Stress Testing (Jorion's FRM Handbook Q26.14.3)

[ankitagarwal]

Thank you for the reply David.
I had one more question. How should I study 'Foundation of risk management'.
I started this now after completing 2,3,4 books, but this involves lot of theory which is quite difficult to remember.
What type of questions are expected out of this book 1.
Thab
Thanks

 

[David Harper CFA FRM]

Hi @ankitagarwal I am copying @Nicole Seaman so she can help as we have should have some pre-existing responses in the forum to this general question. Thanks for your patience!

 

[ankitagarwal]

Okay. We'll wait for the response. I had one more doubt.

When calculating theoritical price of t-bond after calculating current price e of bond we subtract accrued interest from. It to calculate quotes price,,,, but since we didn't add that in the price why is that being subtracted.
Let me know if I am not clear.Thanks.

 

[Nicole Seaman]

Thank you for the reply David.
I had one more question. How should I study 'Foundation of risk management'.
I started this now after completing 2,3,4 books, but this involves lot of theory which is quite difficult to remember.
What type of questions are expected out of this book 1.
Thab
Thanks

@ankitagarwal

I have not had the chance to search the forum extensively yet for your questions here, but our exam feedback threads may be helpful to start with. Many of our members post questions that they remember from the exam. Those threads are located here under the "About FRM" section here: https://forum.bionicturtle.com/forums/about-frm.2/. This will give you an idea of the types of questions that have been asked on previous exams.

Okay. We'll wait for the response. I had one more doubt.

When calculating theoritical price of t-bond after calculating current price e of bond we subtract accrued interest from. It to calculate quotes price,,,, but since we didn't add that in the price why is that being subtracted.
Let me know if I am not clear.Thanks.

Our search function in the forum is very useful for questions like this. We always recommend that our members try search before posting to see if their question has already been answered If you search for theoretical price of treasury bond, it will bring up quite a few threads that discuss this. If you have further questions after going through the original posts and comments, you can post your question directly in those threads so the concepts are being discussed in one place and not in multiple threads. These are just a few threads that come up in search:

• https://forum.bionicturtle.com/thre...e-of-a-bond-vs-forward-price.7282/#post-25934
  
• https://forum.bionicturtle.com/thre...t-to-deliver-theoretical-futures-price.10636/
  
• https://forum.bionicturtle.com/threads/determining-the-theoretical-future-price.5558/

I hope this is helpful!

Thank you,

Nicole

 

[David Harper CFA FRM]

@ankitagarwal @Nicole Seaman is correct to point you to other links, only because we've elsewhere discussed this difficult, tedious T-bond futures calculation in some detail (and I built an XLS that tries to simplify, including express this succinctly as a COC model). I think especially relevant is her link to https://forum.bionicturtle.com/threads/determining-the-theoretical-future-price.5558/

You are correct the calculation does not add AI, yet it subtracts the AI in the final step (to retrieve the implied quoted futures price from the futures dirty ["cash"] price based on the cost of carry model). The reason is that at settlement the cash received (by the short position) will be (Settlement price * CF) + Accrued Interest; like a regular bond, the seller receives the quote (aka, flat, clean) price plus accrued interest. However, pricing (and forward pricing) is generally conducted necessarily on the invoice (aka, full, dirty) price because that's the cash price and the price that really applies on the compounded/discounted cash flow scale. I hope that's helpful, thanks!

 

[ankitagarwal]

Hi David,
Thank you for the reply. I read the posts but have still one concern. I understand the bond is to be delivered with coupon payment done in past, and the bond is set to expire before next coupon. So why do we subtract accrued interest, as since the bond is expired there will be no accrued interest.
Really sorry but I am not getting this...
Please direct me. Thanks

 

[David Harper CFA FRM]

Hi @ankitagarwal But the underlying bond is not set to expire, rather the futures contract is expiring. See below, which is just Hull's example 6.2 input into our learning XLS (although I think I made up the hypothetical dates to match his timeline). The exercise must, in advance, assume the cheapest to deliver (CTD) bond without really knowing which it will exactly be. In this case, the T-bond futures contract matures on 4/28/18 and the pricing exercise presumes delivery of the underlying CTD bond; but that bond is between coupons, having paid its last coupon 148 days ago (12/1/17) and awaiting the next coupon on 6/2/18. We can forget about the futures contract momentarily. Imagine that I sell you this CTD bond on 4/28/18, then you (as they buyer) will pay me the quoted (aka, clean) price plus the accrued interest (i.e., 148/183 * $6.00), because you will hold the bond on 6/2/18 and you will keep the entire coupon. The forward cash price of $119.711 is the correct cash price of this CTD bond on the future contract's maturity (final settlement) date of 4/28/17; but the AI is subtracted to retrieve the quote/clean price on the same date. I hope that clarifies!