MR Revision Ques

8/9/2019 MR Revision Ques

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Backtesting VAR

Question 4 - #30110In using a log-likelihood ratio to backtest a VAR model, the reason to measure the conditional rather than theunconditional coverage of the model is to consider the:A) number of assets in the portfolio tested.

B) size of the portfolio.C) timing of exceptions.D) the influence of the positions of individual traders.Your answer: B was incorrect. The correct answer was C) timing of exceptions.The unconditional coverage test statistic allows for potential time variation ofthe data. A bunching of exceptionsmay indicate that market correlations or trading positions have changed.This question tested from Topic Area 1, Topic 5, AIM 5

Within the Basel penalty zones, which of the following multipliers would most likely apply to a yellow zone with

five to nine exceptions?A) 3.65.B) 4.00.C) 3.35.D) 3.00.Your answer: B was incorrect. The correct answer was A) 3.65.The yellow zone applies for five to nine exceptions with multiplier ranges from3.40 to 3.85. The green zoneapplies for zero to four exceptions with a multiplier of 3.00. The red zone applies for ten or more exceptions witha multiplier of 4.00.This question tested from Topic Area 1, Topic 5, AIM 6

The Basel market risk charges require VAR to be computed over a horizon of:A) two calendar weeks or ten trading days.B) at least one year.C) at least three months.2 of 4 12/Mar/2014 10:59 AMD) one month or 21 trading days.Your answer: B was incorrect. The correct answer was A) two calendar weeks or ten trading days.The Basel Accord requires VAR to be calculated over a 2-week period or 10 trading days.

Question 10 - #26972

Comparison analyses on backtesting methods indicate that the most powerful verification test of VAR is the:A) unconditional parametric test statistic.B) conditional non-parametric test statistic.C) Basel committee test statistic.D) Kuiper test statistic.Your answer: B was incorrect. The correct answer was D) Kuiper test statistic.The Kupier test statistic has been shown to be the most powerful verification test.This question tested from Topic Area 1, Topic 5, AIM 3

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Basics of Residential Mortgage Backed Securities.pdf


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Question 1 - #126332Strip interest only CMOs are bonds that only pay the interest portion of mortgages. Assuming the CMO is tradedat par value, the duration is ____________ and the convexity is ____________.A) Positive; negative.B) Negative; negative.

C) Positive; positive.D) Negative; positive.Your answer: B was correct!One of the biggest drawbacks to mortgage cash flows is the negative convexity. As interest rates decline the risein present value is offset by the prepayments. As interest rates increase, the decline in present value iscompounded by the extension of the mortgages.

Question 2 - #124987In the past, if mortgage rates fell by more than 2%, refinancing activity wouldincrease dramatically. That effect is

best described as the:A) lock-in effect.B) burnout effect.C) refinance effect.D) media effect.Your answer: B was incorrect. The correct answer was D) media effect.Large declines in rates will likely gain the attention of the media.Lock-in effect refers to borrowers who may wish to avoid the costs of a new mortgage which likely consists of ahigher mortgage rate.Burnout effect can be described as follows: consider a mortgage pool that was formed when rates were 8%,then interest rates dropped to 5%, rose to 8%, and then dropped again to 5%. Man

y homeowners will haverefinanced when interest rates dipped the first time. On the second occurrence of 5% interest rates, mostowners in the pool who were able to refinance would have already done so.There is no such thing as a refinance effect per se.This question tested from Topic Area 1, Topic 17, AIM 3

Question 9 - #124988Which of the following statements regarding principal-only (PO) and interest-only (IO) strips is (are) CORRECT?The IO price is positively related to mortgage rates at I. low current rates.II. The IO exhibits some negative convexity at low rates.III. PO strips are sold at a moderate discount to par.IV. PO prices increase when interest rates fall.A) I and II.B) II and III.C) I and IV.D) III and IV.Your answer: B was incorrect. The correct answer was C) I and IV.The PO (not IO) exhibits some negative convexity at low rates.PO strips are sold at a considerable (not moderate) discount to par.This question tested from Topic Area 1, Topic 17, AIM 8

Question 10 - #9421Which of the following best describes a stripped mortgage-backed security (MBS)?A stripped MBS is a security:


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A) that provides no interest payments.B) that provides no principal payments.C) whose distribution of principal and interest has been altered from a pro ratadistribution to an unequaldistribution.D) whose distribution of principal and interest has been altered from an unequaldistribution to a pro rata

distribution.Your answer: B was incorrect. The correct answer was C) whose distribution of principal and interest has beenaltered from a pro rata distribution to an unequal distribution.With a passthrough security, interest and principal payments generated by the underlying mortgage pool areallocated to the bondholders on a pro rata basis. This means that each passthrough certificate holder receivesthe same amount of interest and the same amount of principal. Stripped mortgage-backed securities differ in thatprincipal and interest are not allocated on a pro rata basis.

