Exam Flashcards
(107 cards)
1
Q
What does CAPM (Security Market Line) hold for?
A
Holds for all assets
2
Q
What does the Capital Market Line represent?
A
Only efficient portfolios are on the line
3
Q
What is a negative equity an indication of?
A
A sign of default
4
Q
What is the definition of margin in trading?
A
The amount the investor invests from its equity
5
Q
What is the formula for Value of Forward?
A
V(T,K) = value of forward with maturity T and strike price K
6
Q
What does F_0 represent?
A
Forward price at time 0
7
Q
What is the present value of a dividend payment at time t?
A
Z(t)*D_t
8
Q
What is the main difference between forwards and futures?
A
Futures settle daily (MTM) and can be traded on an organized exchange
9
Q
What is basis risk in hedging?
A
The risk of choosing a future that does not perfectly match the underlying asset
10
Q
What is a payer swap?
A
Pays fixed, receives variable
11
Q
What is a receiver swap?
A
Pays floating, receives fixed
12
Q
What is a call option?
A
Right to buy a predetermined amount at a predetermined price at a predetermined time
13
Q
What is a put option?
A
Right to sell a predetermined amount at a predetermined price at a predetermined time
14
Q
What does a protective put strategy involve?
A
Owning the stock and buying a put option on that same stock
15
Q
What is a covered call?
A
Buying stock and selling a call option on the same stock
16
Q
When is a straddle strategy used?
A
When expecting volatility but uncertain about the direction of price movement
17
Q
What is the setup for a butterfly spread?
A
Involves three different strike prices but the same stock and expiration date
18
Q
What does put-call parity relate to?
A
The relationship between the prices of European and American options
19
Q
Are American options more valuable than European options?
A
Yes, American options are at least as valuable as European options
20
Q
What is the Black-Scholes formula used for?
A
Option pricing
21
Q
What is volatility in the context of risk management?
A
Standard deviation of the return provided by the variable per unit of time
22
Q
What is continuous compounded return?
A
Return compounded continuously
23
Q
What is the alternative definition of daily volatility?
A
Standard deviation of the relative returns
24
Q
What is the standard deviation of the return provided by the variable per unit of time when expressed using continuous compounding?
A
Standard deviation of return
25
What is the unit of time for option pricing?
1 year
26
What is the unit of time for risk management?
1 day
27
What is a continuous compounded return?
The return is compounded continuously, not daily or annually
28
When are the log return and simple return very close?
When price changes are small
29
What is an alternative definition of daily volatility?
Standard deviation of the relative returns
30
What happens to the 2-day volatility when daily returns are correlated with ρ > 0?
Underestimate the 2-day volatility
31
What happens to the 2-day volatility when daily returns are correlated with ρ < 0?
Overestimate the 2-day volatility
32
What is the formula for portfolio variance?
Annual σ_p = sumproduct(mmult(covariance matrix, value of investment), value of investment)
33
What does implied volatility (IV) represent?
The level of expected volatility backed out from the market price of an option
34
How is implied volatility obtained?
Using the BS formula based on the market price of an option
35
What does the VIX represent?
The IV of S&P 500 options with 30-days to maturity
36
What does historical volatility estimate?
Volatility of asset returns using past data
37
What is the use case for implied volatility?
Pricing, risk management, hedging
38
What are the two assumptions regarding volatility that are questionable?
* Normal distribution
* Constant over time
39
What is the Exponentially Weighted Moving Average (EWMA)?
Weights decrease exponentially as we move back in time
40
What does Value-at-Risk (VaR) define?
The amount V ≥ 0 in the statement: 'We are X % certain that we will not lose more than V dollars in the T.'
41
What does expected shortfall represent?
The expected loss during time T conditional on the loss being greater than VaR
42
What is the marginal VaR?
Measures how the total VaR of a portfolio changes when you slightly increase your position in one asset
43
What does component VaR represent?
The actual contribution to VaR from each asset
44
What is the formula for total portfolio VaR?
Total portfolio VaR = sum of marginal VaRs weighted by each position
45
What is the historical simulation approach?
Estimates potential future losses by replaying past market movements
46
What is the key characteristic of the model-building approach?
Assumes returns follow a known distribution (typically normal)
47
What is Delta in the context of options?
The sensitivity of a portfolio to the price change of the underlying asset
48
What does Gamma measure?
How sensitive delta is to the changes in the underlying asset price
49
What is Theta in options trading?
The rate of change of the option price with regards to the passage of time
50
What does Vega measure?
The rate of change of the value of the portfolio with respect to the volatility of the underlying asset
51
What is gamma in options trading?
Gamma is the rate of change of delta with respect to the price change of the underlying asset.
52
What does a gamma-neutral portfolio protect against?
It protects against larger movements in the asset price.
53
What is theta in the context of options?
Theta is the rate of change of the option price with regards to the passage of time.
54
Why is it not sensible to hedge against the effect of passage of time?
There is no uncertainty regarding the passage of time.
55
What is vega in options trading?
Vega is the rate of change of the value of the portfolio with respect to the volatility of the underlying asset.
