Level 2: Post what your remember here...

[Dennis Choi]

Dennis: Read this from Hull and you will know why... I too screwed this one up... Honestly, Swaps are not covered in detail in Lvl 2 and I just wish my memory from Lvl 1 back in 2009 was better... View attachment 27

@troubleshooter. Well I'm not bragging about my memory but I do can say that 32.5 is absolutely right. First of all, I calculated every type of LiboR+3.xx% while the bond appreciated 20%(I think I even remember the index rates which were 9600->11500). There is absolutely noway that an interest payment of 8.5M can come out. Anybody, try it yourself. The 3.xx portion I recall was 3.00. (So it was LiBoR + 3.00%) When you use 0.25% as the LiBoR rate the only time you can get an 8.5M interest is when it is LiBoR+4.00%.... I am like 200% sure that it wasn't starting with a 4. It was definitely starting with a 3 and I recall it was 3.00%
Any one who doesn't agree well ok then.
Oh and the notional on the reference was 200M.

 

[troubleshooter]

I really hope you are right...
Let's try to recreate the problem the best we can.
1. Notional Amount = 200 M (confirmed.)
2. Index went from 9,500 to 11,400, so the rise was (11,400 - 9,500)/9,500 = 1,900/9,500 = 20% (I am pretty sure of this)
3. Floating rate at the start at the initial of the swap = Libor0 + x (Unfortunately, I cannot be sure of these values)
4. Floating rate at the end of the period = Libor1 in the end + x. Note this is not relevant to the question and is there to screw with your head, which worked in my case.
So Total Return Receiver gets 200 M * 20% = 40 M

Does anyone remember what Libor0 and x for this question? The sum of Libor+x has to be 4.25% get the answer of 31.5 M.

 

[Dennis Choi]

I really hope you are right...
Let's try to recreate the problem the best we can.
1. Notional Amount = 200 M (confirmed.)
2. Index went from 9,500 to 11,400, so the rise was (11,400 - 9,500)/9,500 = 1,900/9,500 = 20% (I am pretty sure of this)
3. Floating rate at the start at the initial of the swap = Libor0 + x (Unfortunately, I cannot be sure of these values)
4. Floating rate at the end of the period = Libor1 in the end + x. Note this is not relevant to the question and is there to screw with your head, which worked in my case.
So Total Return Receiver gets 200 M * 20% = 40 M

Does anyone remember what Libor0 and x for this question? The sum of Libor+x has to be 4.25% get the answer of 31.5 M.

to apply the 4.25%. It would have to be LiBOR + 4.00%............the number 4 was definitely not what I saw and wrote down on the test sheet . Even when assuming that I have a bad memory and it was LIBOR + 3.5%. You would have to add 0.75% to get 8.5M for the 31.5 outflow.
So back to applying my memory. it was LiBOR +3.00%....Then multiplying 3.75% to 200M and subtracting 7.5M would get a value of 32.5

 

[majesta]

I remember that:
Floating rate at the start at the initial of the swap = 3% + Libor (25 bps) = 3,25%
Floating rate at the end of the period = 3% + Libor (75 bps) = 3,75%
S0 TRS receiver net payout (3,75% - 20% ) * 200 M = 32,5M

 

[troubleshooter]

I remember that:
Floating rate at the start at the initial of the swap = 3% + Libor (25 bps) = 3,25%
Floating rate at the end of the period = 3% + Libor (75 bps) = 3,75%
S0 TRS receiver net payout (3,75% - 20% ) * 200 M = 32,5M

If your memory is correct, which I strongly believe it is because I got 32.5 and I am quite certain I used the Libor from the end of the period. But sorry to tell you, Majesta, that it is wrong. We are supposed to use Libor from the start of the swap (see my earlier post today with Hull's screenshot). So the correct anwer I believe is 33.5 (200*20% - 200*3.25% = 40 - 6.5 = 33.5). In any case, I know that I screw this one up as I used the Libor from the end...

 

[JP2932]

Hi ji.park1234,

Thank you for your comments. I'd like to point it out that you can change your username from your email address. I'd recommend that you do so for added privacy protection. See this link here for instructions: http://www.bionicturtle.com/news-an...mend-you-change-your-screen-name-in-the-forum

Thanks,
Suzanne

Thanks so much Suzanne.
Just changed it.

Cheers!

 

[Dennis Choi]

If your memory is correct, which I strongly believe it is because I got 32.5 and I am quite certain I used the Libor from the end of the period. But sorry to tell you, Majesta, that it is wrong. We are supposed to use Libor from the start of the swap (see my earlier post today with Hull's screenshot). So the correct anwer I believe is 33.5 (200*20% - 200*3.25% = 40 - 6.5 = 33.5). In any case, I know that I screw this one up as I used the Libor from the end...