Question 14 - #9463Which of the following most accurately describes the term "securitizing a mortgage"?A) Selling an entire mortgage to another investor.B) Selling shares of one mortgage to other investors.C) Including a mortgage in a pool of mortgages that is used as collateral for amortgage passthroughsecurity.D) Offsetting the mortgage payments by an investment that generates exactly thesame cash flows.Your answer: B was incorrect. The correct answer was C) Including a mortgage ina pool of mortgages that is

used as collateral for a mortgage passthrough security.A mortgage passthrough security represents a claim against a pool of mortgages.Any number of mortgages maybe used to form the pool, and any mortgage included in the pool is referred to as a securitized mortgage.Passthrough securities may be traded in the secondary market, and, as such theyeffectively convert illiquidmortgages into liquid securities. This process is called securitization.This question tested from Topic Area 1, Topic 17, AIM 5

Question 16 - #126320The following are reasons that a prepayment model will not accurately predict future mortgage prepayments.Which of these will have the most significant effect on the convexity of mortgage pass-throughs?A) Seasoning.B) Refinancing burnout.C) Seasonality.D) Refinancing incentive.Your answer: B was incorrect. The correct answer was D) Refinancing incentive.The economic incentive to refinance as interest rates fall is the most powerfulfactor affecting the prepayment ofmortgage obligations.This question tested from Topic Area 1, Topic 17, AIM 3

Question 17 - #30166Which of the following have greater price volatility than the pass-through from


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which they are derived?A) Principal only strips.B) Interest only strips.C) Neither interest only strips nor principal only strips.D) Interest only strips and principal only strips.Your answer: B was incorrect. The correct answer was D) Interest only strips andprincipal only strips.

Both IOs and POs exhibit greater price volatility than the pass-throughs from which they are derived. This occursbecause IO and PO returns are negatively correlated.This question tested from Topic Area 1, Topic 17, AIM 8

Question 18 - #30117Which of the following variables affect mortgage prepayment rates?I. Earthquakes.II. Season of the year.III. Volatility of mortgage rates.IV. Original rate on the mortgage.

A) I and IV only.B) II and IV only.C) II only.D) I, II, III, and IV.Your answer: B was incorrect. The correct answer was D) I, II, III, and IV.The season of the year, volatility of mortgage rates, natural disasters such asearthquakes, and mortgage loancharacteristics such as the original rate on a mortgage are all factors that mayaffect mortgage prepaymentrates.This question tested from Topic Area 1, Topic 17, AIM 3

Question 20 - #125677A CMO contains 4 tranches with the following characteristics:Tranche OAS (bps) Option cost(bps) Z-spread (bps)1 64 27 912 65 20 853 78 8 864 58 36 94Which of these tranches appears to be cheap?A) Tranche 3.B) Tranche 4.C) Tranche 2.D) Tranche 1.Your answer: B was incorrect. The correct answer was A) Tranche 3.A large option cost indicates a wider risk adjusted spread and a higher relativeprice. In general, the higher OASand the lowest option cost is most attractive. Tranche 3 has the lowest option cost and the highest OAS.This question tested from Topic Area 1, Topic 17, AIM 6

Question 22 - #126326Which of the following products may be expected to provide the best hedge against impairment of mortgageservicing rights?

A) 10-year Treasury note.B) Inverse floating rate collateralized mortgage obligation (CMO).C) Floor contract on the 10-year constant maturity Treasury (CMT) rate.


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D) Program amortization class (PAC) bond.Your answer: B was incorrect. The correct answer was D) Program amortization class (PAC) bond.The mortgage servicing rights associated with CMOs are assets that have cash flows that are uncertain becauseof mortgage prepayment risk. PAC bonds are CMO structures that are designed to minimize CMO prepayment

risk.This question tested from Topic Area 1, Topic 17, AIM 8

Question 26 - #126331A trader is bearish on the U.S. bond market (he thinks prices will fall in the short-term). Which mortgagederivative position will usually yield a profit if the trader's assumption is accurate?A) IO (interest only).B) PO (principal only).C) Inverse floater.