56
What is the relationship between the vega of call and put options?
The vega of the call and put options are the same.
57
What is rho in options trading?
Rho is the rate of change of the value of the portfolio with respect to the interest rate.
58
How does the rho of a put option compare to that of a call option?
Rho of put = - rho of call.
59
What does linear approximation ignore in options pricing?
It ignores the curvature of the relationship between the option value and the underlying asset.
60
What does positive gamma translate into regarding return distribution?
Positive gamma translates into positive skewness in the return distribution.
61
What is the quadratic approximation also known as?
The delta-gamma approximation.
62
What is the first moment in the context of options portfolios?
Expected change.
63
What is the second moment in the context of options portfolios?
It includes delta-driven variance and gamma-driven variance.
64
What is the primary measure of liquidity in financial markets?
Bid-ask spread.
65
What is the Liquidity Coverage Ratio (LCR) requirement under Basel III?
LCR ≥ 100%.
66
Define cumulative default probability.
The sum of the default probabilities before the end of year t.
67
What is the survival probability formula?
V(t) = 1 – Q(t).
68
What is the default rate in the context of credit risk?
The probability of default during year t as seen at time zero.
69
What does a CDS (Credit Default Swap) provide?
Compensation to the buyer in case the reference entity defaults.
70
What is the relationship between credit spread and default rate?
Credit spread ≈ Default rate * (1 – recovery rate).
71
What is the difference between risk-neutral and real-world default probabilities?
Risk-neutral PD is higher than real-world PD.
72
What is the structural model in credit risk?
A model that treats a company like a stock + debt structure, where default occurs if asset value falls below a threshold.
73
What is the distance to default?
The difference between the firm value and the face value of the debt.
74
What are the two types of capital defined in Basel I?
Tier 1 capital and Tier 2 capital.
75
What does Basel I set standards for?
International risk-based standards for capital adequacy.
76
What is the required capital adequacy ratio under Basel I?
At least 8% of risk-weighted assets (RWA).
77
What is the function of the Net Stable Funding Ratio (NSFR)?
To ensure stability of funding sources consistent with the permanence of the assets that have to be funded.
78
What is the primary disadvantage of the structural model?
Requires difficult-to-observe firm asset value and volatility.
79
What does the Cornish-Fisher Expansion adjust for?
Adjusts quantiles of the normal distribution to account for skewness.
80
What does the liquidity-adjusted VaR account for?
It adjusts VaR by adding liquidation costs.
81
What is the main measure of liquidity risk?
Bid-ask spread.
82
True or False: A solvent company can still fail due to liquidity issues.
True.
83
What is netting in the context of financial transactions?
All transactions between two counterparties are treated as a single one; if they default on one, they default on all of them.
## Footnote
This concept is supported by ISDA.
84
What does NRR stand for in credit equivalent calculation?
Net Replacement Ratio
85
Which risk was Basel I primarily concerned with?
Credit risk
86
What additional risk did the Basel II amendment consider?
Market risk
87
What is the difference between the trading book and the banking book?
Trading book: investments designed to hold for trading; Banking book: assets held till maturity.
## Footnote
Banking book assets are planned to be held until maturity.
88
What is the capital requirement percentage for minimum capital under Basel II?
8% of the sum of credit risk, market risk, and operational risk.
89
What are the two approaches for calculating market risk capital requirements?
* Standardized approach
* Internal model-based approach
90
What does the standardized approach for market risk do?
Assigns capital requirements for each type of risk separately.
91
What is one limitation of the standardized approach?
Correlation of different risk types is not taken into account.
92
What does the internal model-based approach reflect?
The diversification effect
93
What is VaR typically calculated with?
Historical simulation
94
What is the formula for the capital requirement in the internal model-based approach?
VaR = VaR_(t-1) + VaR_avg + m_c
## Footnote
Where m_c is a scaling factor chosen by regulators, m_c > 3.
95
What does SCR stand for?
Specific Risk Charge
96
What are the three pillars of Basel II?
* Minimum capital requirement
* Supervisory review
* Market discipline
97
What is the risk of losses from failures of the bank’s procedures or from an adverse external event called?
Operational risk
98
What percentage is the weight for retail loans under the standardized approach?
75%, except for residential mortgage loans – 35%
99
What does IRB stand for in the context of credit risk?
Internal Ratings-Based approach
100
What does WCDR stand for?
Worst Case Default Rate
101
What is the probability associated with WCDR?
The default rate during time T that will not be exceeded with the probability of X%.
102
What is the required capital formula for credit risk?
RWA = 12.5 * EAD * LGD * (WCDR - PD) * MA
103
What does EAD stand for?
Exposure at Default
104
What does LGD represent in credit risk calculations?
Loss Given Default
105
What is the capital requirement for Stressed VaR?
VaR calculated from a stressed period of 250 days.
106
What is the Incremental Risk Charge (IRC) used for?
To discourage moving risk from banking book to trading book.
107
What does CRM stand for in risk measures?
Comprehensive Risk Measure
