A good beginning is half done.
Metallgesellschaft’s Case
Hi David,
I went thru this case and also your and Jacks discussion on the same but i could not get 1 simple concept clear. can you pls help me with a simple example
1) MG had Long position in short term futures.
2) Markets went into Contango.
3) Now if MG is in a long position he is locked it at a price say 20$.
4) Market goes into contango i.e futures price is above spot lets assume now its 25$.
5) Then actually MG is gaining as it had bought futures at 20$ and now the same is 25$
How is MG losing? Can you pls explain me in layman terms with the same example as i gave as i got utterly confused after i went thru the earlier thread.
Thx & Rgds
Amit
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8 Investing Lessons From John Paulson
November 23, 2009 - 8:42 am
Posted in Business, Finance & Investment | 1 comment
Even as the financial system collapsed last year, and millions of investors lost billions of dollars, one unlikely investor was racking up historic profits: John Paulson, a hedge-fund manager in New York.
His firm made $20 billion between 2007 and early 2009 by betting against the housing market and big financial companies. Mr. Paulson’s personal cut [...]
Bank Fees You Don’t Know You’re Paying
November 19, 2009 - 6:47 am
Posted in Business, Finance & Investment | No comments
by David K. Randall Friday, September 25, 2009provided by
Banks are cutting overdraft fees, but there are other hidden charges.
In the wake of the uproar over bank fees charged to debit card holders–and the looming threat of congressional action–banking giants Bank of America, JPMorgan Chase, and Wells Fargo have announced drastic changes [...]
conversion factor
November 19, 2009 - 6:24 am
Posted in Financial Risk Manager | No comments
Hi David,
Could you pls clarify this question? I wonder why “as yields lower than 6% imply that the CF for long-term bonds is lower than otherwise. This will tend to favor bonds with high conversion factors, or shorter bonds”? what is the relationship between CF and maturity?
Thanks.
The Chicago Board of Trade has reduced the notional coupon of its Treasury
futures contracts from 8% to 6%. Which of the following statements are
likely to be true as a result of the change?
a. The cheapest-to-deliver status will become more unstable if yields hover
near the 6% range.
b. When yields fall below 6%, higher-duration bonds will become cheapest
to deliver, whereas lower-duration bonds will become cheapest to deliver
when yields range above 6%.
c. The 6% coupon would decrease the duration of the contract, making it
a more effective hedge for the long end of the yield curve.
d. There will be no impact at all by the change.
a. The goal of the CF is to equalize differences between various deliverable bonds.
In the extreme, if we discounted all bonds using the current term structure, the
CF would provide an exact offset to all bond prices, making all of the deliverable
bonds equivalent. This reduction from 8% to 6% notional reflects more closely
recent interest rates. It will lead to more instability in the CTD, which is exactly
the effect intended. Answer b) is not correct, as yields lower than 6% imply that
the CF for long-term bonds is lower than otherwise. This will tend to favor bonds
with high conversion factors, or shorter bonds. Also, a lower coupon increases the
duration of the contract, so c) is not correct.
Core Reading Versus AIMS
November 19, 2009 - 5:42 am
Posted in Financial Risk Manager | No comments
Hi all,
Are the core readings supposed to exactly mirror the reading lists given in the AIMS?
I purchased – and subsequently read – the printed copy of the Core readings for the Level 1 exam. However, looking through the AIMS I can see a lot of extra readings that weren’t provided in the Core reading pack. In particular, the Financial Markets & Products AIMS lists chapters 1,2,3,4,5,6,7,9,10 of Hull!! These were not provided in the Core readings pack – and translates into a lot of extra reading in very little time!
Thanks,
John
Regression
November 19, 2009 - 2:13 am
Posted in Financial Risk Manager | No comments
Consider 3 random variables X,Y,Z Suppose corr(x,y) =0.4 and corr(z,y)=0.3 which of the following statements is true?
a) corr(x,z) cannot be negative.
b) corr(x,z) has to be larger than 0.3
c) corr(x,z) cannot be negative
d) none of the above.
can u throw some light on this question.
thanks and do reply soon.
FRM L1 exam format
November 19, 2009 - 12:45 am
Posted in Financial Risk Manager | No comments
Hi there,
I have a question about the exam format for the L1.
I noticed that there will be 2 sessions (morning and afternoon), will this sessions have different chapters? (ie. morning session covers Foundation of RM and QA, afternoon session covers M&P and Valuation) or they are all mixed and have same format for the morning and afternoon.
