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FRM Updated
What is the effective spread and how is it different from the quoted spread?
Quoted = ask-bid; Effective = 2|P-mid| (actual cost); Realized = 2|P-mid_t+5| (MM revenue after impact)...
What is the order processing cost component of the spread?
Processing cost covers fixed costs of maintaining markets: tech, fees, capital, personnel — relatively stable component...
What is repricing gap analysis and what are its limitations?
Repricing gap analysis groups assets and liabilities into time buckets based on when they next reprice, then computes the gap in each bucket.
What is VWAP and why is it used as an execution benchmark?
VWAP is price weighted by volume across a period. It's a popular execution benchmark because it's passive-friendly, observable, and fair, though it doesn't capture impact from the trade itself.
What's the difference between implicit and explicit transaction costs?
Explicit costs are invoiced (commissions, fees, taxes). Implicit costs are embedded in execution prices (spread, impact, opportunity), typically dwarfing explicit for institutional size.
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.
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.
How is concentration risk measured with the Herfindahl index?
HHI = sum of weighted exposures squared, flags concentration; Basel uses granularity adjustments when HHI exceeds thresholds...
How does the Fed's CCAR supervisory stress test actually work?
Fed publishes 3 scenarios in Feb, banks submit FR Y-14 in April, Fed runs own models, publishes trough CET1 and SCB in June. SCB = max(starting - trough, 2.5%) + dividends.
What is the governance structure for stress testing?
Board approves framework; exec risk committee owns execution; CRO runs methodology; finance owns PPNR; treasury owns liquidity; model validation and internal audit challenge.
How does inventory risk affect market-maker quotes?
Inventory risk: MMs with non-zero positions shade quotes to offset, widening effective spreads...
How does adverse selection widen the bid-ask spread?
Adverse selection: MMs can't distinguish informed traders, so they widen spreads to cover expected losses...
How much do transaction costs actually drag on portfolio performance?
Transaction costs compound significantly: 15–150 bps annually depending on asset class and turnover, eroding compounded returns over decades.
How does the bid-ask spread absorb transaction costs?
The bid-ask spread is what market orders pay to trade immediately. Half-spread per cross, full spread round-trip; it compensates makers for processing, inventory, and adverse selection.
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.
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