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Flashcards in RM and Derivatives Deck (47)
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1
Q

Risk Management

A

understand risks; determine when it’s appropriate to take risk

  1. identify risks
  2. set risk tolerances
  3. report risk to stakeholders
  4. monitor
2
Q

Risk Governance

A

policies and procedures establishing risk management

  • structure - centralized (best), decentralized
  • reporting
  • methologies
  • infrastructure needs
3
Q

Enterprise Risk Management

A

centralized risk management

  1. identify risk factors
  2. quantify risk
  3. aggregate to measure firm wide risk
  4. report/ allocate risk
  5. monitor
4
Q

Financial Risk

A

due to events external to firm, in financial markets

  1. market risk
  2. credit risk
  3. liquidity risk

mitigate with derivatives (options, swaps)

5
Q

Market Risk

A
  1. interest rate risk
  2. exchange rate risk
  3. equity price risk
  4. commodity price risk
6
Q

Nonfinancial Risk

A
  1. operational risk
  2. settlement/ perf netting risk - one party pays, other defaults
  3. model risk - GIGO
  4. sovereign risk
  5. regulatory risk
  6. tax, accounting, political risk

mitigate with insurance

7
Q

VaR

A

probability of expected loss over a specified time; comparable across asset classes, not managers

  1. analytical: VaR = [R - z * σ] V
  2. historical
  3. monte carlo simulation
8
Q

One Tail SD

A
  • 5% = 1.65 SD
  • 1% = 2.33 SD
9
Q

VaR Complements

A
  • incremental VaR: risk from additional factor
  • cash flow/ earnings at risk: min CF loss for given prob over time
  • tail value at risk (TVaR): avg outcomes in tail
10
Q

Credit Risk

A

possibility counterparty defaults; current and potential credit risk

prob default * PV losses

PV rec - PV paid

11
Q

Credit Risk of Currency Forwards

A

long base currency

S0 / ( 1 + b )t - Ft / ( 1 + p )t

highest credit risk in middle of forward’s life

12
Q

Credit Risk of Currency Swaps

A

highest credit risk btwn middle/end of swap’s life

PV rec - PV pay

13
Q

Credit Risk of Options

A

long position = credit risk

current credit risk when option is exercised

14
Q

Managing Credit Risk

A
  1. limiting exposure
  2. marking to market
  3. collateral
  4. netting payments
  5. closeout netting
  6. credit derivatives
15
Q

Risk Budgeting Factors

A

must consider correlation of risk in diff units

  1. VaR limits
  2. position limits
  3. liquidity limits
  4. performance stopout
  5. risk factor limits
16
Q

Sortino Ratio

A

ratio of excess return to risk; doesn’t penalize manager for good performance

( Rp - MAR ) / downside deviation

17
Q

Forward vs Future

A

Forward: custom, high default risk, less liquidity; currency, int payments

Futures: standardized, trade on exchange, low default risk; bond, equity

18
Q

Modifying Equity Beta

A

contracts = ( Δβ / βf ) * ( Vp / Vf )

19
Q

β

A

covi,m / σm2

20
Q

Effective Beta

A

%Δ value of portfolio / %Δ value of index

21
Q

Why Effective Beta Deviates

A

basis risk = imperfect hedge

  • num/ demon based on diff items
  • evaluating before expiration
  • # contracts rounded
  • F and S not priced correctly
22
Q

Modifying Bond Duration

A

contracts = βyield * ( ΔMD / MDf ) * ( Vp / Vf )

23
Q

Synthetic Stock

A

beta = 1

repliate buying contracts; buy futures contract, long T-bills

  • Nf = FVVp / Vf
  • terminal shares replicated = Nf * mult (beg = discount by div yield)
  • initial eqty eq = PV( Nf * mult * price ) [terminal = FV]
24
Q

Synthetic Cash

A

beta = -1

replicate selling contracts; long equity, short futures contract

  • Nf = - FVVp / Vf
  • initial cash eq = PV( Nf * mult * price ) [terminal = FV]
  • terminal shares = Nf * mult
25
Q

Exchange Rate Risks

A
  1. transaction risk
  2. economic risk
  3. translation risk (translating financial statements)
26
Q

Hedging Currency Positions

A
  • receiving foreign curr = sell forward
  • paying foreign curr = buy forward
27
Q

Covered Call

A

long stock, short call; exp lower volatility

  • payoff: St - max( 0, St - X ) - S0 + C
  • max gain: (ex opt) X - S0 + C
  • max loss: (don’t ex opt, St = 0) S0 - C
  • breakeven: (initial cost) S0 - C
28
Q