Thanks in advance,
Jason
Why is small actual volatitlity profitable for a long call option?
November 19, 2009 - 12:07 am
Posted in Financial Risk Manager | 1 comment
Dear David,
Appreciate your enlightenment on the FRM handbook question (page 335 Example 13.3 5th edition) below. The book’s explanation is that the long call position is profitable when the actual volatility is small but this statement seems contradictory to what I’ve learned about long options that long a option is long implied volatility therefore it benefits from increasing volatility?
Example 13.3
A trader buys an at-the-money call option with the intention of delta-hedging it to maturity. Which one of the following is likely to be the most profitable over the life of the option?
A. An increase in implied volatility
B. The underlying price steadily rising over the life of the option
C. The underlying price steadily decreasing over the life of the option
D. The underlying price drifting back and forth around the strike over the life of the option
Answer Provided: D
Thanks
Liming
19/11/09
Black & Scholes Formula Changue for different instruments
November 18, 2009 - 11:22 pm
Posted in Financial Risk Manager | 3 comments
Hi David.
I have some questions.
In practice, can you teach me in spreedsheet, how changue the black & Schoels formula for: Options for shares that pays dividens, options on indexes and options on currency or Foreign Exchangue.
Saludos from MEXICO
GABRIEL
ABX protection buyer
November 18, 2009 - 9:02 pm
Posted in Financial Risk Manager | No comments
Hi David,
I wonder if ABX protection buyer shorts ABX? If so, if there is any credit loss, the protection buyer will compensate the buyer, and meanwhile the ABX price also drops, so the ABX protection buyer who shorts ABX also gains.. is this a double-dip? or I misunderstand something?
Thanks.
PRM Exam Question-Need help
November 18, 2009 - 6:36 pm
Posted in Financial Risk Manager | 1 comment
1) The provision for credit risk in calculated to cover
a. Expected losses
b. Expected and unexpected
c. Unexpected
d. None of the above
2) Marginal Economic Capital is a suboptimal method to analyze
a. The amount of capital consumed by an instrument
b. The movements of economic capital from one business to another on a
marginal basis
c. The marginal increase in the overall risk
d. The removal of the entire business which represents a significant
share of the total economic capital
3) Which of the following should be considered to compute the Gross
income indicator when using Basic indicator Approach as per BASEL 2
a. Income from Insurance
b. Operating expenses
c. Unrealized income and expenses
d. None of the above
4) Which of the following should be considered to compute the Gross
Income Indicator?
a. Income From insurance
b. Operating Expenses
c. Realized P&L from securities in the banking book
d. Unrealized P&L from securities in the banking book
5. Which is not typically included in casual based definition of OR
a. Strategic Planning
b. Legal Planning
c. People Systems
d. Inadequate or failed operations
6. The Altman credit risk approach is modeled by
a. Focusing only on firms that have defaulted
b. Focusing only on firms that have survived
c. Country accounting
d. Quadratic equation of various accounting measure
7. LGD is a function of
a. Capital Adequacy of counterparty
b. Seniority of the claims
c. Market movements between now and default
d. All
8 Let A & B be 2 uncorrelated risky portfolio with Normally
distributed returns. Their Ceteris Paribus is
a. VAR (A+B) = >VAR (A) + VAR (B)
b. VAR (A+B) < VAR (A) + VAR (B)
c. VAR (A+B) > = VAR (A) + VAR (B)
d. VAR (A+B) can be either > or < than VAR (A) + VAR(B)
Email responses to jason dot jason57 at gmail dot com
December 7, 2009 - 12:27 pm
I was thinking about the same question and read quite a few analyses but none was very clear. So, this is what I think about it. It is mentioned in John Hull’s book that it was actually the drop of the price that caused big trouble for MG.
Let’s assume MG’s fixed price was $20.00, the spot prices on the following dates were
$20.00 on 01/01/19xx,
$25.00 on 02/01/19xx,
$20.00 on 03/01/19xx,
$15.00 on 04/01/19xx,
$20.00 on 05/01/19xx,
reflecting oscillations and returning to the mean, and the difference between the one month future and spot price was $1.00 . Let’s also assume MG’s counterparties either cashed in or bought oil at the end of every month.
On 01/01/19xx, the spot price was $20, MG bought one month future price at $21 in contango market.
On 02/01/19xx, according to the contract, MG needed to pay buyer half the difference between spot and fixed price. So MG needed to pay buyer 0.5*(25.00-20.00)=2.5 .
