FRM Part II Book 1: Market risk measurement and management (2013 SchweserNotes)

244 Pages·2016·25.16 MB·English

SCHWESERNOTES”

FOR THE FRM* Exam

FRM’ 2013

Part II | Book 1

e_ |

and Management

CHWESER
FRM Parr II Book 1: Market Risk
MEASUREMENT AND MANAGEMENT

WeLcome To THE 2015 ScrweserNores
Reaping Assignments anp AIM StarEMents
Marker Risk MEASUREMENT AND MANAGEMENT

|: Bssimating Marker Risk Measates

2: Non Paramertic Approaches

3: Modeling Dependsive: Contelaions and Coyulas

4; Purumetic Apovoaelies (ID): Excteane Valu

>: Bachiesting VaR

6. VaR Mapping

7: Volatility Smiles

&: Exotic Options

9: The Seience of Term Sects Models

11 The Peolution af Shor Rares and rhe Shape of the'Term Scricrire

1 The Art of'Teom Srmerire Models: Dit
iene

13: Overview of Moztpages and she Consumer Morrpage Marker

1: Basics of Residensial Morcgage Baccee Secusiies
15: Overview of dhe Mortgage Bavted Seuities Marke
1: Teclutqus for Valuing MBBSs

V7: Messages fious Ube Academic Literature os Rish Mews areusennt

for she Trading Book.

‘Seir-Test: Marer Risk MEASUREMENT AND MANAGEMENT

Pasr FRM Exam Quistions
ForMuLas
APPENDIX

Tnpex

‘GIO Kap, Ine

Art af'esm Structure Models: Volatilixy and Diseibution
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PRM PART I[BOOK I: MARKET RISK MEASUREMENT AND MANAGEMENT
£92015 Kaplan, ne, és. Kaplan Schwese> lights escrved,

Penis inthe Uiited Stance of Ame,

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Sehusewe” TTEM®, GARPS, asd Global Asstiation of Rsk Profenional™ are walemachs waa by dhe
(Global Ausocicicn of Risk Profesional,

GARP ERM Practice Exam Quedious ae primed wid yermiaion. Capygh, 2012, Gla Acsciaon ol
Bis Psfesionake.Allnghss treed,

Tie iia ye i il WB Yn nb 1 es" nila iin
ofthese note ica vilzton of zlobal eopyigh lew, You asarcs in pursuing potential volatx: ofthis aw x

ently append

Disclaimer Te SchiesNows should be used in zonjusetion with 2h oiginal ceding at forth by
GNP The nfrmation comts nen these hocks is eed 9 the oe ginel renings and cele te
oan: Howey aie curd comm geese ab sy waranty coupe Ltr ae 20

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WELCOME TO THE 2013 SCHWESERNOTES

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tims and te

‘The Pars ILTRM exam isa formidable challenge {covering 71 assigned readings and
5s AIM stuements), sid you must devote vousiderable dine and effort w be propetly
prepared. There are no sho-tewts! You must learn the macerial, know the terminology and
techniques, understand the concepts, and be able ro answer 80 multinle choice questions
quick! and (ar least 70%) enrrcetly. A good estimare of the sridy time required ar
average '8 280 hon, hur some cand/eres will nese! mars ar less time, depending on heir
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in-depth coverage of dificule concepts, instant feedback dusing leceare and Q&A sessions
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Page 4 E013 Kaplan, Ine
‘Welcome to the 2013 Schoverer
Part Il Topic Area Weighting

1s preparing for the exam, yn mst pay tention the weighrs assigned on ech topic arca
Pare Il topic area weights are as Follows:

Bonk Tipe dacs Fears Weigir Foam Questions
1 Markce Rik Neamitement 2-7 Management 20
2 Cree Riek Meatirement and Managment 2
$ Operational and Lategated Risk Managetncic 0
[Risk Me:agesseat and Investment Management 2
4 (Cantent Tues to inane Markets 8

