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FRM Part I Updated
How does a PO strip behave and why is it called a leveraged rate play?
A PO strip receives all principal and no interest. Fast prepayments accelerate the par payoff, so POs gain sharply when rates fall — large positive duration and convexity.
How do antithetic variates reduce Monte Carlo variance?
Antithetic variates pair each random draw Z with its negative -Z, simulating two paths from each random number stream and averaging...
How does Merton's jump-diffusion model price options?
Merton's jump-diffusion adds compound Poisson jumps to Brownian motion. Option prices are Poisson-weighted sums of Black-Scholes prices, producing steep short-dated skew and fat tails.
What's the difference between a credit rating outlook and a credit watch?
Rating Outlook is the agency's view on the likely direction of the rating over a 6-24 month horizon. Four states: Positive, Stable, Negative, Developing. CreditWatch is a short-term (usually 90 days) flag signaling that a rating change is imminent...
What are the key Greek features of lookback options?
Lookback options have rising delta toward the running extreme, larger vega than vanillas, and slower theta decay. Path-dependence creates hedging slippage.
Why do IO strips have inverse price behavior to most bonds?
An IO strip receives only interest. Fast prepayments destroy the balance and the IO's cash flow; rising rates slow prepays and boost the IO's value, giving it negative duration.
How do I simulate path-dependent exotics like Asian and lookback options?
Path-dependent options require simulating full price trajectories and computing payoff from path statistics...
What are the benefits of multilateral netting at a CCP?
Multilateral netting collapses gross bilateral exposures into net amounts through the CCP, delivering major collateral savings, Basel capital relief, and simpler operations.
What role does the clearing house play in futures markets?
The clearing house novates trades, becoming buyer to every seller and seller to every buyer. It manages margining, default waterfalls, multilateral netting, and reporting.
How do Greeks behave for knock-in and knock-out barrier options?
Barrier-option Greeks go wild near the barrier: gamma spikes, delta jumps, vega can flip sign. Desks shift internal barriers and use touch-option overlays.
How does a TAC tranche differ from a PAC, and what protection do you actually get?
A TAC targets a single PSA speed. It protects against contraction (fast prepay diverted to support) but offers no extension protection if speeds slow.
What are the tradeoffs between implicit and explicit finite difference schemes?
Explicit FD computes each new node directly from known adjacent nodes - simple, fast per step, but conditionally stable...
What are the SABR model parameters and how are they interpreted?
SABR has four parameters: alpha (ATM vol level), beta (elasticity/backbone), rho (correlation controlling skew), nu (vol of vol controlling smile curvature).
How do I track a futures margin account balance across multiple days?
Track the margin account day by day: add daily MTM to the balance, check against maintenance, record margin calls that restore the balance to initial margin.
How do variation margin calls work during volatile markets?
Variation margin settles MTM changes in cash. Beyond normal end-of-day flows, clearing houses can issue intraday calls during stress events, payable within hours.
What are the main conflicts of interest at credit rating agencies?
Four main conflicts affect the Big Three NRSROs: issuer-pays model (the company requesting the rating pays), ancillary services (rating advisory sold alongside), analyst revolving door, and rating stability preference...
What is psi and when should I worry about dividend sensitivity?
Psi measures sensitivity to the dividend yield. Calls have negative psi, puts have positive psi. Most relevant for long-dated options on high-dividend stocks.
What is a PAC tranche and how does the 'collar' protect its schedule?
A PAC delivers a fixed principal schedule inside its PSA collar. Support tranches absorb prepayment variation; the PAC stays on schedule until the support is exhausted.
What is the Crank-Nicolson scheme and why is it preferred for option pricing?
Crank-Nicolson averages the explicit and implicit schemes, evaluating spatial derivatives at both the current and next time step with equal weight...
What's the difference between initial margin and maintenance margin?
Initial margin opens the position; maintenance margin is the minimum to keep it open. Falling below maintenance triggers a call back to the initial level.
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