Well I think GARP was like assuming that the 0.75% was like another start which was slightly the past of before the index soared to 11400. That's the only thing we can come up with for this Q. The options only contained 31.5 and 32.5 I believe

 

[LankyLint]

Well I think GARP was like assuming that the 0.75% was like another start which was slightly the past of before the index soared to 11400. That's the only thing we can come up with for this Q. The options only contained 31.5 and 32.5 I believe

The answer was 31.5

I don't remember the question as precisely as I did on the day of the exam. But, using the starting LIBOR, the payouts were -40 and +8.5

 

[David Harper CFA FRM]

David, Thank you for answering most of my queries. I did learn quite a bit from your posts and the posts from other users here. It seems GARP likes to repeat questions going by the posts made by test takers in the previous years. I am referring to a couple of them, namely the [email protected]% confidence and the BASEL question regarding which model explicitly incorporates diversification. I came across the latter in your PQ. Also, I was able to answer the question on loan equivalent RAROC as I had looked at one of your examples in the slides a couple of days before the exam. Although, you said that GARP would not likely test us on the mechanics of the High-water mark. They did test it, but I was able to answer that one as well because I decided not to leave anything to chance.

Hi laxsun, thanks for the feedback, really appreciated. In regard to the high-water mark, I think you refer to my comments here appended to the associated practice question here (a question which itself includes a quantitative application). Given the AIM reads "Discuss" and not "Calculate," I am indeed surprised there was a quantitative high-water mark question.

This is a constant struggle for me because: as the exam nears, a highly popular question for us is 'Will this be tested?' I always try to first qualify with "I cannot predict with certainty" etc, but I do try to give an informed best guess as to what I call "testability." But this (assuming a quantitative question was asked of a an AIM with "Describe") sort of illustrates a "feature" of the exam methodology: the AIMs can be a little loose.

 

[David Harper CFA FRM]

In case it's helpful, with respect to the discussion re: cumulative vs. conditional PDs above. While i can't discern the exact question, I wanted to share a screen from the 6.3.c learning XLS, below, which merely elaborates on Hull's exhibit shared by troubleshooter here @ http://forum.bionicturtle.com/threads/level-2-post-what-your-remember-here.5923/page-11#post-17871

please note:

• If we are given cumulative default rates; e.g., 2-year cumulative PD [Caa-rated] = 30.494% and 3-year cumulative PD [Caa-rated] =39.717%, then:
• The unconditional PD [Caa] during the third year = 39.717% - 30.494% = 9.223%
• The conditional PD during Year 3 = 9.223%/(1-30.494%) = 13.27%
• Not shown, but hazard rate (aka, default intensity) connotes an instantaneous(continuously compounding) conditional PD, such that (as usual, compound frequency matters!) we can also compute a (instantaneous) hazard rate = -1/T*LN(1 - cumulative PD) = -1/3*LN(1-39.717%) = 16.87%; ie., the hazard rate implied by the 3-year cumulative PD, which could then be reversed back into the cumulative PD with the exponential function (see Rachev): cumulative PD = 1 -exp(-lambda*T); ie, given hazard rate 16.87%, 3-year cumulative PD = 1-exp(-16.87%*3) = 39.72%. I hope that helps, thanks,

 

[troubleshooter]

If I remember this correctly, the question was for third year default intensity for Baa with the same numbers as the spreadsheet here. I think the answer was 0.426...

 

[hanyongdok]

32.5 Is (a) isnt it?

 

[troubleshooter]

Not sure Sir, but it's wrong...

 

[Robert Morris]

Certainly - Decline in stock price provided an opportunity to increases the cash flow - Coupon is mere a static cash flow (not an increase)

http://www.barclayhedge.com/researc...edge-fund-strategy-convertible-arbitrage.html

The idea behind convertible arbitrage is that a company’s convertible bonds are sometimes priced inefficiently relative to the company’s stock. Convertible arbitrage attempts to profit from this pricing error.

To illustrate how convertible arbitrage works, a hedge fund using convertible arbitrage will buy a company’s convertible bonds at the same time as it shorts the company’s stock. If the company’s stock price falls, the hedge fund will benefit from its short position; it is also likely that the company’s convertible bonds will decline less than its stock, because they are protected by their value as fixed-income instruments. On the other hand, if the company’s stock price rises, the hedge fund can convert its convertible bonds into stock and sell that stock at market value, thereby benefiting from its long position, and ideally, compensating for any losses on its short position.

I'm still not convinced on this one. A stock price decline would mean the delta hedge needs to be rebalanced. Since the hedge is short the stock vs long delta on the CB, they would need to buy stock to rebalance. This would be a cash outflow. However I don't recall whether the question specified the direction of the cash flow increase.

The other options were Dividends,Coupon and PB fees. I chose Coupon because it was the only +ve cash flow.

 

[troubleshooter]

I'm still not convinced on this one. A stock price decline would mean the delta hedge needs to be rebalanced. Since the hedge is short the stock vs long delta on the CB, they would need to buy stock to rebalance. This would be a cash outflow. However I don't recall whether the question specified the direction of the cash flow increase.