D) None of these.Your answer: B was incorrect. The correct answer was A) IO (interest only).A trader who is bearish on the U.S. bond market believes that interest rates will rise. Of the three securitieslisted, only the IO would increase in value in such a scenario.This question tested from Topic Area 1, Topic 17, AIM 8

Question 28 - #9424Which of the following best describes how accrual bonds distribute prepayment risk among tranches to createproducts that provide better asset and liability matching for institutional investors? Accrual bonds:

A) do not allow prepayment for certain types of mortgages.B) accrue the interest for one tranche and redistribute it to the other tranches.C) have several different tranches to which accrued interest is directed sequentially.D) have a fixed principal repayment schedule that must be satisfied as long as the support tranches exist.Your answer: B was correct!For many sequential-pay CMO structures, the last tranche to be paid principal also does not receive currentinterest until the other tranches have been paid off. This tranche is called theZ-tranche or accrual tranche, andthe securities that represent a claim against its cash flows are called Z-bondsor accrual bonds. The interest thatwould ordinarily be paid to the accrual tranche is applied against the outstanding principal of the other tranches, insequence. The diverted interest from the accrual tranche accrues. That is, it isadded to the outstanding principalbalance of the Z-tranche.This question tested from Topic Area 1, Topic 17, AIM 8

==============================================================================================================================Estimating Market Risk Measures

Question 4 - #49125


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The Westover Fund is a portfolio consisting of 42 percent fixed income investments and 58 percent equityinvestments. The manager of the Westover Fund recently estimated that the annualVAR(5 percent), assuming a250-day year, for the entire portfolio was $1,367,000 based on the portfolios market value of $12,428,000 and acorrelation coefficient between stocks and bonds of zero. If the annual loss in

the equity position is only expectedto exceed $1,153,000 5 percent of the time, then the daily expected loss in thebond position that will beexceeded 5 percent of the time is closest to:A) $72,623.B) $55,171.C) $46,445.D) $21,163.Your answer: B was incorrect. The correct answer was C) $46,445.Begin by using the formula for dollar portfolio VAR to compute the annual VAR(5%) for the bond position:VAR2

portfolio = VAR2Stocks + VAR2Bonds + 2VARStocksVARBonds ?Stocks, Bonds(1,367,000)2 = (1,153,000)2 + VAR2Bonds + 2(1,153,000)VARBonds(0)VARBonds = [(1,367,000)2 (1,153,000)2]0.5 = 734,357Next convert the annual $VARBonds to daily $VARBonds:734,357 / (250)0.5 = 46,445This question tested from Topic Area 1, Topic 1, AIM 2

Question 6 - #43310A large bank currently has a security portfolio with a market value of $145 mill

ion. The daily returns on the banksportfolio are normally distributed with 80% of the distribution lying within 1.28 standard deviations above andbelow the mean and 90% of the distribution lying within 1.65 standard deviationsabove and below the mean.Assuming the standard deviation of the banks portfolio returns is 1.2%, calculatethe VAR(5%) on a one-daybasis.A) $2.87 million.B) $2.23 million.C) $2.04 million.D) cannot be determined from information given.Your answer: C was incorrect. The correct answer was A) $2.87 million.VAR(5%) = z5% s portfolio value= 1.65 0.012 $145 million= $2.871 millionThis question tested from Topic Area 1, Topic 1, AIM 2

Question 7 - #70828You wish to estimate VAR using a local valuation method. Which of the followingare methods you might use?Historical I. simulation.II. The delta-normal valuation method.III. Monte Carlo simulation.

IV. The grid Monte Carlo approach.A) I only.B) I and II only.


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C) III and IV only.D) II only.Your answer: B was incorrect. The correct answer was D) II only.Local valuation methods measure portfolio risk by valuing the assets at one point in time, then makingadjustments to relevant risk factors that are expected to cause changes in the overall portfolio value. The deltanormal

valuation method is an example of a local valuation method.This question tested from Topic Area 1, Topic 1, AIM 2

Question 31 - #124969Which of the following statements regarding value at risk (VAR) and expected shortfall (ES) is least accurate?A) The calculation of lognormal VAR and normal VAR will be similar when dealingwith long-time periods.B) The ES provides an estimate of the tail loss by averaging the VARs for increasing confidence levels inthe tail.