Tlow to Succeed

‘There are no shorteuss ro seudying for this exam. Exosct GARD to test you in a way th
‘will eveal how well you know the Puet Ef vutrivulun, You shou'd begin studying eal and
sick w your study plan. You should iss read Uke SelweserNvies and complete the Concept
‘Checkers for each topic. Ar the end of zach books you should answer che provided Self Tes=
questions and past FRM exam questions to understand how concepts hav been rested in
the nat. You shan finish ths avers] curricubim a* lest wo wecks before the FRM czam,
“This will allow sufficiens time for Practice Fxams and: farther review of those topes vor

have not yer masczred,

regard,

Sse Sauce
Evie Sauith, CEA, FRM

FRM Product Manager
‘Kaplan Schvveser

GH Rapin ae Bs
Page 6

READING ASSIGNMENTS AND
AIM StaTEMENTS

The following manevisl i a review of the Mahe Risk Measucencent nd Mamagennene principles
designed to udesess the AIM stasements set forth by the Global Asorission of Risk: Prfessonas

READING ASSIGNMENTS

Kevin Dowd, Meatving Marker Rich 2nd bdivion (West Sussex, England: Jobr. Wiley 8
Sons, 205)

‘Estimating Market Risk Measures,” Chapter 3

“Non parametric Approaches,” Chapter 4

3. “Appendix Modeling Dependence: Conelatiors and Copulas,” Chapee:5

4, "Paremerric Approaches (iI): Extreme Value,” Chapter 7

Philipas Jovion, Viluestltinks The New Bemchmsk for Managing Fnancis! Rick, Srl
uc, (New York: MsGraw Hill, 2007)

5. “Rackreating VaR,” Chapter 6

é

"VaR Mp ping,” Chaptes 12

John Hill, Options, Bstunrs, andl Other Deviuarives, 8th Falzion (Sew York: Pearson
Prontice Hall, 2072),

*Volail:ay Suailes," Chapter 19

"Pantie Options” Chapter 25 a

Bruce Tucktan, Fixed Income Securitie, Ind Eduion (Hoboken, NJ: Jolin Wiley &
Sons, 2013

9. "The Science of Term Structure Models,” Chapesr 7

1), “The Evolution of Shori Raves and che Shape of die Tern Suuctuse.”
Chaprer 8 (page 119)
11 “The Artof Term Saructure Models: Dil,” Chapter 9 (pege 125)

12, "Tae Arc of'Term Scructure Models: Volatility and Dist-ibucion,’
Chaprer 10 page M0)

Bos Kaplan, oe
13

we

Reading Acsignments and AIM Statem

Prank Faborri, Anand Bhactachsrya, William Berliner, Morrgage Backed Securities,
ret Eason (Flobokeu, NJ: Jobun Wiley b¢ Souss 2011.

“Overview of Mortgages and che Consumer Mor

re Marker,’ Chapzer | (page 150)

Pictco Veronesi, Féwa Income Securities (Hoboken, NJ; John Wiley:

¢ Sons, 2010).
“Basics of Residential Mormgaze Baciced Securities," Caaprer & (page 162)

Prank Fabozti, Anand Bhactach-ya, William Berliner, Morrguge Backed Securities,
Bret Eason (Hiobokeu, NJ: Jobn Wiley b¢ Souss 2011).

“Ovorviow of the Marngngy-Racked Soosttis Meret," Chaprer 2. (page 179)

. “Tecuques for Valuing MBS," Chapter 10 (page 189

“Messages from the Academic Litcranite on Risk Measuremen' for the Treding Book,”
Bassl Committor an Banking Supervision,
Workiag Paper, No. 19, Jan. 201 (page 208)

13 Kaplas, Tae

Pa
Boole 1

Reading Assignments and AIM Scacemems

1

‘AIM StareMENTs

Estimating Marker Risk Measures

‘Candids=e, after completing this resding, should be able to:

1. Caleulate VaR wsing a historical simulation approach. (page 15)

2. Caleulate VaR sing a parrmetric estimation approach asaaming thet the rerun
disriuarion is either normal or lognormal. (page 17)

3. Caleulate the expected shortfill given P/Lor retun daca. (page 1}

4. Define coherent siske measures. (page 19)

5. Descsibe die method of estimating colieren risk mscasutes by etisnating quantiles,
(page 19)

be the methed of escimating scandard e-tors for estimacors of coherent risk

measies, (page 20)

