Market Risk Credit Risk FRM L2 (Book1) Prep Strategy Info [Learn FRM using MATLAB/R/VBA]

Market Risk FRM L2

Three most interesting areas in Market Risk Uni variate and Multi Variate :

1. EVT
2. Multi Variate Models
3. Back Testing
4. Monte Carlo
5. Copula

4 Chapters in which the area is divided:

1. Uni variate
2. Multivariate
3. Volatility
4. MBS: OAS, etc. Pre payment, trenching, etc

The first two might be theoretical and more maths, but the last 2 are seen extensively in the market. Volatility index is something which is often seen and an important area.

Credit risk

A highly practical subject

1. Includes CDO, CDS, pre payments, etc
2. default probability and CDS
3. sovereign rating: GDP, currency and debt of the nation
4. measuring default from market prices
5. spread and default
6. merton model
7. currency swap interest rate swap
8. CDO structure trenching: junior senior

Other topics

Hedge fund risk / portfolio risk

MATLAB VAR:

http://gloria-mundi.com/library_journal_view.asp?journal_id=8769

http://www.mathworks.com/matlabcentral/fileexchange/32154-estimation-value-at-risk-by-using-conditional-copula-garch

http://www.mathworks.com/help/finance/conditional-value-at-risk-portfolio-optimization.html

http://www.mathworks.com/help/finance/portvrisk.html

http://www.docstoc.com/docs/73976635/Matlab-Code-for-Value-at-Risk-Methods

http://www.analyticsresearch.net/Documents/VALUE%20AT%20RISK.new4practical.pdf

http://datavir.com/?p=304

http://www.thetaris.com/wiki/Value_at_Risk

http://www.mathfinance.cn/value-at-risk-estimation-with-copula/

http://www.sfu.ca/~rgencay/evim.pdf

https://editorialexpress.com/cgi-bin/conference/download.cgi?db_name=ESAM2011&paper_id=145

http://phd.london.edu/pnath.phd98/MatlabUtilities.htm

Credit Risk Research & Prep guide for FRM Level 2, Credit Risk Interview, CFA L2 Fixed Income

Credit Risk Research & Prep guide for FRM CFA Fixed Income/Job Interviews
By Satyadhar Joshi


Introduction

This thread is about Credit Risk for FRM Level 2, Credit Risk Interview, and other topics of Modeling Credit Risk. One thing that is very important for you to understand is that is that if you read without understanding the matter, you might fail in the interviews which run for over 2 hours, with at least 50 questions for a Credit Risk Job.

To start with, I will assume you are through with FRM and CFA Level 1 or MBA Finance and know all the basics of Finance. Now we will jump into the advanced areas of credit risk.

FRM Level 2

Areas of Credit Risk that are interesting to look into are (also in the form of chapters in readings in FRM Level 2):

1. MBS: Securitization, Tranching & CMO.
2. Measuring of Credit Risk & Measuring of default Risk: Requires Probability.
3. Credit Exposure calculations.
4. CDS & CDO (Structural Finance), CDO contains all of them and is most complex.
5. Managing Credit Risk.

Now how these credit risk elements are modeled and simulated is another important aspect.

Quant Finance application in credit research:

1. Stochastic Calculus & Black Scholes (use to find interest rates of the future)
2. Monet Carlo (CFA L2 talks about how to use it for Option adjusted Spread)
3. Neural Networks (used to reverse engineering elements from market, saw some research papers on this area, will try to post the link).

Modeling Aspects in Credit Risk, to be done using SAS or VBA Excel:

1. Database Management in SAS, Access, Business Objects, Hyperion and Cognos.
2. Using decision tree or cluster analysis to group together similar operating variables, environment etc.
3. Using regression based models (Logistic, OLS, Discriminant, etc.) to arrive at EL (Expected loss per Quarter), PD (Probability of Default), LGD (Loss Given Default) and Exposure at Default.
4. Modeling probability based on logistic regression in SAS.
5. Sensitivity (Elasticity) analysis, Interest rate/Discount rate to compute NPV of deal.
6. Sovereign risks to model interest rate.
7. Basel Credit Risk Modeling (PD, LGD & Stress Testing).
8. Logistic Regression, Linear Regression, Cluster, CHAID and Time Series Forecasting.
9. SAS, FICO Model Builder, Knowledge Seeker, MS Office and Minitab.

