb. An increase and decrease in value, respectivelyc. A decrease and increase in
What is the main reason why convertible bonds are generally issued with a call?a. To make their analysis less easy for investorsb. To protect against unwanted takeover bidsc. To reduce durationd. To force conversion if in-the-money
A corporate bond with face value of $100 is convertible at $40 and the corporation has called it for redemption at $106. The bond is currently selling at $115 and the stock’s current market price is $45. Which of the following would a bondholder most likely do?a. Sell the bondb. Convert the bond
Trader A purchases a down-and-out call with a strike price of USD 100 and a barrier at USD 96 from Trader B. Both traders need to unwind their delta hedge at the barrier. Which trader is more at risk if there is a price gap (discontinuity) that prevents them from exiting the trade at the barrier?a.
A non-dividend-paying stock has a current price of $100 per share. You have just sold a six-month European call option contract on 100 shares of this stock at a strike price of $101 per share. You want to implement a dynamic delta-hedging scheme to hedge the risk of having sold the option. The
A trader buys an at-the-money call option with the intention of delta-hedging it to maturity. Which one of the following is likely to be the most profitable over the life of the option?a. An increase in implied volatilityb. The underlying price steadily rising over the life of the optionc. The
You are the risk manager of your bank responsible for the derivatives desk.A trader has sold 300 call option contracts each on 100 shares of Nissan Motors with time to maturity of 90 days at USD 1.80. The delta of the option on one share is 0.60. You have hedged the option exposure by buying 18,000
What is the implied correlation between JPY/EUR and EUR/USD when given the following volatilities for foreign exchange rates? JPY/USD at 8%;JPY/EUR at 10%; EUR/USD at 6%.a. 60%b. 30%c. −30%d. −60%
Assume that implied volatilities from equity option prices display a volatility skew and that implied vols from currency option prices display a volatility smile. Which of the following statements about option price implied volatility curves are true?I. The implied volatility of a deep
53.2. At the end of 1999, you are holding USD 4 million in stock P.You are considering a strategy of shifting USD 1 million into stock Q and keeping USD 3 million in stock P. What percentage of risk, as measured by standard deviation of return, can be reduced by this strategy?a. 0.5%b. 5.0%c.
225; covariance between the return of stock P and the return of stock Q
100; variance of return of stock Q
You are given the following information about the returns of stock P and stock Q: variance of return of stock P
Natural gas prices exhibit seasonal volatility. Specifically, the entire forward curve is more volatile during the wintertime. Which of the following statements concerning VAR is correct if the VAR is estimated using unweighted historical simulation and a three-year sample period?a. We will
Which of the following statements about VAR estimation methods is wrong?a. The delta-normal VAR method is more reliable for portfolios that implement portfolio insurance through dynamic hedging than for portfolios that implement portfolio insurance through the purchase of put options.b. The
Which of the following is most accurate with respect to delta-normal VAR?a. The delta-normal method provides accurate estimates of VAR for assets that can be expressed as a linear or nonlinear combination of normally distributed risk factors.b. The delta-normal method provides accurate estimates of
In early 2000, a risk manager calculates the VAR for a technology stock fund based on the past three years of data. The strategy of the fund is to buy stocks and write out-of-the-money puts. The manager needs to compute VAR. Which of the following methods would yield results that are least
Brenda Williams is a risk analyst who wants to model the dependence between asset returns using copulas and must convince her manager that this is the best approach. Which of the following statements are correct?I. The dependence between the return distributions of portfolio assets is critical for
A hedge fund manager has to choose a risk model for a large equity marketneutral portfolio, which has zero beta. Many of the stocks held are recent IPOs. Among the following alternatives, the best isa. A single index model with no specific risk, estimated over the last yearb. A diagonal index model
The historical simulation (HS) approach is based on the empirical distributions and a large number of risk factors. The RiskMetrics approach assumes normal distributions and uses mapping on equity indices. The HS approach is more likely to provide an accurate estimate of VAR than the RiskMetrics
Which of these statements regarding risk factor mapping approaches is/are correct?I. Under the cash flow (CF) mapping approach, only the risk associated with the average maturity of a fixed-income portfolio is mapped.II. Cash flow mapping is the least precise method of risk mapping for a
Which of the following statements about expected shortfall (ES) isincorrect?a. ES provides a consistent risk measure across different positions and takes account of correlations.b. ES tells what to expect in bad states: It gives an idea of how bad the portfolio payoff can be expected to be if the
What is the 99%, one-day expected shortfall (ES) of the portfolio?a. USD 433b. USD 1,428c. USD 1,861d. USD 2,259
Greg Lawrence is a risk analyst at ES Bank. After estimating the 99%, oneday VAR of the bank’s portfolio using historical simulation with 1,200 past days, he is concerned that the VAR measure is not providing enough information about tail losses. He decides to reexamine the simulation results.