C) As the number of VAR observations increases, the ES will increase.D) The calculated VAR amount is always reported as a negative value.Your answer: D was incorrect. The correct answer was A) The calculation of lognormal VAR and normal VAR willbe similar when dealing with long-time periods.The calculation of lognormal VAR and normal VAR will be similar when dealing with short time periods. VAR isalways negative, but is typically reported as a positive value since the negative amount is implied. As the numberof VAR observations increases, the ES increases and approaches the theoretical true loss.This question tested from Topic Area 1, Topic 1, AIM 3

Question 32 - #49501The relationship between a three month call option and its underlying stock arepresented in the following table.Volatility: s = 15.0%Risk-free rate = 6.0%Exercise price (X) = 24Time to maturity = 3 monthsS = $25.00C = $1.60Stock Price, S $21.00 $22.00 $23.00 $24.00 $24.75 $25.00Value of Call, C $0.04 $0.15 $0.42 $0.91 $1.41 $1.60PercentageDecrease in S16.00% 12.00% 8.00% 4.00% 1.00%PercentageDecrease in C97.46% 90.39% 73.55% 43.37% 11.92%Delta (?C%/?S%) 6.09 7.53 9.19 10.84 11.92Part 1)Using the linear derivative VAR method and the information in the above table, what is a five percent VAR for thecall options weekly return?A) 40.9%.B) 10.8%.

C) 15.8%.D) 21.3%.Your answer: C was incorrect. The correct answer was A) 40.9%.


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The weekly volatility is approximately equal to 2.08 percent a week ( ). The 5 percent VAR for thestock price is equivalent to a one standard deviation move, or 1.65 for the normal curve. The 5 percent VAR ofthe underlying stock is 0 2.08%(1.65)= 3.432%. A one percent change in the stockprice results in a 11.92percent change in the call option value, therefore, the delta = 0.1192/0.01 = 11

.92. For small moves, delta can beused to estimate the change in the derivative given the VAR for the underlying asset as follows: VARCall =?VARStock =11.92(3.432%) = 0.409 or 40.9%. In words, the 5 percent VAR implies there is a 5 percentprobability that the call option value will decline by 40.9% or more.This question tested from Topic Area 1, Topic 1, AIM 2

Question 36 - #14145Which value at risk methodology is most subject to model risk?A) Parametric.B) Monte Carlo simulation.

C) Variance/covariance.D) Historical.Your answer: B was correct!Monte Carlo simulation is subject to model risk.This question tested from Topic Area 1, Topic 1, AIM 2

Kiera Reed is a portfolio manager for BCG Investments. Reed manages a $140,000,000 portfolio consisting of30 percent European stocks and 70 percent U.S. stocks. If the VAR(1%) of the European stocks is 1.93 percent,or $810,600, the VAR(1%) of U.S. stocks is 2.13 percent, or $2,087,400, and thecorrelation between European

and U.S. stocks is 0.62, what is the portfolio VAR(1%) on a percentage and dollar basis?A) 2.07% and $2.90 million.B) 1.90% and $2.90 million.C) 1.90% and $2.67 million.D) 2.07% and $2.67 million.Your answer: B was incorrect. The correct answer was C) 1.90% and $2.67 million.VAR for the portfolio on a percentage and dollar basis is calculated as follows:This question tested from Topic Area 1, Topic 1, AIM 2

============================================================================================================================Exotic Options

Question 4 - #49583Which of the following describes a compound option?A) Selling a call and put at the same strike price.B) Buying a call and put at the same strike price.1 of 5 12/Mar/2014 11:09 AMC) Buying a call option on another call option.D) Selling a forward contract on a put option.Your answer: B was incorrect. The correct answer was C) Buying a call option onanother call option.Compound options are options on other options. Buying a call option on another c

all option allows the owner todetermine whether he wishes to exercise the first option to own the second.


