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FRM Part I Updated
How do storage costs shape the commodity futures curve?
Storage costs drive a persistent upward tilt in commodity forward curves, but the magnitude varies enormously by commodity type due to physical and economic storage differences...
Why do cross-currency swaps exchange principal while single-currency swaps don't?
Cross-currency swaps exchange principal because legs are in different currencies — FX risk is real. Single-currency swaps skip it because identical notionals cancel...
What is a par equivalent CDS spread and why do practitioners use it?
PECS is the single running coupon making a CDS zero-PV today, translating the post-2009 standard fixed-coupon-plus-upfront quote into a comparable par spread. A 4.2pt upfront plus 100bp running might equal roughly 192bp par spread.
How is a CDS spread decomposed into its components?
CDS spread equals expected loss plus risk premium plus liquidity premium. A 210bp spread on Vanora Logistics might be 120bp expected loss, 60bp risk premium, 30bp liquidity. Risk-neutral PDs are typically 2-4x physical PDs for IG.
Why do currency swaps exchange principal at both start and maturity?
A currency swap exchanges principal and interest payments in two currencies because each leg cannot net against the other.
How do commodity swaps provide index exposure without storing physical goods?
A commodity swap exchanges a fixed commodity price for a floating index price on a notional quantity.
What exactly is convenience yield and why does it matter for commodity risk?
Convenience yield is the implicit, non-pecuniary benefit a holder of a physical commodity receives from having the inventory on hand rather than holding a forward contract...
How is a plain vanilla fixed-for-floating interest rate swap priced at inception?
Plain vanilla IRS priced so fixed leg PV equals floating leg PV at inception. Float PV = N(1-D(T)). Swap rate K = float PV / annuity factor...
What's the difference between a credit curve steepener and flattener trade?
A steepener buys long-dated protection and sells short-dated, profiting when the curve steepens. A flattener is the opposite. Steepeners work early in credit cycles; flatteners when near-term distress looms but survival is likely.
Default risk vs downgrade risk — how should I think about them separately?
Default risk is actual payment failure with recovery; downgrade risk is rating deterioration causing spread widening without default. Use a transition matrix: a BBB bond might have 13% downgrade probability and 0.5% default probability in one year.
What is an equity swap and why would a hedge fund be the total return receiver?
An equity swap exchanges the total return on an equity for a funding leg, typically SOFR + spread.
How do fixed-for-floating interest rate swaps work and who benefits from each leg?
A plain-vanilla interest rate swap exchanges a fixed coupon for a floating coupon on a notional principal that is never exchanged.
How do I price a commodity forward using the cost of carry model?
The cost-of-carry model for commodity forwards extends the financial forward formula by adding storage costs (u) and subtracting convenience yield (y). The continuous-compounding version is F = S * e^((r + u - y) * T)...
How do swap mechanics actually work from trade date through final settlement?
A swap is a bilateral contract exchanging cash flow streams. Meridian Pacific enters 5-year $100M IRS with Beacon Bank: pays 4.20% fixed semi-annual, receives SOFR+15bp quarterly...
How do I quantify the impact of a 50bp spread widening on my bond portfolio?
Use spread duration: loss equals -spread duration x spread change x market value. A $480M portfolio with 5.8-year spread duration loses about $13.9M on a 50bp widening. Add convexity and consider non-parallel moves for precision.
What is credit spread risk and how does it differ from default risk?
Credit spread risk is the risk that market-implied spreads widen causing mark-to-market losses even without default, while default risk is the actual failure to pay. A BBB bond on Meridian Cascade Industries can lose 6% from spread widening alone.
What is stratified sampling and when should I use it in option pricing?
Stratified sampling divides the sampling space into strata and allocates samples proportionally, ensuring tail regions get representation...
How does the control variate technique work in Monte Carlo?
Control variates exploit a correlated auxiliary payoff Y with known analytical value E[Y]. Your control variate estimator has reduced variance...
What does 'through the cycle' rating mean and why do agencies use it?
Through-the-cycle (TTC) ratings attempt to reflect an issuer's credit quality over a full economic cycle (5-7 years), smoothing out short-term volatility. Point-in-time (PIT) ratings reflect the current 12-month default probability given today's conditions...
How do you aggregate Greeks across a multi-instrument portfolio?
Portfolio Greeks sum linearly with quantity and multiplier. Net delta, gamma, vega per underlying, but watch for basis risk, exotic sampling noise, and cross-Greeks.
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