CFA helps in Credit Analysis as it has in CFA Level 2:

1. Valuing media bonds and understanding of accounting for corporate bond valuations.
2. Understanding how Moody uses the algo for bond rating.
3. CDS uses bond valuation which is not covered in FRM but in CFA L2 for corporate bonds.

From FRM Level 1 Monte Carlo & Interest rate dynamics

1. One Box Ingersoll Ross one factor model for short term interest rates.
2. Two factor Brennan and Schwerz Model for short term and long term rates.

Numerical of Credit Risk (CFA Level 2):

1. Binomial numerical CFA L2.
2. CPR PSA.
3. Tranches in CMO.
4. Valuation last chapter of CFA L2 Fixed Income is interesting.
5. Monte Carlo Simulation for calculating probability of default and or OAS and CMO.

Important points that comes out from CFA L2:

1. CDO is an ABS.
2. OAS is an interesting thing to read on, and how they are used with Monte carlo simulation.
3. OAS over valued and under valued.

Trends in Credit Research

In all, we have to also understand computation of default frequency and numerical for default frequency and reverse interpretation from Rating agency. Models to calculate default frequency and loss given default and change of yield is an important parameter which is quite hot.

Tough numerical of FRM Level 2 is interesting, which you learn when you will give the Level 2 exam.

Linking SAS for credit risk [1]:

1. Classification trees, neural networks, time-series modeling.
2. Roll rate models, predict delinquencies and perform vintage curve analysis to generate highly accurate credit loss forecasts (these are interesting research areas that are being researched).
3. Probability of default, exposure at default, credit migration, regulatory capital, risk weighted assets, credit value at risk (CVaR) and economic capital (areas seen in FRM L2).
4. Mark-to-market calculations, model risk factors, run Monte Carlo simulations, explore scenarios and build stress tests.

Things that were interesting but not prepared by me, please learn about them before entering:

1. Merton Model.
2. Migration Risk.
3. Copula and Multivariate Analysis.
4. Advanced VBA, but there is no international exam on this.
5. SAS is the most relevant software for Credit Risk, SQL Excel and how to link them in SAS software is another interesting thing.

3rd Party Resources (Credit to respective authors):

Quoting Kenny Ming of HK from [2] where he talks about interview questions. And I Quote

1. Basel II and Implication.

2. Risk Management in Derivatives Product, Structured Products and Hybrid Products.

3. Forecasting Time Series by Garch(1.1), Garch(1.1)-t, Garch-M, Nonlinear-Garch, Kurtosis of Garch model, CHARMA, EGarch Model by Maximum Likelihood function . IGarch(1.1) for Risk Metrics

4. Risk Metrics approach for portfolio risk.

5. Monte Carlo Simulation for portfolio stocks, structured products such as equity linked products, hybrid products.

6. Greeks for dynamic hedging by closed form formula for standard European Option and finite difference method for non-linear structured product and exotic option.

7. Static Hedging of Option by Derman and Peter Carr Approach and Quasi Static Approach for re-hedging structured products.

8. Value at Risk: Law of Coherent Risk (Axioms and examples)

9. Extreme Value Theory: Estimation of tail distribution, Dynamic extreme value theory, Multivariate EVT

10. Statistics and Probability: e.g. skewness, tail effect, distribution, conditional probability, tower law of probability.

11. Back-testing and Stress-testing principle

12. Using add-in Excel function and VBA for large scale risk management assessment.

13. Pricing non-linear option by C++ programming.

14. Interest rate model, Swaption, fixed income

GARCH (1.1) model to simulate the volatility due to "leverage" effect?

How about if there is great jump/drop?

How about if the volatility forecasting is related to other variable?

How do you compare with the difference between GARCH and implied volatility?