A market risk manager uses historical information on 1,000 days of profit/loss information to calculate a daily VAR at the 99th percentile, or $8 million.Loss observations beyond the 99th percentile are then used to estimate the conditional VAR. If the losses beyond the VAR level, in millions, are
Which of the following statements regarding extreme value theory (EVT) is incorrect?a. In contrast to conventional approaches for estimating VAR, EVT considers only the tail behavior of the distribution.b. Conventional approaches for estimating VAR that assume that the distribution of returns
Tycoon Bank announced that there were eight days in the previous year for which losses exceeded the daily 99% VAR. As a result, concerns emerged about the accuracy of the VAR implementation. Assuming that there are 250 days in the year, which of the following statements is/are correct?I. Using a
Backtesting routinely compares daily profits and losses with model-generated risk measures to gauge the quality and accuracy of their risk measurement systems. The 1996 Market Risk Amendment describes the backtesting framework that is to accompany the internal models capital requirement. This
The Market Risk Amendment to the Basel Capital Accord defines the yellow zone as the following range of exceptions out of 250 observations:a. 3 to 7b. 5 to 9c. 6 to 9d. 6 to 10
Which of the following procedures is essential in validating the VAR estimates?a. Stress-testingb. Scenario analysisc. Backtestingd. Once approved by regulators, no further validation is required.
A large, international bank has a trading book whose size depends on the opportunities perceived by its traders. The market risk manager estimates the one-day VAR, at the 95% confidence level, to be USD 50 million. You are asked to evaluate how good a job the manager is doing in estimating the
An investor is long a short-term at-the-money put option on an underlying portfolio of equities with a notional value of USD 100,000. If the 95% VAR of the underlying portfolio is 10.4%, which of the following statements about the VAR of the option position is correct when second-order terms are
An option on the Bovespa stock index is struck on 3,000 Brazilian reais(BRL). The delta of the option is 0.6, and the annual volatility of the index is 24%. Using delta-normal assumptions, what is the 10-day VAR at the 95%confidence level? Assume 260 days per year.a. 44 BRLb. 139 BRLc. 2,240 BRLd.
An option portfolio exhibits high unfavorable sensitivity to increases in implied volatility and while experiencing significant daily losses with the passage of time. Which strategy would the trader most likely employ to hedge the portfolio?a. Sell short-dated options and buy long-dated options.b.
How can a trader produce a short vega, long gamma position?a. Buy short-maturity options, sell long-maturity options.b. Buy long-maturity options, sell short-maturity options.c. Buy and sell options of long maturity.d. Buy and sell options of short maturity.
Which of the following statements is incorrect?a. The vega of a European-style call option is highest when the option is at-the-money.b. The delta of a European-style put option moves toward zero as the price of the underlying stock rises.c. The gamma of an at-the-money European-style option tends
Steve, a market risk manager at Marcat Securities, is analyzing the risk of its S&P 500 index options trading desk. His risk report shows the desk is net long gamma and short vega. Which of the following portfolios of options shows exposures consistent with this report?a. The desk has substantial
Which of the following statements is true regarding options Greeks?a. Theta tends to be large and positive when buying at-the-money options.b. Gamma is greatest for in-the-money options with long maturities.c. Vega is greatest for at-the-money options with long maturities.d. Delta of deep
Ms. Zheng is responsible for the options desk in a London bank. She is concerned about the impact of dividends on the options held by the options desk. She asks you to assess which options are the most sensitive to dividend payments. What would be your answer if the value of the options is found by
Suppose an existing short option position is delta-neutral, but has a gamma of−600. Also assume that there exists a traded option with a delta of 0.75 and a gamma of 1.50. In order to maintain the position gamma-neutral and deltaneutral, which of the following is the appropriate strategy to
A bank has sold USD 300,000 of call options on 100,000 equities. The equities trade at 50, the option strike price is 49, the maturity is in three months, volatility is 20%, and the interest rate is 5%. How does the bank delta-hedge?a. Buy 65,000 sharesb. Buy 100,000 sharesc. Buy 21,000 sharesd.
