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How do I set up a key rate duration hedge for a bond portfolio?
Decompose portfolio duration into 2/5/10/20/30Y KRDs. Compute DV01 at each point and short matching Treasury futures contracts.
Why is the support (companion) tranche the riskiest part of a CMO, and who would buy it?
The support tranche absorbs all prepayment variability in a CMO, with average life swinging from under 2 years to over 24 years. It offers the highest yield (100-300+ bps above PAC tranches) and is purchased by hedge funds and sophisticated traders who can actively manage the prepayment risk.
What is an 'asset play' investment strategy and how do you identify hidden asset value?
An asset play targets companies whose market capitalization understates the realizable value of underlying assets — including real estate at historical cost, overlooked subsidiaries, NOL carryforwards, and LIFO reserves. Analysts compare adjusted NAV to market cap and identify potential catalysts.
What are embedded derivatives and when do they need to be separated from the host contract?
An embedded derivative modifies the cash flows of a host contract in a derivative-like way. Bifurcation is required when the embedded derivative is not closely related to the host, would qualify as a standalone derivative, and the hybrid is not already at fair value through P&L. Under IFRS 9, financial assets no longer require bifurcation but are instead classified entirely based on the SPPI test.
How do you calculate basic EPS versus diluted EPS?
Basic EPS equals net income minus preferred dividends divided by weighted average shares outstanding. Diluted EPS adjusts for potentially dilutive securities: stock options use the treasury stock method (adding only incremental shares), while convertible bonds and convertible preferred use the if-converted method (adjusting both numerator and denominator).
How is the remeasurement gain or loss calculated under the temporal method, and where does it go?
Under the temporal method, the remeasurement gain or loss is the balancing figure that arises from translating monetary and non-monetary items at different exchange rates. It is recognized in the income statement, not OCI.
How is a sale-and-leaseback transaction accounted for, and when is the 'sale' not really a sale?
In a sale-and-leaseback, if the transfer qualifies as a sale, the seller-lessee recognizes only the portion of the gain attributable to the rights actually transferred to the buyer. If the transfer fails the sale criteria, the entire transaction is treated as a financing arrangement.
How does IFRS handle financial reporting for subsidiaries in hyperinflationary economies?
Under IAS 29, financial statements of subsidiaries in hyperinflationary economies are first restated to current purchasing power using a general price index, then translated to the parent's currency at the current exchange rate. Monetary gains or losses from holding net monetary items during inflation are recognized in the income statement.
How do straight-line and double-declining-balance depreciation affect financial statements differently?
Straight-line and double-declining-balance depreciation produce the same total expense over an asset's life but allocate it differently. DDB front-loads expense, resulting in lower income and assets in early years, with a crossover point occurring around mid-life.
How does herding behavior manifest among institutional investors and what are the market consequences?
Herding among institutional investors is more nuanced than simply 'following the crowd.' Professional fund managers herd for several rational and behavioral reasons, and the effects on markets can be significant.
How do you price a bond using a binomial interest rate tree?
Binomial interest rate trees price bonds by modeling the possible evolution of short-term interest rates and working backward to determine present value. For callable bonds, at each node you take the minimum of the calculated value and the call price.
What is ICAAP and how do banks run internal capital adequacy assessments?
ICAAP is the bank's own process for identifying, measuring, and managing all material risks with capital planning and stress testing.
How does Pillar 3 market discipline work and what disclosures are required?
Pillar 3 requires banks to publish standardized disclosures so markets can evaluate risk and discipline excessive risk-taking.
How is the S&P GSCI commodity index constructed?
The S&P Goldman Sachs Commodity Index (GSCI) is a world-production-weighted index covering 24 commodities across energy, metals, agriculture, and livestock...
How are property and casualty insurance risks different from life risks?
P&C risks are premium, reserve, catastrophe, and latent liability — driven by short-tail volatility and correlated event exposure.
How is the unwind or termination value of a swap calculated?
Termination value = current MTM. Emberline's 10Y receive-fixed IRS at 3.95% with 6Y remaining and current 4.42% rate has negative $3.72M MTM — pays counterparty to exit...
PFE vs EPE — what's the difference and when do I use each?
PFE is a high-percentile tail measure at a point in time used for credit limits. EPE is the time-average of EE used for regulatory capital (EAD = 1.4 x effective EPE). For Vanguard Helix, 97.5% PFE of 8M.
What percentile defines potential future exposure and how is it used for limits?
PFE is typically the 95% or 97.5% percentile; some banks use 99% for stress. For a 7y cross-currency swap with Nordhaven, 95% PFE of 34M, 99% of $42M. Set limits at netting-set level tiered by counterparty quality.
What is GIPS and why should I care about it for CFA Level I?
GIPS is a voluntary global standard for presenting investment performance. Key principles: firm-wide compliance, inclusion of all portfolios in composites, time-weighted returns, and prohibition of cherry-picking results.
How do I use the Gordon Growth Model to value a stock? It seems too simple to actually work.
The Gordon Growth Model values a stock as V₀ = D₁/(r-g). While seemingly simple, it works well for mature companies with stable dividend growth but breaks down when growth approaches the required return or for non-dividend payers.
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