P1 Focus Review 4th of 8: Products
The 4th (of 8) Part 1 Focus Review video (Products) is here at http://www.bionicturtle.com/how-to/video/2012.p1.-focus-review-4/
Associated practice question sets:
These three skills will put you in a good position: compound frequencies; present value (bond) pricing based on discounted cash flow; and implied forward rates given spot rates:
Futures/Forwards (Commodities)
Like many others, this is a potentially deep topic. But I think your focus should be on the following:
I think you should focus on:
Apologies, but I don't have a strong historical basis for saying what's important here, given it's only the single Fabozzi Chapter assignment. The only question we retrieved from the three-year sample (i.e., for these focus reviews, we tried to collect and categorize questions from GARP samples in 2010, 2011 and 2012) is the question, included in the FR, on negative convexity (due to the embedded call). Which is hardly deep coverage.
The 4th (of 8) Part 1 Focus Review video (Products) is here at http://www.bionicturtle.com/how-to/video/2012.p1.-focus-review-4/
Associated practice question sets:
- P1.T3. Hull, Chapters 1-3
- P1.T3. Hull, Chapters 4-6
- P1.T3. Hull, Chapter 7
- P1.T3. Hull, Chapters 10-11
- P1.T3. McDonald, Chapter 6 & Geman, Chapter 1
- P1.T3. Saunders, Chapter 14 & Fabozzi, Chapter 13
- P1.T3. Global Topic Drill
- Interest rates
- Futures/Forwards (Commodities)
- Interest rate futures
- Corporate Bonds
These three skills will put you in a good position: compound frequencies; present value (bond) pricing based on discounted cash flow; and implied forward rates given spot rates:
- You absolutely need to be fluent with compound frequencies. Probably, like the last exam (and our feedback helped achieve this outcome), the default compound frequency will be annual. However, you still need to be ready to convert. If a rate is 8.0% per annum with annual compounding, you should easily be able to convert to its semi-annual and continuous equivalents.
- Next, as I show in the FR, probably the most basic pricing skill is vanilla bond pricing. For example (page 6), given a zero rate curve (5% @ 0.5 years, 5.8% at 1.0 year, 6.4% at 1.5 years, and 6.8% at 2.0 years, each continuously compounding), what is the price of a two-year $100 face bond that pays a semi-annual coupon at a coupon rate of 6.0%. You should be able to do this without pausing, it should be so natural.
- GARP loves to test the implied forward rate given the spot rate curve. You can almost expect to be asked. For example, if the 2-year spot rate is 1.2% and the 3-year spot rate is 1.4%, you should be able to infer the one-year forward rate, f(2,3), under continuous, annual and/or semi-annual compound frequencies.
- Please note that GARP like a price-based variation on the implied forward rate, which I reviewed here at http://forum.bionicturtle.com/threads/shortcut-to-forward-rates-if-you-have-bond-prices.4927/
Like many others, this is a potentially deep topic. But I think your focus should be on the following:
- Cost of carry; i.e., be facile with computing the implied model forward price. But please do not only practice solving for F(0). You must be sufficiently comfortable such that you can, for example, extract the convenience yield if given F(0).
- The minimum variance hedge ratio is extremely likely to be tested; I included two examples in the FR, given it appears every year
- Please practice the optimal hedge (minimum variance) with both commodities and equity portfolios (hedged with index futures)
- I think margin accounts are testable (initial and maintenance margins for the futures positions that are used to hedge)
- With respect to futures contract sizes, I think you should know that T-bond futures are standardized at $100,000; Eurodollars at $1,000,000; and S&P 500 at a 250 multiple (*250). They are likely to be provided, but are common enough that it helps to just know them. More detail here at http://forum.bionicturtle.com/threads/futures-contract-sizes.4959/#post-13442
- Be comfortable with contango/backwardation (observed) and normal contango/backwardation (unobserved)
I think you should focus on:
- Day count conventions
- Understanding the mechanics of the Eurodollar futures contract and Treasury bond futures contracts
- GARP really likes to test cheapest-to-deliver (CTD); i.e., given three or four eligible bonds, identify the CTD
- Definitely be ready to compute the number of interest rate futures contracts used to duration hedge a fixed-income position (as illustrated, GARP may give you two durations. You do NOT want to hedge with the current durations, but RATHER the expected forward durations at maturity).
Apologies, but I don't have a strong historical basis for saying what's important here, given it's only the single Fabozzi Chapter assignment. The only question we retrieved from the three-year sample (i.e., for these focus reviews, we tried to collect and categorize questions from GARP samples in 2010, 2011 and 2012) is the question, included in the FR, on negative convexity (due to the embedded call). Which is hardly deep coverage.