"Cholesky Decomposition"

How to create VAR for:

1) Private Debt Securities (PDS)

2) IRS & CCS

3) Convertible Bonds

4) American style FX Options

5) European style interest rate caps & floors

6) Callable Range Accruals

7) American style exchange traded Equity Warrants

8) Multi-asset basket options.

Mountain Range Options taken from [2].

Conclusion

Three sources needs to be seen: CFA FRM and bits of quant finance to understand and work in credit risk area. The area is very deep and you need to read a lot to know more about how things go. The jobs here are very interesting and fascination. If I get time I will develop a video series for this area.

List of place to read about financial risk [3]:

1. www.wbstraining.com/php/events/showevent.php?id=117
2. www.financial-conferences.com
3. www.incisive-events.com/public/showPage.html?page=im_events_quanteuro2006_prog&tempId=334063
4. doi:10.1111/j.1467-9965.2006.00281.x.

My Targets are to model the following in MATLAB [6] for Credit Risk:

1. Questions of VAR
2. CDO
3. CDS
4. OAS
5. Monte Carlo Simulation for various applications.

I will try to put my code here as well so that you can run the program on your system as well.

References

[1] http://www.sas.com/industry/financial-services/banking/credit-risk-management/index.html

[2] http://www.wilmott.com/messageview.cfm?catid=16&threadid=49249

[3] http://www.wilmott.com/messageview.cfm?catid=11&threadid=43404

[4] My SAS Post on the same Blog: http://stockcreditfinancecfa.blogspot.in/2011/12/sas-base-certification-study.html

[5] http://www.sas.com/offices/europe/uk/education/courses/bb3c61.html

[6] http://www.mathworks.in/computational-finance/.

Taken from Naukri.com:

• Familiarity with PD, LGD models with hands on experience in creating these.
• Knowledge of Basel framework and regulations and experience in creating related models.
• Running SAS queries to prepare datasets used in analysis and predictive modeling.
• Ability to use SQL from SAS to extract and aggregate data from larger data sources.
• Perform ad-hoc analysis/statistical analysis and generate actionable reports.
• Provide assistance/guidance to other team members in SAS/SPSS/MS Excel/MS Access and VBA etc.
• Exposure to other analysis tools like SPSS, R, and other is useful.
• Exposure to IT data management tools and BI platforms is a plus.
• Generally hedge funds/Asset managers needs to implement market risk solution in the enterprise wide. risk framework. It requires understanding of the details of Market Risk/Credit risk and derivative products from major asset classes (Fixed Income, Equity and derivatives).
• Working across risk framework ladder which typically covers risk production, pricing and valuation, risk analytics and risk advisory Key Skills.
• Expertise in Market risk/ Credit risk is required focusing on value at Risk, scenario analysis and stress testing and Portfolio p&l attribution.
• Knowledge about pricing and modelling of financial products from Fixed Income, Equity and structured products domain.
• Knowledge of Global markets dynamics including macroeconomics, news analysis and ability to relate financial markets event to trade performance etc.

FRM Level 1 & 2: Strategy

FRM Levels  1&2  Strategy

Abstract: This article will be about the strategies and areas of FRM for the FRM exam. Strategy to crack both exams on the same day in one go, or a single.

Free recordings on FRM Part 2 -  http://qcfinance.in/frm-part-ii-videos/

Link to one on one Course - http://www.wiziq.com/course/48106-one-on-one-training-to-prepare-for-frm-part-ii-exam

Introduction: If you have registered for the FRM exam then this post will talk about some strategies you should take.

FRM 1:

Tough areas that are important for exam are:

• Cheapest to deliver.
• Bound quotation and how to use the conversion factor and other things in cheapest to deliver the entire concept.
• Euro Dollar Futures.
• Beta changing and hedge effectiveness using index futures.
• Stack and Roll strategy.
• Areas of 2nd Level when comes in First level like MBS duration (from old question bank).
• Pension funds based long questions on liabilities and asset movements.
• Most of the people who give this exam are very prepared and professional and each question count in this exam.

Hence It is all about exam management.