Now the future that MG bought on 01/01/19xx would worth about the spot price. So, MG actually made $25.00-21.00=$4.00 in future. So, on 02/01/19xx, MG’s monthly net earning was 25.00-21.00-0.5*(25.00-20.00) = 1.5 .
On 02/01/19xx, MG bought one month future at price $26.00.
On 03/01/19xx, the spot price dropped to $20. The margin account lost $26.00-20.00=6.00. MG also bought oil from market at spot price and sold it to buyers. So, on 03/01/19xx, the monthly net earning was 20.00-26.00+20.00-20.00 = -6.0.
On 03/01/19xx, MG bought one month future price at $21.
On 04/01/19xx, the spot price dropped to $15.00. MG lost 21-15 =6 in future. MG also bought oil at $15.00 and sold it to buyer at $20.00 and made $20-15=$5.00. So, on 04/01/19xx, the monthly net earning was 15.00-21.00 + 20.00 – 15.00 = -1.0.
On 04/01/19xx, MG bought one month future price at $16.00.
On 05/01/19xx, the spot price was $20.00, MG made $20-16=$4 in future. MG also bought oil at spot price $20.00 and sold it to the buyers at $20.00. So on 05/01/19xx, the monthly net earning was 20.00 – 16.00 + 20.00 -20.00 = 4.00.
So, at the end of the price wave circle, MG’s 4 month net earning was 1.5-6-1+4=-1.5 .
If during the next circle the market was backwardation, the situation would be totally different. Suppose the difference was still $1, but the future price was lower, then
For month 5, MG’s net earning would have been 25-19 – 0.5*(25-20) = 3.5 .
For month 6, 20-24+20-20= -4.0
For month 7, 15-19 + 20 -15 = 1.0
For month 8, 20-14+20-20 = 6.0
So, at the end of the circle, the 4 month net earning would be 3.5 – 4.0 + 1.0 + 6.0 = 6.5 .
If during the following circle, future prices were equal to the spot prices, MG would have made $2.5 for the 4 month.
At the end of the first year, MG’s first year earning would have been
-1.5 (contango) + 6.5 (backwardation) + 2.5 (spot) = 7.5 .
So, on paper, MG was in a very good position. The problem was that the buyers would cash in when the spot price was higher than the fixed price. But they wouldn’t buy when the spot price was lower because the contract was too long. So those 20.00 – 15.00 never realized. When those future profits are taken out of the equations, the 4-month net earnings are -6.5 for contango, 1.5 for backwardation and -2.5 for spot. In case the difference between the future and spot prices is $0.5 instead of $1.0, those net earning are -4.5 for contango, -0.5 for backwardation, and -2.5 for spot.
So, the problem was not contango or backwardation, it was that buyer would not buy. The contract was simply too long.
I wonder what if MG had only bought futures when the spot price was equal or higher than the fixed price.
January 29, 2010 - 12:12 pm
Hey guys,
I was just reading a couple sites about the MG Case. In my undergrad derivatives class (years back) we had to do a case study on MG, and I didn’t really understand what I was talking about back then so I thought I would revisit it.
From my understanding now, the problem seems to be coming from the fact that MG took such large positions without adequate cash. Contango and backwardation were not the true problems because they were only losing/gaining a little when they would roll over their futures positions. The problem came when Oil prices dropped combined with position size.
The hedge hypothetically worked because the loss on the futures position would be a gain on the forward position. BUT they did not factor in the Margin Call they would face on their Futures positions. Thus they would need to meet the margin requirement with cash that they did not have available. So, the next measure would be to liquidate their futures positions to meet the margin call. Since they were so heavily exposed you can imagine the amount of money they would need to raise to reach their margin requirement and price shock that would occur for selling off such a large position.
I have not ran into any actual pricing on any of these contracts, but I would imagine that the premium they were receiving from the forward was not adequate to cover the cash needed to meet margin requirements. They would also be taking a loss with the swaps they had engaged in as they were paying fixed and receiving variable (which I would assume eat up most of the gain from the Forward Contract premiums).
I think that their position would have worked if they had done it in moderation and have been able to let it run its course over the long run. I really don’t see this as a true Hedge because they are going to face gains and losses (but breaking even doesn’t keep a business going).
Lastly, Yh WU, you had mentioned only buying futures when spot was equal to or higher then the forward price. I think you could really start getting yourself into trouble with Naked positions.