Advanced Topics Flashcards

In an asset-backed security, 'overcollateralization' enhances credit quality by:

Answer: Pledging collateral whose value exceeds the issued notes

Overcollateralization means the collateral pool exceeds the principal of the issued securities, providing a loss cushion.

The EWMA (exponentially weighted moving average) volatility model differs from a simple equally-weighted estimate by:

Answer: Assigning greater weight to more recent returns

EWMA places exponentially declining weights on past returns, emphasizing recent data over older observations.

A GARCH(1,1) model adds which feature compared to EWMA?

Answer: A long-run mean variance to which volatility reverts

GARCH(1,1) includes a weighted long-run average variance term, giving it mean reversion that EWMA lacks.

Stress testing differs from VaR primarily because stress testing:

Answer: Examines specific extreme scenarios rather than probability-based loss estimates

Stress testing evaluates portfolio impact under defined extreme or hypothetical scenarios rather than statistical quantiles.

Liquidity-adjusted VaR (LVaR) incorporates which additional element relative to standard VaR?

Answer: The cost of unwinding positions over a liquidation horizon

LVaR adds the bid-ask spread and time needed to liquidate positions, capturing market liquidity risk.

The 'risk-neutral' probability of default extracted from CDS spreads is generally:

Answer: Higher than the real-world (physical) default probability

Risk-neutral default probabilities embed a risk premium, making them typically higher than historically observed physical probabilities.

Under the Basel leverage ratio, the exposure measure is compared against which capital base?

Answer: Tier 1 capital

The Basel III leverage ratio is defined as Tier 1 capital divided by a non-risk-based total exposure measure.