I will be developing hybrid questions which can be helpful which are 2 times as tough as the real exam where I will try to use real data:

1. EMWA + GARCH on real data.
2. Portfolio Management (taken from CFA L3, sortorio, information ratio, etc)..
3. Regression based on ab initio methods (summations rules).
4. More complex swaps, floating rate vs. fixed.
5. Unexpected loss mixed with other's areas (and with junk data).
6. Bigger portfolio for VAR Calculations.
7. Multiple regression for more beta and many regression equations build on data.
8. Questions which taken into detail Brownian motion in a more detailed way of delta-t.
9. Greeks Management including many options and Vega+Gamma hedge using options and shares (book talks very simple questions about them).
10. Cheapest to deliver derivations on how it all came into existence.
11. All stories of fraud in risk management.
12. Real case studies on Stack and Strip hedge in commodities.
13. 1 and 2 error and hypothesis testing in more detail.
14. Margin and maintenance variation calls and namings.
15. Expected loss formula and the derivation of unexpected loss.
16. convexity basic problem using common numbers.
17. calculator advanced functions.
18. memory cards for FRM, and mind maps.

Similar to this, these are areas of the CFA exam which are seen here so for those who are giving both exams can focus on:

1. Types 1 and 2 errors.
2. Hypothesis testing of non zero.
3. Chi square test.
4. Bayes theorem.
5. Hardcore theory questions in corporate Finance.

Getting info about Valuation at risk models and foundation of risk management.

1. We can start with the easiest topic "Foundation of Risk Management", which is nearly one-fourth of the exam. I will read the last few chapters i.e. ERP, Financial disaster, failures, GARP conduct codes.
2. Quantitative part is simple, so this can be done easily.
3. Financial Markets and product are the heart and soul of the exam respectively. It is mostly made up of derivatives.
4. Valuation and Risk model is again theoretical and easy.

The only thing in FRM Level 1 which gives me trouble is the distributions where using and applying them is very important to understand the essence of the subject. Pareto, Beta, Extreme value, Weibull are some which are tough to understand and requires some patience. 

Foundation of Risk Management can be divided into 4 major blocks:

1. MPT.
2. APT Arbitrage pricing theory vs. CAPM is an important area to understand.
3. Risk and failures.
4. GARP Code.

This is also the most easy and scoring one.

Financial Markets and product are the toughest as well as most important part of the FRM. There are many things that gives a lot of resistance in this area to those who have not studied any of this part before, but I will be sharing all what I can on this area.

1. Interest rate instruments options, swaps.
2. Stock options are very easy.
3. Commodity is easy but new.

In total, this is the most fascinating area, and most difficult.

Valuation and Risk Models

Now this chapter is very important in terms of models like Black-Scholes, binomial and other important models for valuations. When I was doing it, the most interesting was the subject of Greeks in options. It took some time to get things in. The best part about this part of FRM is that you can read more and more and understand as there is a lot of depth attached to this area. For example, the derivation from Kinetic theory gases, stochastic calculus of blacks-scholes.

Quantitative Techniques is similar to all other Quant you might have done in CFA, Engineering, Modeling so it will be skipped in my discussions.

FRM Level 1 Nov 2012 Strategy

Level 2 of FRM has been talked about very less in all forums and blogs. I will be taking about some of the course material.

Resources: Readings Core (1444 pages old of 2009), Handbook for FRM (800 pages), Scz (book and questions).

No Videos on Youtube: There were no videos on youtube so I will add videos on the same in 1 month. Bionic still remains only option.

Core Reading: Are from various books, also see the AIM statements. Does not have a lot of questions.

Research Areas: How did these distributions came into play: F stat, t sats, Chi... these three are to be known by common sense and as well from their roots. comparing variance of 2 population and formula derivation of chi-square distribution. Derivation of standard error and that root term in denominator. How and when did DoF started and how it is imp? Derivation of integration of variance formula with the denominator 12, how to convert that limit into integration? Story of Normal distribution.

Book to check out: Jogn Hull, chap. 11.