Protective Put

A

long stock, long put; exp higher volatility

  • payoff: St + max( 0, X - St ) - S0 - P
  • max gain: unlimited
  • max loss: (ex opt) S0 + P - X
  • breakeven: (initial cost) S0 + P
29
Q

Bull Call Spread

A

long CL, short CH; long PL; short PH; exp inc S

  • profit: CH - CL + max( 0, S - XL ) - max( 0, S - XH )
  • max profit: (both ex) XH - XL + CH - CL
  • max loss: (neither ex) CL - CH
  • breakeven: (ex CL) XL + CL - CH
30
Q

Bear Put Spread

A

long PH, short PL; long CH, short CL; exp dec S

  • profit: max( 0, XH - S ) - max ( 0, XL - S ) + PL - PH
  • max profit: (both ex) XH - XL + PL - PH
  • max loss: (no ex) PH - PL
  • breakeven: (ex PH) XH + PL - PH
31
Q

Butterfly Spread with Calls

A

long CL and CH; short 2 CM; exp dec volatility

  • profit: max( 0, S - XL ) + max( 0, S - XH ) - 2max( 0, S - XM ) + 2CM - CL - CH
  • max profit: (ex CL, CM) XM - XL + 2CM - CL - CH
  • max loss: (no ex) CL + CH - 2CM
  • breakeven: 2CM - CL - CH + 2XM - X
    • CL + CH - 2CM + XL
32
Q

Butterfly Spread with Puts

A

long PL and PH; short 2 PM; exp dec volatility

  • profit: max( 0, XH - S ) + max( 0, XL - S ) - 2max( 0, XM - S ) + 2PM - PL - PH
  • max profit: (ex PH, PM) XH - XM + 2PM - PL - PH
  • max loss: (no ex) PL + PH - 2PM
  • breakeven: PL + PH - 2PM +
    • 2PM - PL - PH +
33
Q

Straddle

A

long call and put OR short call and put; exp inc price volatility

  • profit: max ( 0, S - X ) + max ( 0, X - S ) - C - P
  • max gain: unlimited
  • max loss: (inv) C + P
  • breakeven: X - C - P or X + C + P
34
Q

Collar

A

stock, long PL, short CH; exp low price volatility

  • profit: max ( 0, XL - S ) + max ( 0, S - XH ) + S - S0
  • max profit: XH - S0
  • max loss: S0 - XL
  • breakeven: S0
35
Q

Box Spread

A

combo of bull and bear spreads; arbitrage opp

  • profit: XH - XL + PL - PH + CH - CL
  • compare annualized HPR to rf
36
Q

Interest Rate Call Payoffs

A
  • net loan: loan - FV(premium)
  • call payoff: NP [max[ 0, LIBOR - X] * D/ 360 ]
  • eff $ int cost = loan int - call payoff
  • EAR: [(loan + eff $ int cost) / net loan]365/D - 1
37
Q

Interest Rate Put Payoffs

A
  • net loan: loan + FV(premium)
  • put payoff: NP [max[ 0, X - LIBOR] * D/ 360 ]
  • eff $ int cost = loan int + put payoff
  • EAR: [(loan + eff $ int cost) / net loan]365/D - 1
38
Q

Interest Rate Cap

A

payment when rate > X

series of int rate calls; caplets

good for floating rate payer

39
Q

Interest Rate Put

A

payment when X < rate

series of int rate puts; floorlets

good for floating rate receiver

40
Q

Delta

A

change in option price/ change in underlying

41
Q

Delta Hedging

A

hedge downside risk of short options (dealers); earn rf

stock required = - delta * # options

42
Q

Gamma

A

change in delta/ change in underlying

43
Q

Vega

A

change in underlying/ change in volatility

44
Q

Swap Duration

A
  • fixed duration = 0.75 maturity
  • floating duration = 0.5 reset period
  • Dpay floating = Dfixed - Dfloating = +D
  • Dpay fixed = Dfloating - Dfixed = -D
45
Q

Modifying Swap Duration

A

NP = [( MD - MD0 )/ MDswap] Vp

rec floating = neg swap duration

46
Q

Payer Swaption

A

buyer = right to be fixed-rate payer, receive floating

exp rates to go up

47
Q

Receiver Swaption

A

buyer = right to be fixed-rate receiver, pay floating

exp rates to go down