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=============================================================================================================================Messages from the Academic Literature on Risk Measurement for the Trading Book

Question 1 - #150857Looking at the Basel regulatory framework, how would the Basel approach be best

described?A) Idiosyncratic.B) Non-compartmentalized.C) Non-integrated.D) Integrated.Your answer: B was incorrect. The correct answer was C) Non-integrated.The Basel approach is a building blockapproach, which is a non-integrated approach to risk measurement.This question tested from Topic Area 1, Topic 9, AIM 5

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Modeling Dependence - Correlations and Copulas

Question 2 - #49336Which of the following are NOT potential problems with the risk analytics for Basel II?I. Estimating the correlation of defaults is difficult as simultaneous defaultsare very rare.II. Validation of credit rating systems is difficult because default is rare.III. Using copulas to estimate correlation of default ignores fat tails.IV. Operational risk losses may be difficult to classify.A) III only.B) I only.C) II only.

D) Two of the above are not potential problems.Your answer: B was incorrect. The correct answer was A) III only.Copulas show promise in estimating correlation of default as they may include characteristics such as fat tails.This question tested from Topic Area 1, Topic 3, AIM 2

Question 3 - #117321Which of the following copula functions are used to price tranches of collateralized debt obligations (CDOs)?A) Gaussian (or normal) copula.B) Independent copula.C) Gumbel (or logistic) copula.D) Extreme value copula.Your answer: B was incorrect. The correct answer was A) Gaussian (or normal) copula.The one-factor Gaussian copula models are used to price tranches of CDOs.

Question 4 - #124973Which of the following copulas is used specifically when variables A and B are countermonotonic?A) Minimum copula.1 of 2 12/Mar/2014 10:57 AMB) Maximum copula.C) Gaussian copula.D) Archimedean copula.

Your answer: B was correct!

uestion 5 - #124972


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Which of the following statements regarding correlation is (are) CORRECT?If returns are not normally distributed, then a zero correlation implies that rI. eturns are independent.II. Correlation is not a good measure of dependence for all elliptical distributions.III. Correlation is not a good measure of dependence for all non-elliptical distributions.

The correlation of two random variables A and B will be the same as the correlation between ln(A) andln(B).IV.A) I only.B) III only.C) III and IV.D) II and III.Your answer: B was incorrect. The correct answer was D) II and III.Correlation is not a good measure of dependence when the underlying variables have non-elliptical distributions. Itis also not a good measure for all elliptical distributions, for example, when r

eturns have a multivariate normaldistribution. It is a good measure for some (but not all) elliptical distributions.If returns are not normally distributed, then a zero correlations does not necessarily imply that returns areindependent.Correlation is not invariant to transformations so for example, the correlationof two random variables A and B willnot be the same as the correlation of ln(A) and ln(B).This question tested from Topic Area 1, Topic 3, AIM 1

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Non-parametric Approaches

Question 1 - #134153Which of the following statements is incorrect regarding bootstrap historical simulation? The bootstrappingtechnique:A) is a simple and intuitive estimation procedure.B) draws a sample from the original data set, records the VAR from that particular sample and returnsthe data.C) can be performed to estimate the expected shortfall (ES).D) provides less precise estimates of coherent risk measures than historical simulation on raw dataalone.Your answer: B was incorrect. The correct answer was D) provides less precise estimates of coherent riskmeasures than historical simulation on raw data alone.Empirical analysis demonstrates that the bootstrapping technique consistently provides more precise estimates ofcoherent risk measures than historical simulation on raw data alone.This question tested from Topic Area 1, Topic 2, AIM 1

Question 2 - #134154Which of the following statements is least accurate regarding non-parametric density estimation?

A) The major downfall of the non-parametric approach compared to the traditionalhistorical simulationapproach is that VAR can only be calculated for a continuum of points in the dat


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a set.B) One of the advantages of non-parametric density estimation is that the underlying distribution is freefrom restrictive assumptions.C) existing data points can be used to smooththe data points to allow for VAR calculation at allconfidence levels.

D) Makes an adjustment that connects the midpoints between successive histogrambars in the originaldata sets distribution.Your answer: B was incorrect. The correct answer was A) The major downfall of the non-parametric approachcompared to the traditional historical simulation approach is that VAR can onlybe calculated for a continuum ofpoints in the data set.The major improvement of the non-parametric approach over the traditional historical simulation approach is thatVAR can be calculated for a continuum of points in the data set.This question tested from Topic Area 1, Topic 2, AIM 2

Question 4 - #134156With of the following items is not one of the advantages of non-parametric simulation methods?A) Intuitive and often computationally simple.B) Data that requires adjustments is often readily available.C) Not hindered by parametric violations of skewness.D) Can accommodate more complex analysis.Your answer: B was correct!An advantage of non-parametric methods is that data is often readily available and does not require adjustments(e.g., financial statements adjustments).

