Sample Scoring Key: 1 point for each correct explanation.. Sample Scoring Key:1 point each for correctly identifying whether the comment is correct.. “Gamma measures how delta changes in
Trang 1DERIVATIVES/RISK MANAGEMENT
Answers
Question 1
Part A
The first two are legitimate goals: identify the risks and quantify them
The third is not Just minimizing risk will target the risk-free rate of return and make the business unprofitable (It would not cover the cost of capital.)
Sample Scoring Key:
1 point for each correct explanation
Part B
The first three are nonfinancial They do not relate directly to asset price change
The fourth, liquidating at a fair price, is liquidity related and a financial risk
Sample Scoring Key:
1 point for each correct identification
Part C
Template for Question C
Comment
Is the comment correct?
(circle one)
Explanation
“The analytic method allows for the
modeling of the correlation of risks.”
Yes
No
Correlation can be included in calculating total firm risk (standard deviation), which then becomes part of the analytic VAR calculation
“I like using nominal position limits
with derivatives because that gives
the portfolio manager a set amount of
capital to work with and limits the
maximum amount that can be lost.”
Yes
No
Derivatives often involve leverage More than the initial investment can be lost
Trang 2Sample Scoring Key:
1 point each for correctly identifying whether the comment is correct
1 point for each explanation
0 points if yes/no decision is incorrect
Part D
Yes, TVAR measures the average of what can happen within the left tail, so it looks at events that are worse than the VAR result
Sample Scoring Key:
1 point for yes and then 2 points for explaining why
Question 2
Part A
Comment
Is the comment correct?
(circle one)
Explanation
“A bull spread using call
options can be created by
selling a call with a low
exercise price and buying a
call with a high exercise
price.”
Yes
No
This creates a bear spread
Or
A bull spread is a long call with a lower strike and short a call with a higher strike price
“You can use a long put on
interest rates to place an
upper limit on the effective
interest earned by a
floating-rate lender.”
Yes
No
This places a floor on return for a floating-rate lender, not
an upper limit
“Gamma measures how
delta changes in response
to a change in an asset’s
price.”
Yes
No
Sample Scoring Key:
1 point each for identifying the correct “no” answers 2 points for the “yes” answer
1 point for each requested explanation
0 points if yes/no decision is incorrect
Trang 3Part B
A straddle requires a long call and put with the same strike price The only available combination is the 50 strike price
Max loss if the stock closes at the strike price of 50, lose the two premiums: 2.50 + $5.25 = 7.75 Breakevens: from the loss of 7.75 if the stock is 50, the stock must increase or decrease 7.75 to: 42.25 or 57.75
Max gain is infinite as the stock increases
Sample Scoring Key:
2 points each for the four correct results No points are awarded for simply identifying which
options to use
Question 3
Part A
Hedge 10% of 157 million: 15.7 million
((0 – 1.04) / 0.97) (15,700,000 / (1,024 × 500)) = –32.88
Sell 33 contracts
Sample Scoring Key:
Two points for setting up the calculation components and one point for 33 contracts Leaving the solution as fractional contracts is not correct
Part B
The periodic risk-free rate and dividend yield are required
The number of contracts sold will be increased by (1 + rf periodic)
Hold shares of the underlying equal to [500 × 33(1 + rf periodic)] / (1 + dividend yield
periodic)
No cash equivalents are required for the trade
Sample Scoring Key:
One point each for the two additional items required One point each for: accurately calculating the increased number of contracts, shares to hold, and that no cash equivalents are involved
Trang 4Candidate discussion: The goal is reducing equity exposure, which means creating synthetic cash equivalent to 10% of the portfolio For synthetic, the amount hedged must be increased to a FV (i.e., multiply target amount by 1 + rf periodic) Multiplying the number of contacts for a standard hedge by 1 + rf periodic is the exact same numeric result For synthetic cash, sufficient shares must
be held (with dividend reinvested) to settle the short contract position at expiration The question specifically says quantify, so you must set up the calculations even though you cannot perform the final numeric calculations In other words, do what can be done with the information provided to answer the question asked
Part C
Gain on contracts sold: (1,024 – 973)(500)(40) = 1,020,000
Plus EV of stocks: 1,020,000 + 147,750,000 = 148,770,000 EV of hedged portfolio
Hedged portfolio return: 148.77/157.0 – 1 = –5.24%
Effective beta: –5.24/–5.7 = 0.92
Sample Scoring Key: One point each (if correct) for the four calculation elements required to
solve the problem
Part D
The contract may have behaved differently than its initially estimated beta
The portfolio may have behaved differently than its initially estimated beta
This is a cross hedge with portfolio stocks differing from those of the index
The contract may have been mispriced
Goodwell may have made changes in the stock positions during the six months (changing the portfolio’s characteristics)
Sample Scoring Key: Two points each for two reasons
Candidate discussion: The question directs you not use contract rounding as a reason The
contract was held to expiration, so basis risk is not a factor Basis risk is sometimes used as a generic reference to any hedging risk, so you could say basis risk if you then go on to explain a specific relevant item, such as the portfolio or contract beta changed over the period
Part E
Enter a swap to pay an equity index return and receive a cash equivalent rate of return
The equity index return paid on the swap may be more than the return earned on the stocks held, producing a negative return differential
If the index return paid exceeds the cash return received on the swap, Goodwell must pay the difference: a cash flow risk
Counterparty risk
Trang 5Sample Scoring Key: One point each for describing each side of the correct swap One point each for two reasons
Candidate discussion: The first two reasons are different The first is a return risk and the second
a cash-flow risk A generic statement that returns (or cash flows) can differ is too vague The data allows you to determine the market circumstances that would be detrimental
Part F
No additional data is needed In efficient markets with both risks hedged, the expected return is the investor’s domestic risk-free rate
Sample Scoring Key: One point each for: no data is needed, earn risk-free, and making it clear the investor’s risk-free rate is the expected net result
Candidate discussion: If you list all the ending values needed to project ex-post results, that is incorrect They are not needed in this case If you fail to explain that expected return is the
investor’s risk-free rate, there is not sufficient discussion to show the grader you understand the situation