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FRM Updated
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 is SA-CVA (Standardized Approach CVA) under Basel III?
SA-CVA is the standardized approach for calculating regulatory CVA capital, finalized in the Basel III reform package. Banks must have supervisory approval; otherwise they default to BA-CVA. Six risk buckets: IR, FX, credit spread, equity, commodity, CCR spread...
What is intraday liquidity risk and how do banks monitor it?
Intraday liquidity risk is meeting same-day payments despite end-of-day balances being fine. BCBS 248 defines seven metrics including peak usage, available liquidity, and time-specific obligations.
What is a CMBS IO tranche and why does it trade like a corporate bond?
CMBS Class X IOs receive the excess spread on a reference notional. Prepayment lockouts make them bond-like rather than option-like; credit losses and maturity defaults drive risk.
How do I stress test a correlation matrix?
Correlation stress testing applies shocks to the off-diagonal entries of your correlation matrix and revalues the portfolio under the stressed matrix...
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 process verification in model validation?
Process verification tests implementation correctness, data pipelines, model environment controls, output integrity, and user overrides. Complements conceptual and outcomes review.
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 is the Net Stable Funding Ratio computed and why is the horizon one year?
NSFR = ASF / RSF ≥ 100%. ASF weights liabilities by stability, RSF weights assets by required funding. Addresses year-long structural mismatch beyond LCR.
What's the difference between a conduit CMBS and a single-borrower CMBS?
Conduit CMBS are diversified 50-80-loan pools; SASB deals are concentrated on one asset with intense underwriting; CRE CLOs are managed pools of transitional bridge loans.
Why does diversification fail during crisis periods?
Diversification is a feature of normal market regimes. During crises, three mechanisms collapse it - liquidity stress, hidden factor exposure, and funding contagion...
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 does a conceptual soundness review actually cover?
Conceptual soundness review evaluates theoretical basis, assumption appropriateness, data quality, feature selection, estimation, limitations, and alignment with use.
How does yield curve risk differ from parallel rate risk in ALM?
Yield curve risk arises from non-parallel shifts: steepener, flattener, short-rate up, short-rate down, and humped changes.
What's an example of right-way risk for a corporate?
Right-way risk (RWR) occurs when exposure to a counterparty is negatively correlated with the counterparty's probability of default. Example: Kettridge Copper Mines sells copper forward to Tanaka Electronics. If copper collapses, Kettridge's MtM rises AND Tanaka benefits from lower input costs...
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