7. Desorthe tho se oF QQ plots fo idenrifying the distribution oF data. (page 22)

Non-parametric Approaches

‘Candidsces, after completing this reading, should be able to
41. Diesorthe the hnotserap historical simmlerian apprcach ro estimating enherent rise

measites, (page 28)

ibe histories! simulation using non-parimet imation. (page 291

3. Deswabe tie following weighted historie siaulation approcies:

+ Age-neighted historic simulation

+ Volatlcy weighted historic simulation

+ Contelation weighted historic simulation

+ Fitcted historical simlation

ibe ths advanzages and disadvantages of noa-paramestic essimation methods.
(page 22)

Modeling Dependence: Correlations and Copulas

Candidszes,
1, Explain the drawbacks of using corselssion to measute dependence. (page 38)
2. Desvabe how vopakss peovide an alternative measure of depeulenes, (page 39}
3. Mlsuify basic extaples of eopuls, (page 39)

4, Explain how mil dependence can be investigated using copulas. ‘page 41)
Parametric Approaches (II):Extreme Value

Candidasess ace complain this reading, should be able

1. Explain the importance and challenges of erreme vaiues for risk management.
page 45)

‘complzring this reading, should be able to:

2. Dieserhe extreme valve shenry (EVT) and ies nae in vs management. (page 45)

3. Desorhe the peake-ever-thresheld (SOT) appeoach. (page 47)

4. Compare generalized exiseme value and POT. (page 49)

5. Describe the gerameters of a generslized Paceto (GP) distribution. (page 47)

6. Expl he ude ae sein dbe daseahold level w aie applying Une GP
distribution. ‘page 48)

7. Compute VaR and expected short using tae POT approach, given various
pparamerer values. (page 48)

8, Paplain the importance of mulcvaeiate PY'T for risk managemens (page $1)

32055 Kaplan, ne
5

6

Bo
Reading Assignments snd ATM Statem

Backtesting VaR

(Candids ass complain this reading, should be able

1, Define buckiesting aud exezptions and explais de iaportauar of bavktesti
models. (page 55)

2. Explain the significanc ditficulties in backsesting a VaR model. (page 56)

3. Raglan the framework of brckresting mosicls with the ia of exceprian sor failure
raoa. (page $6)

4. Define and idensify type Land type Il exons. (page 56)

5. Explain why isis necessary x consider conditional coverzge ia the backtesting
Feamework. (page 5

¢ Basel rules ‘or backrest. (page 58}

Mak

completing this realing, should be able:
1, Explai che principles underlying Vat Mapping, iss and eserbe dhe mapping
process. (page 63)
2. Explain how the mapping process caprures gene
3. List and describe the three methods af mapping portflias of Axed income
securities. (page 66)
4. Map a fixed income portfolio inzo pesitions of srzndard inssruments. (page 66)
5. Deswibe how aupping of risk Factors van suppote suess vesting. (page 67)
6. Explain how VaR car be used as performatce benelunark, (page 68)
7. Describe the methed of mepping forwards, commacity forwards, forward sare
‘agreements, an¢ interes reze swaps. (page 68}
vihe ths method of repping options. (page 69)

Candidszes, afte:

1. Define valesiiry smile and volatility sew. (p

2. Explain howe pu-call parity indicates that che implied volatility
‘options isthe saraz used ro price put options. (page 73)

3. Compate the shape of the volatility smile (or sew to che shape of the implied
distibutiow of dhe uudedlying wast price and w de pricing vf eptivrs on the
tuderlving asset, (page 74)

{Explain why foreign exchange rates are noc necessarily lognormally éistibuced and
‘the implications this can have on aprion prices ancl implied volatility (page 74)

ste pice cal

5. “ihe the volaility am’ls For equity aptians and give possible ceplansrions for its
ape. (page 75)
6. Desc-ibe alternative ways of charscterizing the volz:lity smile. (page 76}

7 Descaibe volaity tna suucaues sad yolaclty suniaves and love they may be wed
(pave opions. (page 77)

8, Explain the impact of th
(page 77)

9. Faoplein the impact nfassc price jomps om velariiy smiles. (page 78)

avility smile on the calculation of che “Greeks.”

(©2015 Kaplan, Ine. Ps