This question tested from Topic Area 1, Topic 2, AIM 4

Question 5 - #134155Which of the following statements accurately describe filtered historical simulation? Filtered historical simulation:A) is the most comprehensive, and hence most complicated, of the parametric estimators.B) is not flexible enough to capture conditional volatility and volatility clustering.C) is only reasonable for small portfolios, and empirical evidence does not support its predictive ability.D) combines the historical simulation model with conditional volatility models.Your answer: B was incorrect. The correct answer was D) combines the historicalsimulation model withconditional volatility models.The filtered historical simulation is the most comprehensive, and hence most complicated, of the non-parametricestimators. The process combines the historical simulation model with conditional volatility models (like GARCHor asymmetric GARCH). Thus, the method contains both the attractions of the traditional historical simulationapproach with the sophistication of models that incorporate changing volatility.In simplified terms, the model isflexible enough to capture conditional volatility and volatility clustering as well as a surprise factor that could have

an asymmetric effect on volatility. From a computational standpoint, this methodis very reasonable even for largeportfolios, and empirical evidence supports its predictive ability.


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===============================================================================================================================Overview of Mortgages and the Consumer Mortgage Market

Question 2 - #124984Based on recent trends, which of the following measures of creditworthiness is generally seen as least importantby mortgage lenders?A) Documentation provided by borrower.B) Loan-to-value ratio.C) Income ratios.D) Credit scores.Your answer: B was incorrect. The correct answer was A) Documentation provided by borrower.Recent trends indicate that supplying documentation is becoming a less viable tool for mortgage lenders.

Borrowers may not be denied credit in the event of no or little documentation, however, the mortgage rateassigned will reflect the riskiness of the loan.This question tested from Topic Area 1, Topic 18, AIM 1

Question 3 - #143160In supervising an analysts research report on mortgages, you review a number of his statements.I. Longer mortgage terms result in slower build up of equity.II. Contiguous interest-only hybrid ARMs are generally less risky than noncontiguous interest-only ARMs.III. A front ratio of 33% would likely result in the classification of the loan as prime.

Which of the analysts statements is/are correct?A) I only.B) I and II.C) II and III.D) I, II, and III.Your answer: B was incorrect. The correct answer was A) I only.Statement I is correct. Shorter mortgage terms are used by borrowers who want topay down their mortgagesfaster and build up their equity faster.Statement II is incorrect. Noncontiguous interest-only hybrid ARMs are meant toavoid the sudden increase inpayments usually associated with the simultaneous resetting and recasting of ARMs for contiguous interest-onlyhybrid ARMs.Statement III is incorrect. Loans that are classified as prime have a front ratio of 28% or less and a back ratio of36% or less.This question tested from Topic Area 1, Topic 18, AIM 1

Question 4 - #126325Which of the following risk factors listed in the prospectus for a MBS (mortgage-backed security) contributes tocredit risk?General I. business risk.II. Prepayment considerations.

III. Limited obligation.A) I only.B) II only.


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C) I and III only.D) I, II, and III.Your answer: B was incorrect. The correct answer was A) I only.Prepayment consideration is the risk that the securities will be paid off early.There is no limited obligation forMBSs. Thus, only general business risk contributes to credit risk.This question tested from Topic Area 1, Topic 18, AIM 3

Question 5 - #126319Which of the following statements describes the typical price behavior of a lowpremium mortgage pass-throughsecurity?A) It is similar to a U.S. Treasury bond.B) When interest rates fall, its price increase would lag that of a comparable duration U.S. Treasury.C) It is similar to a plain vanilla corporate bond.D) When interest rates fall, its price increase would exceed that of a comparable duration U.S. Treasury.Your answer: B was correct!