The other options were Dividends,Coupon and PB fees. I chose Coupon because it was the only +ve cash flow.

I too chose coupon as +ve cash flow. I am not convinced about the logic of coupon being "static cash flow". It's not an easy one to be certain either way.

 

[EIA]

Hi Robert & Troubleshooter,

Below is from BT note on T8.d R&I note pg 31.

Explain the common arbitrage strategies of hedge funds, including: Convertible arbitrage
2012 FRM Risk & Investment Management 8.c Stowell, Hedge Fund Invest Strategies: Ch. 12

Returns: The returns in a convertible
arbitrage are generated from three sources:
•Income generation: This is the
straightforward income from the
convertible bond hedge
•Monetizing Volatility: By creating a
delta neutral position, the arbitrageur
can also create an additional gain. In an effective strategy, if the stock prices fall, the gain from the short position could be greater than the loss from the long convertible bond position, and vice-versa.
•Purchasing of undervalued convertible: If the arbitrageur has purchased an undervalued convertible bond, compared to its theoretical value, then this can generate additional profits. These profits increase with increase in volatility.

This is the way it is in the note. You can also confirm from the core reading.

BR

EIA

 

[FRM_Exam]

Hi Robert & Troubleshooter,

Below is from BT note on T8.d R&I note pg 31.

Explain the common arbitrage strategies of hedge funds, including: Convertible arbitrage
2012 FRM Risk & Investment Management 8.c Stowell, Hedge Fund Invest Strategies: Ch. 12

Returns: The returns in a convertible
arbitrage are generated from three sources:
•Income generation: This is the
straightforward income from the
convertible bond hedge
•Monetizing Volatility: By creating a
delta neutral position, the arbitrageur
can also create an additional gain. In an effective strategy, if the stock prices fall, the gain from the short position could be greater than the loss from the long convertible bond position, and vice-versa.
•Purchasing of undervalued convertible: If the arbitrageur has purchased an undervalued convertible bond, compared to its theoretical value, then this can generate additional profits. These profits increase with increase in volatility.

This is the way it is in the note. You can also confirm from the core reading.

BR

EIA

Hi David, I will really appreciate if you can please comment on this one.


Many Thanks

 

[troubleshooter]

Here's an attachment with the extract of the questions that were remembered by our posters here. Thanks to all for posting the questions. There was total of 76 out of 80 questions accounted for.

I have about 58/76 correct which translates to about 61/80. This is based on pretty harsh marking; Guesses and unsure assumed to be wrong. Based on my previous analysis, 60 should be a certain pass (assuming criteria of top 5% score 95% and pass mark is set at 80% of that which is also pretty harsh I guess.). So I am feeling comfortable at getting a pass... Best of luck to everyone... ...

Thanks David for all the guidance...

 

[David Harper CFA FRM]

Hi EIA,

I don't see the question about the convertible? But the quoted notes look correct and consistent with the FRM knowledge base (including previous Jaeger) on convertibles. If we here refer to a vanilla convertible strategy which is long the convertible bond plus short the stock in a delta-neutral hedge, then there are three sources of return (or two, depending)

1. static (income): coupon + short rebate (ie, interest) - borrowing cost - stock dividends
2. gamma trade (i.e., long volatility): the long convertible is long vega and long gamma. This is non-directional profits earned on the volatility due to the positive gamma created by the option. Essentially the same as volatility profits on [long call option + short delta share]. Positive gamma here means that convertible delta is an increasing function of stock price (see Stowell Figure 1); under a dynamic delta neutral hedge (ignoring transaction costs), the produces a net gain in either direction.
3. price inefficiencies (ie., buy cheap, sell expensive). Sometimes this (3) is grouped with (2) such that there is static (income) and trade (capital) sources of return. I hope that helps,

 

[troubleshooter]

Hi EIA,

I don't see the question about the convertible? But the quoted notes look correct (and consistent with the FRM knowledge base including previous Jaeger) on convertibles. If we are refer to a vanilla convertible strategy which is long the convertible bond plus short the stock in a delta-neutral hedge, then there are three sources of return (or two, depending)

1. static (income): coupon + short rebate (ie, interest) - borrowing cost - stock dividends
2. gamma trade (i.e., long volatility): the long convertible is long vega and long gamma. This is non-directional profits earned on the volatility due to the positive gamma created by the option. Essentially the same as volatility profits on [long option + short delta share]. Positive gamma here means that convertible delta is an increasing function of stock price (see Stowell Figure 1); under a dynamic delta neutral hedge (ignoring transaction costs), the produces a net gain in either direction.
3. price inefficiencies (ie., buy cheap, sell expensive). Sometimes this (3) is grouped with (2) such that there is static (income) and trade (capital) sources of return. I hope that helps,

David,
There was only viable choices on this convertible arbitrage that asked when you get an increase in CF - 1. Coupon on the bond 2. Share price going down. So does you answer above mean it would be coupon?