1.One advantage of the Brennan and Schwartz model over the Cox-Ingersoll-Ross model for modeling interest-rate dynamics is that the Brennan and Schwartz model:
A. gives attention to the mean reversion of interest rates.
B. gives attention to interest-rate volatility.
C. allows interest-rate volatility to decline as rates fall.
D. is a more effective method for dealing with complex, leveraged portfolios.
2.Consider the primary methods of assessing the risk of a portfolio position through stress testing. Which of the following does not accurately describe an advantage or disadvantage related to a stress testing method?
A. A disadvantage to the historical simulation approach is that it is limited to historical data which may be inappropriate in future periods.
B. An advantage of the historical crisis approach is that it requires no assumptions regarding the underlying distribution of portfolio returns.
C. A disadvantage to the stress scenario analysis method is that it can produce misleading risk measures.
D. An advantage to the stress scenario analysis method is that it accounts for asset-class-specific risk factors.
3.How does the convexity of a bond influence the yield on the bond? All else the same, for a bond with high convexity investors will require:
A. a lower yield.
B. a higher yield.
C. the same yield as for a low convexity bond.
D. a higher or lower yield depending on the bond's duration.
4.Asset liquidity risk is most pronounced for
A. A $10 million position in distressed securities
B. A $10 million position in Treasury bonds
C. A $100 million position in distressed securities
D. A $100 million position in Treasury bonds
5.A pension plan reports $12 billion in assets and $10 billion in present value of the benefit obligations. Future pension benefits are indexed to the rate of inf1ation. To immunize its liabilities, the plan should
A. Invest $12 billion of assets in fixed-coupon long-term bonds
B. Invest $10 billion of assets in fixed-coupon long-term bonds
C. Invest $10 billion ofassets in cash
D. lnvest $10 billion of assets in Treasury Inf1ation. Protected Securities
6.The market price deviations for puts and calls from Black-scholes-Merton prices indicate:
A. Equivalent put and call implied volatiliiy.
B. Equivalent put and call moneyness.
C. Unequal put and call implied volatility.
D. Unequal put and call moneyness.
Answer:
1.D
The Brennan and Schwartz model is more effective when fixed-income portfolios become complex.
2.D
The stress scenario analysis method analyzes varying predetermined stress scenario to determine the effect on the current portfolio. The advantage of this approach is that it is not limited to historical events. Disadvantages include its inability to account for asset-class-specific risk factors and its tendency to produce deceptive risk measures.
3.A
Convexity is to the advantage of the bond holder because a high-convexity bond's price will decrease less when rates increase and will increase more when rates decrease than a low-convexity bond's price.
4.C
Asset liquidity risk is a function of the size of the position and the intrinsic liquidity of the instrument. Distressed securities trade much less than Treasury bonds, and so have more intrinsic Iiquidity. A $100 million position is more illiquid than a $10 miHion position in the same instrument.
5.D
lmmunization occurs when assets are invested so as to perfectly hedge changes in liabilities. So the amount to invest is $10 billion, which is the value of liabilities. In this case, we are told that the pension payments are indexed to the rate of inflation. Because the liabilities are tied to inflation, immunization requires that the assets should react in a simílar way to inflation. This can be achieved w?th Treasury Inflation-Protected Securities (TIPS).
6.A
Put-call parity indicates that the implied volatility of a call and put will be equal for the same strike price and time to expiration.
