CDP CDP Portfolio Management & Analytics 2 — Questions and Answers
Question 1: What is 'convexity' in the context of fixed-income derivatives?
- The linear relationship between bond prices and interest rates
- The measure of the curvature in the price-yield relationship of a bond or fixed-income derivative (Correct answer)
- The degree of correlation between two fixed-income instruments
- The premium paid for interest rate options
Correct answer: The measure of the curvature in the price-yield relationship of a bond or fixed-income derivative
Convexity measures how the duration of a bond or fixed-income derivative changes as interest rates change, capturing the non-linear (curved) price-yield relationship.
Question 2: What is 'cross-gamma' risk in multi-asset derivatives portfolios?
- Risk from holding options on two different underlying assets with identical strikes
- The sensitivity of one position's delta to price changes in a different underlying asset (Correct answer)
- The risk that two options expire in the same period
- Gamma risk arising from currency-denominated derivatives
Correct answer: The sensitivity of one position's delta to price changes in a different underlying asset
Cross-gamma measures how the delta of one instrument changes when the price of a different underlying asset moves, important for portfolios with derivatives on correlated assets.
Question 3: What does 'expected shortfall' (ES), also known as CVaR, measure?
- The average profit over a specified confidence interval
- The expected loss in scenarios that exceed the VaR threshold (Correct answer)
- The minimum loss a portfolio will experience in extreme conditions
- The shortfall in margin deposits below required levels
Correct answer: The expected loss in scenarios that exceed the VaR threshold
Expected Shortfall (ES), or Conditional VaR (CVaR), measures the average loss in the worst-case scenarios beyond the VaR threshold, providing a more complete picture of tail risk.
Question 4: What is 'rebalancing' a derivatives portfolio?
- Replacing expired options with new ones at different strikes
- Adjusting portfolio positions to restore target risk exposures or allocations (Correct answer)
- Converting futures positions to options positions
- Adding new derivatives to increase total notional exposure
Correct answer: Adjusting portfolio positions to restore target risk exposures or allocations
Rebalancing involves buying and selling derivatives positions to bring the portfolio back into alignment with target risk levels, exposures, or allocations as market conditions change.
Question 5: What does 'theta decay' describe and how does it affect an options portfolio?
- Theta measures the change in an option's price relative to changes in the underlying asset price
- Theta measures the rate at which an option loses value as time passes, eroding option premiums daily (Correct answer)
- Theta measures the sensitivity of an option's price to changes in interest rates
- Theta measures how much an option's delta changes with price moves
Correct answer: Theta measures the rate at which an option loses value as time passes, eroding option premiums daily
Theta (time decay) represents the daily erosion of an option's extrinsic value as expiration approaches, with the rate of decay accelerating as expiration nears.
Question 6: What is a 'vega-neutral' position in portfolio management?
- A portfolio with no exposure to changes in the underlying asset price
- A portfolio structured so that changes in implied volatility have no net effect on its value (Correct answer)
- A portfolio with equal numbers of calls and puts
- A portfolio where all options have the same time to expiration
Correct answer: A portfolio structured so that changes in implied volatility have no net effect on its value
A vega-neutral portfolio is constructed so that the net vega equals zero, meaning changes in implied volatility levels do not affect the overall portfolio value.
CDP CDP Portfolio Management & Analytics 2
What is 'convexity' in the context of fixed-income derivatives?