An analyst is doing a study on the effect on option prices of changes in the price of the underlying asset. The analyst wants to find out when the deltas of calls and puts are most sensitive to changes in the price of the underlying.Assume that the options are European and that the Black-Scholes
You are given the following information about a European call option: Time to maturity = 2 years; continuous risk-free rate = 4%; continuous dividend yield = 1%; N(d1) = 0.64. Calculate the delta of this option.a. −0.64b. 0.36c. 0.63d. 0.64
A 90-day European put option on Microsoft has an exercise price of $30.The current market price for Microsoft is $30. The delta for this option is close toa. −1b. −0.5c. 0.5d. 1
The dividend yield of an asset is 10% per annum. What is the delta of a long forward contract on the asset with six months to maturity?a. 0.95b. 1.00c. 1.05d. Cannot determine without additional information
The current value of the S&P 500 index is 1,457, and each S&P futures contract is for delivery of 250 times the index. A long-only equity portfolio with market value of USD 300,100,000 has a beta of 1.1. To reduce the portfolio beta to 0.75, how many S&P futures contracts should you sell?a. 288
Albert Henri is the fixed income manager of a large Canadian pension fund.The present value of the pension fund’s portfolio of assets is CAD 4 billion while the expected present value of the fund’s liabilities is CAD 5 billion. The respective modified durations are 8.254 and 6.825 years. The
On June 2, a fund manager with USD 10 million invested in government bonds is concerned that interest rates will be highly volatile over the next three months. The manager decides to use the September Treasury bond futures contract to hedge the portfolio. The current futures price is USD
If all spot interest rates are increased by one basis point, a value of a portfolio of swaps will increase by $1,100. How many Eurodollar futures contracts are needed to hedge the portfolio?a. 44b. 22c. 11d. 1,100
What assumptions does a duration-based hedging scheme make about the way in which interest rates move?a. All interest rates change by the same amount.b. A small parallel shift occurs in the yield curve.c. Any parallel shift occurs in the term structure.d. Interest rates’ movements are highly
XYZ Co. is a gold producer and will sell 10,000 ounces of gold in three months at the prevailing market price at that time. The standard deviation of the change in the price of gold over a three-month period is 3.6%. In order to hedge its price exposure, XYZ Co. decides to use gold futures to
A firm is going to buy 10,000 barrels of West Texas Intermediate Crude Oil. It plans to hedge the purchase using the Brent Crude Oil futures contract. The correlation between the spot and futures prices is 0.72. The volatility of the spot price is 0.35 per year. The volatility of the Brent Crude
Which of the following trades contain mainly basis risk?I. Long 1,000 lots Nov 07 ICE Brent Oil contracts and short 1,000 lots Nov 07 NYMEX WTI Crude Oil contracts II. Long 1,000 lots Nov 07 ICE Brent Oil contracts and long 2,000 lots Nov 07 ICE Brent Oil at-the-money put III. Long 1,000 lots Nov
Which of the following statements is/are true with respect to basis risk?I. Basis risk arises in cross-hedging strategies, but there is no basis risk when the underlying asset and hedge asset are identical.II. A short hedge position benefits from unexpected strengthening of basis.III. A long hedge
Mary has IBM stock and will sell it two months from now at a specified date in the middle of the month. Mary would like to hedge the price of risk of IBM stock. How could she best hedge the IBM stock without incurring basis risk?a. Short a two-month forward contract on IBM stockb. Short a
Under which scenario is basis risk likely to exist?a. A hedge (which was initially matched to the maturity of the underlying)is lifted before expiration.b. The correlation of the underlying and the hedge vehicle is less than one and their volatilities are unequal.c. The underlying instrument and
Which of the following methodologies would be most appropriate for stresstesting your portfolio?a. Delta-gamma valuationb. Full revaluationc. Marking to marketd. Delta-normal VAR
John Flag, the manager of a $150 million distressed bond portfolio, conducts stress tests on the portfolio. The portfolio’s annualized return is 12%, with an annualized return volatility of 25%. In the past two years, the portfolio encountered several days when the daily value change of the
Which of the following is true about stress testing?a. It is used to evaluate the potential impact on portfolio values of unlikely, although plausible, events or movements in a set of financial variables.b. It is a risk management tool that directly compares predicted results to observed actual
