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P1 Focus Review: 6th of 8th (Valuation)
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Parametric Value at Risk (VaR)
3
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2012 FRM Valuation and Risk Models 4.a Allen, Understanding Market: Chapter 3
$4
$40
$3
$30
$2 $20
$1 $10
$- $-
$- $5 $10 $15 $20 0% 5% 10%
Stock Price Yield
5
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P1 Focus Review: 6th of 8th (Valuation)
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P1 Focus Review: 6th of 8th (Valuation)
Answer!
Question [Two-asset portfolio VaR]
7
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P1 Focus Review: 6th of 8th (Valuation)
Correlation
Asset E[return] Volatility Stocks Bonds
Stocks 24.0% 18.0% 1.00 0.10
Bonds 15.0% 6.0% 0.10 1.00
8
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P1 Focus Review: 6th of 8th (Valuation)
Answer!
Question [Two-asset portfolio VaR]
GARP 2009.E1.1.
Given the information provided in the table below, what is the portfolio VaR, at the
99% confidence level, of the following 100 million CHF (Swiss francs) equally weighted
investment portfolio?
Correlation
Asset E[return] Volatility Stocks Bonds
Stocks 24.0% 18.0% 1.00 0.10
Bonds 15.0% 6.0% 0.10 1.00
9
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P1 Focus Review: 6th of 8th (Valuation)
a) USD 0.28
b) USD 0.40
c) USD 0.57
d) USD 2.84
10
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P1 Focus Review: 6th of 8th (Valuation)
a. USD 0.28
b. USD 0.40
c. USD 0.57
d. USD 2.84
11
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P1 Focus Review: 6th of 8th (Valuation)
a. USD 32,595
b. USD 145,770
c. USD 2,297,854
d. USD 2,737,868
12
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P1 Focus Review: 6th of 8th (Valuation)
Answer!
Question [Value-at-Risk (VaR)]
Howard Freeman manages a portfolio of investment securities for a regional bank. The portfolio
has a current market value equal to USD 6,247,000 with a daily variance of 0.0002. Assuming
there are 250 trading days in a year and that the portfolio returns follow a normal distribution,
the estimate of the annual VaR at the 95% confidence level is closest to which of the following?
a. USD 32,595
b. USD 145,770
c. USD 2,297,854
d. USD 2,737,868
13
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P1 Focus Review: 6th of 8th (Valuation)
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P1 Focus Review: 6th of 8th (Valuation)
Answer!
Question [Value‐at‐Risk (VaR) Definition and methods]
Assume that portfolio daily returns are independently and identically normally distributed. Sam Neil, a
new quantitative analyst, has been asked by the portfolio manager to calculate the portfolio Value-at-
Risk (VaR) measure for 10, 15, 20 and 25 day periods. The portfolio manager notices something amiss
with Sam’s calculations displayed below. Which one of following VARs on this portfolio is inconsistent
with the others?
15
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VaR (HS)
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P1 Focus Review: 6th of 8th (Valuation)
a. -0.6%
b. -0.7%
c. -1.0%
d. -3.0%
17
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P1 Focus Review: 6th of 8th (Valuation)
Answer!
Question [Value‐at‐Risk (VaR) Definition and methods]
You are the risk manager of a fund. You are using the historical method to estimate VaR. You find
that the worst 10 daily returns for the fund over the period of last 100 trading days are
-1.0%, -.3%, -0.6%, -0.2%, -2.7%, -0.7%, -2.9%, 0.1%, -1.1%, -3.0%. What is the daily VaR for the
portfolio at the 95% confidence level?
a. -0.6%
b. -0.7%
c. -1.0%
d. -3.0%
The daily VaR at 95% confidence level is given by the fifth worst loss over the period which is -1%.
18
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P1 Focus Review: 6th of 8th (Valuation)
At the 99% confidence level, what is your estimate of the daily dollar VaR using the historical
simulation method?
a. USD 14.08mm
b. USD 14.56mm
c. USD 14.72mm
d. USD 15.04mm
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P1 Focus Review: 6th of 8th (Valuation)
Answer!
