11. (5 points) With respect to numerical interest rate risk management techniques,
(i) List and define the common techniques
(ii) Describe the key shortfalls of each common technique
Base your answer on the Canadian Institute of Actuaries Educational Note “Measurement
of Exposure to Interest Rate Risk”.
12. (6 points) Company ABC has an international fund that is benchmarked against an
external index. You are given the following with respect to a benchmark portfolio and
ABC’s fund manager’s portfolio:
Market
Benchmark
Weight
Return on
Equity Index
Currency
Appreciation
Fund Manager’s
Weight
Fund Manager’s
Equity Return
Asian 40% 10% 20% 35% 12%
European 25% 5% -10% 7%
Australian 35% 7% 25% 20%
(a) Describe the risks that are unique to international investments.
(b) The fund manager’s portfolio return matched the return of the index. Determine
the amount that the fund manager invested in the European and Australian
markets.
(c) For your portfolio, calculate the individual impacts of each of the following:
(i) Currency selection
(ii) Country selection
(iii) Stock selection
Show all work.
Course 6: Spring 2005 -38- GO ON TO NEXT PAGE
Afternoon Session
13. (5 points) You are given the following with respect to an 8-year, 6%, sequential-pay
CMO:
Tranche Initial Balance
1 20,000
2 35,000
3 65,000
• The annual payment required to amortize the CMO over eight years is 19,324.31.
• The actual cash flows are as follows:
Year
Interest
Payment
Required Principal
Payment
Additional
Principal Payment
Outstanding
Balance
0 120,000.00
1 7,200.00 12,124.31 1,078.76 106,796.93
2 6,407.81 12,916.50 1,877.61 92,002.82
3 5,520.17 13,804.14 2,345.96 75,852.72
4 4,551.16 14,773.15 2,443.18 58,636.39
5 3,518.18 15,806.13 2,141.51 40,688.75
6 2,441.32 16,882.99 1,190.29 22,615.47
7 1,356.92 17,967.39 185.92 4,462.16
8 267.73 4,462.16 0.00 0.00
(a) Describe the types of CMO structures.
(b) Calculate the outstanding balance for each tranche at the end of each year.
(c) Calculate the interest allocated to each tranche for each of the first three years.
Show all work.
Course 6: Spring 2005 -39- STOP
Afternoon Session
14. (4 points)
(a) Describe the criteria for selecting an interest rate generator.
(b) Describe the characteristics of
(i) a lognormal process
(ii) a mean reversionary lognormal process
(c) Describe the steps used in the Markov chain process to generate interest rates.
15. (4 points)
(a) Describe the advantages and disadvantages of using stochastic simulation when
pricing derivative securities.
(b) Describe the techniques that are available to reduce variance when using Monte
Carlo simulation.
**END OF EXAMINATION**
AFTERNOON SESSION