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21. Which of the following is not a commonly used method for generating a recovery rate function?
A. Nonparametric kernel estimation.
B. Cubic SPLINE estimation.
C. Assume the recovery rate follows a beta distribution.
D. Estimate conditional densities with generalized method of moments.
Correct answer is B
Cubic SPLINE estimation would make little sense here.ffice ffice" />
Reference: de Servigny and Renault, Chapter 4
22. Global Bank has a series of FX forward and swap agreements with European Financial Services Inc. that are subject to a master netting agreement where close-out netting is permitted. It is currently weighing whether to enter into additional hedging agreements with European Financial to hedge a new material FX exposure it has recently discovered or whether it should establish a new relationship with New Firm Financial to offset the FX exposure. New Firm Financials' credit rating is A, European Financials' is BBB and collateral will be posted with the chosen counterparty. Any hedge transaction with New Firm Financial would be subject to a master netting agreement with close-out netting permitted. Global Bank's traders have actually come to you, the Chief Risk Officer, and asked your view on which firm to deal with although they have only given you these couple facts on which to base your decision. You strongly recommend dealing with ___________ for the following reason(s).
A. European Financial because if it declares bankruptcy you can be assured that the collateral used to support your derivative contracts will immediately be subject to a stay by the bankruptcy court providing you with the confidence that your losses will be limited.
B. New Firm Financial because its credit rating is stronger than European Financial's meaning your firm will take less of a hit to its balance sheet and since New Firm wants to establish this relationship with you the collateral you will have to post with New Firm will be significantly less than that posted for any new position with European Financial.
C. European Financial; because you can terminate the swap agreements in the event of its insolvency and create an immediate claim for compensation even if there is a dispute over valuation of the contracts and their cost of replacement.
D. New Firm Financial because you can accelerate the amount owed under the new FX swap agreement in the event of its insolvency and collect those funds and the collateral posted to support the position faster and with more certainty than having to deal with offsetting arrangements and terminating contracts that would be an issue with European Financial .
Correct answer is C
A is incorrect as collateral in the event of a bankruptcy used to support derivative transactions is not subject to a legal stay and as such is immediately available to the non-bankrupt counterparty.
B is incorrect the credit rating will have little to do in the event of an insolvency, and the collateral posted will in all probably be higher as it supports a single position rather than multiple positions subject to a master netting agreement.
C is correct as the master netting agreement and the right of close-out netting will allow you to immediately close out the positions and replace them with a different company with the valuation to be determined at a later time usually by the solvent counterparty although the exact amount may be litigated.
D a derivative agreement is considered an executory contract (no transaction has yet occurred) which requires it be terminated, not accelerated. Accelerating future payments would occur only with non-executory contracts (e.g., loans) and would precede any netting when determining amounts due.
23. Which of the following loans has the lowest credit risk?
A. Loan A
B. Loan B
C. Loan C
D. Loan D
Correct answer is A
The 1 year probability of default needs to be adjusted to the remaining term using the formula [(1-d_month)12 = (1-d_annual)]. We multiply the monthly PD with the loss given default (LGD) to get the expected percentage loss (EL%):
As shown, loan A has the lowest EL%.
Reference: Measuring and Managing Credit Risk, De Servigny and Renault, 2004
24. You are to evaluate pricing models for collateralized securities. Which of the following models is most dependent upon an accurate prediction of collateral prepayment sensitivities?
A. Credit card debt
B. Residential mortgage debt
C. Commercial real estate
D. Hospital receivables
Correct answer is B
Prepayment risk most often arises in the context of home mortgages when there is uncertainty as to whether a homeowner will repay and refinance the mortgage early. Prepayment risks are an important feature of mortgage backed securities, where the investor has granted the borrower the option to prepay the mortgage early.
Residential mortgages are subject to the greatest prepayment risk. This option is a complex option to value because it depends on the age of the loan, spread between mortgage rate and current interest rates, refinancing incentives, economic activities and seasonal factors. Therefore, pricing models for residential mortgage debt are very dependent on prepayment assumptions and models.
Reference: Fixed Income Securities, Tuckman, 2002.
25. Which of the following portfolios would have suffered the greatest drop in value as a result of the Russian debt crisis in 1998?
A. Long-short market neutral ffice:smarttags" />US equity fund
B. Long 5-year on the run US treasury
C. A money market account plus a pay fixed USD swap
D. Duration-matched portfolio, long US low-grade corporate bonds, short US treasuries
Correct answer is D
The Russian Crisis is an example of an environment in which there would be a flight to quality. A flight-to-quality is a flow of funds from riskier to safer investments in times of uncertainty. In this environment we would expect the demand for safer assets, and hence their prices, to increase. Thus, the price of US treasuries will increase. The demand of riskier assets, and hence their price would decline. We would see the prices of US corporates decline relative to US treasuries.
Of the four choices, choice D contains two asset classes which differ on the basis of risk. This duration matched portfolio would suffer the greatest drop if value because the price of US low-grade corporate would decline and the price of US treasuries would increase.
Reference: The Risk Management Process, Culp, 2001.
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发表于 2009-6-13 14:48
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