Which of the following statements about stress testing are true?I. Stress testing can complement VAR estimation in helping risk managers identify crucial vulnerabilities in a portfolio.II. Stress testing allows users to include scenarios that did not occur in the lookback horizon of the VAR data
The 95%, one-day RiskMetrics VAR for a bank trading portfolio is$1,000,000. What is the approximate general market risk charge, as defined in 1996?a. $3,000,000b. $9,500,000c. $4,200,000d. $13,400,000
Assume that portfolio daily returns are independent and identically normally distributed. Sam Neil, a new quantitative analyst, has been asked by the portfolio manager to calculate portfolio VARs over 10, 15, 20, and 25 days. The portfolio manager notices something amiss with Sam’s calculations,
Assume that the P&L distribution of a liquid asset is i.i.d. normally distributed. The position has a one-day VAR at the 95% confidence level of$100,000. Estimate the 10-day VAR of the same position at the 99% confidence level.a. $1,000,000b. $450,000c. $320,000d. $220,000
Worse-than-VAR scenarios are defined as scenarios that lead to losses in the extreme left tail of the return distribution equal to or exceeding VAR at a given level of confidence. Which of the following statements is an accurate description of VAR?a. VAR is the average of the worse-than-VAR
Given the following 30 ordered percentage returns of an asset, calculate the VAR and expected shortfall at a 90% confidence level: −16, −14, −10,−7, −7, −5, −4, −4, −4, −3, −1, −1, 0, 0, 0, 1, 2, 2, 4, 6, 7, 8, 9, 11, 12, 12, 14, 18, 21, 23.a. VAR (90%) = 10, expected
The 10-Q report of ABC Bank states that the monthly VAR of ABC Bank is USD 10 million at the 95% confidence level. What is the proper interpretation of this statement?a. If we collect 100 monthly gain/loss data of ABC Bank, we will always see five months with losses larger than $10 million.b. There
The standard VAR calculation for extension to multiple periods also assumes that positions are fixed. If risk management enforces loss limits, the true VAR will bea. The sameb. Greater than calculatedc. Less than calculatedd. Unable to be determined
Which of the following statements about trader limits are correct?I. Stop loss limits are useful if markets are trending.II. Exposure limits do not allow for diversification.III. VAR limits are not susceptible to arbitrage.IV. Stop loss limits are effective in preventing losses.a. I and IIb. III
Imagine a stack-and-roll hedge of monthly commodity deliveries that you continue for the next five years. Assume the hedge ratio is adjusted to take into account the mistiming of cash flows but is not adjusted for the basis risk of the hedge. In which of the following situations is your calendar
Assume the risk-free rate is 5% per annum, the cost of storing oil for a year is 1% per annum, the convenience yield for owning oil for a year is 2%per annum, and the current price of oil is USD 50 per barrel. All rates are continuously compounded. What is the forward price of oil in a year?a. USD
In late 1993, MGRM reported losses of about $1.3 billion in connection with the implementation of a hedging strategy in the oil futures market. In 1992, the company had begun a new strategy to sell petroleum to independent retailers at fixed prices above the prevailing market price for periods of
Continuing with the previous question, what is the annualized rate of return earned on a cash-and-carry trade entered into in March and closed out in June?a. 9.8%b. 8.9%c. 39.1%d. 35.7%
On January 1, a risk manager observes that the one-year continuously compounded interest rate is 5% and the storage cost of a commodity product A is USD 0.05 per quarter (payable at each quarter end). The manager further observes the following forward prices for product A: March, 5.35; June,
If the lease rate of commodity A is less than the risk-free rate, what is the market structure of commodity A?a. Backwardationb. Contangoc. Flatd. Inversion
Your company is expecting a major export order from a London-based client. The receivables under the contract are to be billed in GBP, while your reporting currency is USD. Since the order is a large sum, your company does not want to bear the exchange risk and wishes to hedge it using
You have entered into a currency swap in which you receive 4%pa in yen and pay 6%pa in dollars once a year. The principals are 1,000 million yen and 10 million dollars. The swap will last for another two years, and the current exchange rate is 115 yen/$. The annualized spot rates (with continuous