Mortgage pass-through securities, unlike Treasuries or plain vanilla corporate bonds, have an embedded optionallowing borrowers to repay the loan at any time. When rates fall, the effectiveduration of these securitiesdecreases because borrowers will refinance mortgages at lower rates (putting theloans back to the investors);but when interest rates increase, borrowers will hold on to mortgages longer than they otherwise would, resultingin an increase in the effective duration of the loans. This is reflected in theprice/yield relationship as negativeconvexity.This question tested from Topic Area 1, Topic 18, AIM 3

Question 6 - #143161You are analyzing an interest-only hybrid ARM. The opening principal balance was$250,000 with a five-year fixedrate period, a ten-year interest-only period (interest is paid monthly), and a 30-year term. The initial fixed ratewas 4% and five years later, the interest rate increased to 5%. Another five years passed and the interest rateincreased to 6% for the remainder of the term.Based on the information provided, which of the following amounts represents thetotal increase in monthlymortgage payments up to the first point the mortgage is recast?A) $958.B) $109.C) $417.D) $1,791.2 of 3 12/Mar/2014 11:10 AMYour answer: B was incorrect. The correct answer was A) $958.At the outset, the mortgage payments are interest-only, which results in a monthly payment of $833 ($250,000 x4% / 12). When the loan is reset (but not recast) five years later at a new rateof 5%, the monthly payment isstill interest-only but increases to $1,042 ($250,000 x 5% / 12). After the interest-only period is over at year 10,the mortgage is recast from interest-only to amortizing for the remaining 20-year term. The interest rate is 6%

for the remainder of the term so the monthly payment increases to $1,791 (blended interest and principal).payment = 250,000 [(0.06 / 12) (1 + 0.06 / 12)^(20 12)] / [(1 + 0.06 / 12)^(20 1


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2) - 1] = 250,000 (0.01655 / 2.31) = $1,791.Therefore, the total increase in mortgage payment is $958 ($1,791 when the mortgage is recast year 10 versus$833 at the outset when the mortgage payments are interest-only).This question tested from Topic Area 1, Topic 18, AIM 2

================================================================================================================================Overview of the Mortgage-Backed Securities Market (Read complete)

================================================================================================================================Parametric Approaches (II) - Extreme Value

Question 3 - #70837Which of the following statements is (are) FALSE concerning extreme value distributions?

Using block maxima, local maxima may not resemble extreme I. observations.II. Small tails reduce the variance of the tail index estimator in cluster analysis.III. The two classes of EVT models are block maxima and generalized extreme value distribution.A) II and III only.B) I and II only.C) I and III only.D) I, II, and III.Your answer: B was incorrect. The correct answer was A) II and III only.Small tails decrease the number of extreme observations, which will increase thevariance of the tail index(Statement II is false). Block maxima and peaks-over-threshold are the two class

es of EVT distributions(Statement III is false).

Question 4 - #124975Which of the following statements regarding generalized extreme value (GEV) andpeaks-over-threshold (POT) isCORRECT?A) POT approach may introduce additional uncertainty.B) Only one of the approaches has a tail parameter denoted ?.C) Both POT and GEV focus on the distribution of extreme values above a specified threshold.D) POT requires the estimation of one more parameter than GEV.Your answer: B was incorrect. The correct answer was A) POT approach may introduce additional uncertainty.The POT approach requires a choice of a threshold, which may introduce additional uncertainty.GEV requires the estimation of one more parameter than POT.GEV theory focuses on the distributions of extremes, whereas POT focuses on thedistribution of values thatexceed a certain threshold.Both approaches have a tail parameter denoted ?.This question tested from Topic Area 1, Topic 4, AIM 4

Question 5 - #67441The Peaks Over Threshold (POT) approach serves as a basis for an expanded model

of risk estimation. Whichof the following statements are false regarding POT?I. Under the POT method, in the case of fattails, not all moments are defined.


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II. POT is often estimated with a Generalized Pareto Distribution.A) Neither I nor II.B) Both I and II.C) I only.D) II only.Your answer: B was incorrect. The correct answer was A) Neither I nor II.Both statements are correct (i.e., neither are false).


Question 6 - #71765Extreme value theory (EVT) can assist with value-at-risk (VAR) calculations by providing better probabilityestimates of observing extreme losses than that indicated by a standard normal distribution because:A) the observed empirical distribution of most asset returns tends to be platykurtic.B) extreme losses appear to occur more frequently than indicated by a normal distribution.C) extreme losses appear to occur less frequently than indicated by a normal dis

tribution.D) EVT is the most efficient method for estimating extreme losses.Your answer: B was correct!Extreme losses appear to occur with a higher frequency than indicated by a normal distribution. EVT has beenshown to generate more realistic probability estimates for extreme losses than anormal distribution.This question tested from Topic Area 1, Topic 4, AIM 2

Question 7 - #126316Extreme value theory (EVT) helps quantify two key measures of risk. The magnitude of:A) an X year return in the loss in excess VAR.

