Advanced Topics Flashcards

When hedging a bond portfolio, immunization that matches both duration and convexity provides protection against:

Answer: Larger parallel shifts more accurately than duration alone

Adding convexity matching improves the approximation of price changes for larger parallel rate moves beyond first-order duration.

A key limitation of historical simulation VaR compared to parametric VaR is that historical simulation:

Answer: Relies entirely on the observed sample period and may miss unobserved events

Historical simulation is bounded by the scenarios in the lookback window, so events not in the sample are not represented.

In a total return swap, the total return payer effectively:

Answer: Transfers the credit and market risk of the reference asset to the receiver

The total return payer passes all economic performance of the asset to the receiver, shedding both market and credit risk.

Wrong-way risk in counterparty credit exposure refers to the situation where:

Answer: Exposure increases as counterparty credit quality worsens

Wrong-way risk arises when the exposure to a counterparty rises at the same time its probability of default increases.

Which Greek measures the rate of change of an option's delta with respect to the underlying price?

Answer: Gamma

Gamma is the second derivative of option value with respect to the underlying, i.e., the sensitivity of delta.

A risk manager backtesting a 99% one-day VaR over 250 days using the Basel traffic-light approach would fall in the 'red zone' starting at approximately how many exceptions?

Answer: 10 exceptions

Under the Basel traffic-light test, ten or more exceptions in 250 days places the model in the red zone.

The funding valuation adjustment (FVA) in derivatives pricing primarily reflects:

Answer: The cost of funding uncollateralized derivative positions

FVA captures the funding cost or benefit associated with hedging and collateralizing uncollateralized derivative trades.