Which of the following statements is correct when comparing the differences between an interest rate swap and a currency swap?a. At maturity, the counterparties to interest rate swaps and the counterparties to currency swaps both exchange the principal of the swap.b. At maturity, the counterparties
Bonumeur SA is a French company that produces strollers for children and is specialized in strollers for twins and triplets for the EU market. The company buys the wheels of the strollers on the U.S. market. Invoices are paid in USD. What is Bonumeur’s currency risk and how can the company hedge
The current spot CHF/USD rate is 1.3680 CHF. The three-month USD interest rate is 1.05%, and the three-month Swiss interest rate is 0.35%, both continuously compounded and per annum. A currency trader notices that the three-month forward price is USD 0.7350. In order to arbitrage, the trader
A stock index is valued at USD 750 and pays a continuous dividend at the rate of 2% per annum. The six-month futures contract on that index is trading at USD 757. The risk-free rate is 3.50% continuously compounded. There are no transaction costs or taxes. Is the futures contract priced so that
Suppose the price for a six-month S&P index futures contract is 552.3. If the risk-free interest rate is 7.5% per year and the dividend yield on the stock index is 4.2% per year, and the market is complete and there is no arbitrage, what is the price of the index today?a. 543.26b. 552.11c. 555.78d.
The yield curve is upward sloping and a portfolio manager has a long position in 10-year Treasury notes funded through overnight repurchase agreements.The risk manager is concerned with the risk that market rates may increase further and reduce the market value of the position. What hedge could be
To hedge against future, unanticipated, and significant increases in borrowing rates, which of the following alternatives offers the greatest flexibility for the borrower?a. Interest rate collarb. Fixed for floating swapc. Call swaptiond. Interest rate floor
A portfolio management firm manages the fixed-rate corporate bond portfolio owned by a defined-benefit pension fund. The duration of the bond portfolio is five years; the duration of the pension fund’s liabilities is seven years. Assume that the fund sponsor strongly believes that rates will
The payoff to a swap where the investor receives fixed and pays floating can be replicated by all of the following excepta. A short position in a portfolio of FRAsb. A long position in a fixed-rate bond and a short position in a floating-rate bondc. A short position in an interest rate cap and a
An interest rate cap runs for 12 months based on three-month LIBOR with a strike price of 4%. Which of the following is generally true?a. The cap consists of three caplet options with maturities of three months, the first one starting today based on three-month LIBOR set in advance and paid in
A bank entered into a three-year interest rate swap for a notional amount of USD 250 million, paying a fixed rate of 7.5% and receiving LIBOR annually.Just after the payment was made at the end of the first year, the continuously compounded spot one-year and two-year LIBOR rates are 8% and 8.5%,
Bank XYZ enters into a five-year swap contract with ABC Co. to pay LIBOR in return for a fixed 8% rate on a principal of $100 million. Two years from now, the market rate on three-year swaps at LIBOR is 7%. At this time ABC Co. declares bankruptcy and defaults on its swap obligation. Assume that
Consider the following information about an interest rate swap: two-year term, semiannual payment, fixed rate = 6%, floating rate = LIBOR + 50 basis points, notional USD 10 million. Calculate the net coupon exchange for the first period if LIBOR is 5% at the beginning of the period and 5.5%at the
Consider a forward rate agreement (FRA) with the same maturity and compounding frequency as a Eurodollar futures contract. The FRA has a LIBOR underlying. Which of the following statements is true about the relationship between the forward rate and the futures rate?a. The forward rate is normally
Which of the following statements related to forward and futures prices is true?a. If the forward price does not equal the futures price, arbitragers will exploit this arbitrage opportunity.b. The level of interest rates determines whether the forward price is higher or lower than the futures
The futures price is 103-17/32 and the maturity date of the contract is September 1. The bonds pay their coupon semiannually on June 30 and December 31. The cheapest to deliver bond is:a. Bond Ab. Bond Bc. Bond Cd. Insufficient information
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