B) VAR and the level of risk obtained from scenario analysis.C) market risk and the magnitude of operational risk.D) market risk and the magnitude of credit risk.Your answer: B was incorrect. The correct answer was A) an X year return in theloss in excess VAR.Extreme value theory (EVT) looks at the value of losses beyond an identified cutoff point.This question tested from Topic Area 1, Topic 4, AIM 2

Question 8 - #67435Under the Extreme Value Theorem (EVT), which of the following is (are) TRUE regarding the modeling of marketrisk?The three key resulting distributions are: Gumbel, Weibull, I. and Frechet.II. EVT permits the analysis of maxima and minima distributions.III. EVT is does not account for heavytails observed in the market place.IV. EVT is dependent upon the normal distribution.A) I and III only.B) I only.C) None of these.D) I and II only.Your answer: B was incorrect. The correct answer was D) I and II only.Statement III is incorrect because EVT allows for heavytails as we see in the market place. Statement IV isincorrect because EVT is not dependent upon the normal distribution.

Question 9 - #29971Extreme value theory (EVT) can assist with value at risk (VAR) calculations by p


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roviding better probabilityestimates of observing extreme losses than that indicated by a standard normal distribution because empiricaldistributions exhibit fat tails. If one uses the generalized Pareto distribution(GPD) method to generate parameterestimates for the shape parameter, fat tails will indicate a:A) positive parameter estimate and VAR calculations that are too small.

B) positive parameter estimate and VAR calculations that are too large.C) negative parameter estimate and VAR calculations that are too small.D) negative parameter estimate and VAR calculations that are too large.Your answer: B was incorrect. The correct answer was A) positive parameter estimate and VAR calculations thatare too small.Fat tails will generate a positive shape parameter, which indicates that VAR estimates are probably too small.This question tested from Topic Area 1, Topic 4, AIM 5

Question 9 - #29971Extreme value theory (EVT) can assist with value at risk (VAR) calculations by p

roviding better probabilityestimates of observing extreme losses than that indicated by a standard normal distribution because empiricaldistributions exhibit fat tails. If one uses the generalized Pareto distribution(GPD) method to generate parameterestimates for the shape parameter, fat tails will indicate a:A) positive parameter estimate and VAR calculations that are too small.B) positive parameter estimate and VAR calculations that are too large.C) negative parameter estimate and VAR calculations that are too small.D) negative parameter estimate and VAR calculations that are too large.Your answer: B was incorrect. The correct answer was A) positive parameter estimate and VAR calculations thatare too small.

Fat tails will generate a positive shape parameter, which indicates that VAR estimates are probably too small.

Question 12 - #117134Which of the following most accurately describes the parameters of a generalizedPareto distribution (GPD)?A) The scale parameter: 0 < . The shape (tail) index: ?, can be any real number.B) The scale parameter: 0 > . The shape (tail) index: ?, can be any real number.C) The scale parameter: , can be any real number. The shape (tail) index: ?, canbe any real number.D) The scale parameter: , which can be any real number. The shape (tail) index: ?> 0.Your answer: B was incorrect. The correct answer was A) The scale parameter: 0 Do not forget to divide by 2 if 6 month couponsDo Question 10

Question 19 - #125675Which of the following statements regarding callable bonds is (are) NOT correct?Callable bonds have more I. price volatility.

II. Callable bonds have negative convexity.III. Capital gains are capped as yields rise.IV. At low yields, reinvestment rate risk rises.


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A) II only.B) I and III.C) III and IV.D) I and II.Your answer: B was correct!Callable bonds have:Less price volatility.

Negative convexity.Capital gains are capped as yields fall, not rise.Exhibit increased reinvestment risk when rates fall as there is an increased chance of the bond beingcalled

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Question 5 - #123628Relative to return-based risk measures, position-based risk measures are:

A) easier to implement and can detect style drift more quickly.B) more difficult to implement and can detect style drift more slowly.C) more difficult to implement but can detect style drift more quickly.D) easier to implement but can detect style drift more slowly.Your answer: B was incorrect. The correct answer was C) more difficult to implement but can detect style driftmore quickly.Position-based risk measures evaluate the managers holdings on a current basis and can thus detect style driftmore quickly. It is more difficult to implement though. Return-based risk measures evaluate risk using historicalreturns whereas position-based risk measures require an examination of each position a manager holds.

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