Question [Value‐at‐Risk (VaR) Definition and methods]
GARP 2010.P1.20
20. Rational Investment Inc. is estimating a daily VaR for its fixed income portfolio currently
valued at USD 800 million. Using returns for the last 400 days (ordered in decreasing order, from
highest daily return to lowest daily return), the daily returns are the following: 1.99%, 1.89%,
1.88%, 1.87%,…, -1.76%, -1.82%, -1.84%, -1.87%, -1.91%.
At the 99% confidence level, what is your estimate of the daily dollar VaR using the historical
simulation method?
Answer:
20. B. $14.56 million
Explanation: VaR = 1.82% * 800 = 14.56 million
20
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Fixed Income Valuation
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2012 FRM Valuation and Risk Models 4.c Tuckman, Fixed Income Securities: Chapter 2
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2012 FRM Valuation and Risk Models 4.c Tuckman, Fixed Income Securities: Chapter 5
Modified Duration
Py Py 1
Deffective Shock, bps 10
2y P Shock, % 0.10%
Yield up 6.10%
Price (Shock up) $844.51
Yield down 5.90%
Price (Shock down) $858.01
Duration 7.931
23
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2012 FRM Valuation and Risk Models 4.c Tuckman, Fixed Income Securities: Chapter 5
Shock up - 1 bps
Yield 4.99% 4.99%
Price $100.0438 $100.1547
DV01 $0.0438 $0.1547
P DMod
Key
Formula
DV 01
10,000
24
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P1 Focus Review: 6th of 8th (Valuation)
a. EUR 904
b. EUR 924
c. EUR 930
d. EUR 950
25
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P1 Focus Review: 6th of 8th (Valuation)
Answer!
Question [Discount factors, arbitrage, yield curves]
Consider a bond with par value of EUR 1,000, maturity in 3 years, and that pays a coupon of 5%
annually.
a. EUR 904
b. EUR 924
c. EUR 930
d. EUR 950
26
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P1 Focus Review: 6th of 8th (Valuation)
a. USD 95.25
b. USD 97.66
c. USD 99.25
d. USD 101.52
27
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P1 Focus Review: 6th of 8th (Valuation)
Answer!
Question [Discount factors, arbitrage, yield curves]
A bond with par value of USD 100 and 3 years to maturity pays 7% annual coupons. The spot rate
curve is as follows:
a. USD 95.25
b. USD 97.66
c. USD 99.25
d. USD 101.52
Using spot rates, the value of the bond is: 7/(1.06) + 7/[(1.07)^2] + 107/[(1.08)^3] = 97.66
28
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P1 Focus Review: 6th of 8th (Valuation)
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P1 Focus Review: 6th of 8th (Valuation)
Assuming parallel movements to the yield curve, the expected price change is:
ΔP = -PΔy * D
where P is the current price or net present value
Δy is the yield change
D is duration
All else equal, a negative impact of yield curve move is stronger in absolute terms at the bond
which is currently priced higher. Upward parallel curve movements makes bonds cheaper.
30
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P1 Focus Review: 6th of 8th (Valuation)
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P1 Focus Review: 6th of 8th (Valuation)
Answer!
Question [Bond prices, spot prices, forward rates]
A hedge fund has invested USD 100 million in mortgage backed securities. The risk manager is
concerned about prepayment risk if interest rates fall. Which of the following strategies is an
effective hedge against the potential loss due to a drop in interest rates?
When rates drop, the long position in the futures and the short position in the FRA both gain.
32
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P1 Focus Review: 6th of 8th (Valuation)
a. Increased
b. Decreased
c. Remained constant
d. Cannot be determined with the data given
33
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P1 Focus Review: 6th of 8th (Valuation)
Answer!
Question [Bond prices, spot rates, forward rates]
A 5-year corporate bond paying an annual coupon of 8% is sold at a price reflecting a yield-to-
maturity of 6% per year. One year passes and the interest rates remain unchanged. Assuming a
flat term structure and holding all other factors constant, the bond’s price during this period will
have
a. Increased
b. Decreased
c. Remained constant
d. Cannot be determined with the data given
Since yield-to-maturity < coupon, the bond is sold at a premium. As time passes, the bond price
will move towards par. Hence the price will decrease.
34
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End of 2012 P1. Focus Review 6th/8
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