FRM Part 2: No idea about Part 2 as still looking at the resources for the exam. I saw the model papers of 2011 and 2010 and the Level 2 was very different. Questions were:

• Theoretical and broad
• Longer and detailed
• Has many statements and we have to select the right combinations
• Less Quant
• Checking good broad knowledge
• Requires experience and consistent reading habits

Based on these parameters you can understand that Part 2 is more about theory than quant, but this is my view based on 3-4 papers I have seen and read on internet.

There are 63 Chapters in the readings which are taken from various books. Interesting areas and overlap:

1. Operations Risk and Sarbanes Oxleys Act (Allied areas have 25% weightage).
2. Portfolio (maths at Level 2).
3. MBS mortgage back securities (may be Quant).
4. Credit Risk Quant is an imp area that is quite fun.

Reading in general and watching generic lectures will help. There is no Quant in L-2 which I was expecting.

In last 2 months you can plan to study for Operation Risk in FRM-2 and Foundations of RM in FRM-1.

Strategy for FRM is to:

Step 1: Read summary or key concepts.

Step 2: Videos youtube.

Step 3: Content of scz.

Step 4: Studying the book.

Step 5: Doing questions.

Topics for each month (FRM Level 1):

4th last 2012: VAR and Valuation and risk models.

3rd last 2012: Foundations of Risk.

2nd last 2012: Financial Market and Products.

last 2012: Quantitative techniques.

Summary of interesting things in var valuation and risk models (FRM Level 1) related to Quant:

1. Single step binomial trees and risk neutral method.
2. e to power sd*root(t).
3. Delta hedging.
4. Coherent Risk.
5. Worst case distributions.
6. 7 Distributions.

Tough areas that I find very interesting:

1. Interest rate swap and 2 methods.
2. Brownian Motion and monte carlo simulations.
3. Formulas of Green that are derived from Black Scholes.
4. Euro Dollar futures.
5. Inverse normal distributions, random number generations, selecting number from 0-1 in random fashion and then taking inverse normal methods.
6. Floating rate adjustment.
7. Poisson distribution derivations.
8. Merton Model for Credit.

FRM Level 2

Quantitative Areas in FRM Level 2

Copulas is an area that I came across which was followed by extreme value theorem and Pareto distribution. Then there is a much talked about VAR back testing. These are few things that you should research in general and read from wiki.

FRM from Kaplan:

The Book 2 of Scz on FRM Level is very easy, whereas the last 3 chapters of book 1 (on VAR) are toughest in the entire FRM Level 1. Some areas of book 1 especially VAR, the 3 chapters help you to get Level 2 and you should look at Level 2 to understand them more even while giving Level 1 to get them inside your brains.

Future Work: I will introduce to you tricky but interesting area and try to develop some motivation for you to study them. Because to study these areas you need to have some pre- idea, motivations, real examples, news items so that you can create right mental frame to study them. The exam is very simple if you work on the things systematically and ready to spend some time.

Important links to read from Wikipedia for FRM level 2:

http://en.wikipedia.org/wiki/Extreme_value_theorem

http://en.wikipedia.org/wiki/Basel_II

Operation Risk

http://en.wikipedia.org/wiki/Merton_Model

http://en.wikipedia.org/wiki/Kernel_density_estimation

http://en.wikipedia.org/wiki/Exotic_option

MBS, cdo and all types teaching securitization etc.

http://en.wikipedia.org/wiki/Mortgage-backed_security

http://en.wikipedia.org/wiki/Collateralized_debt_obligation

Correlation and Copula

http://en.wikipedia.org/wiki/Copula_(probability_theory)

Operation risk

http://en.wikipedia.org/wiki/Standardized_approach_(operational_risk)

Jensons Aplha and information ratio CAPM revision.

KMV model not on wiki.

Crediting scoring model.

Trading gamma (interview question).

Fixed income arbitrage.

Portfolio of CFA and FRM are same.

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Please contact at shivgan@qcfinance.in/arpit@qcfinance.in in case of any suggestions or feedback.

Raw List of Interesting and core areas to search online are:

1. Hypothesis testing.
2. delta of option.
3. Different distribution.
4. degree of freedom.
5. Greeks and partial derivatives.
6. Monte carlo simulation.
7. black scholes model.
8. Boot strapping and spot rates.
9. Regression and beta.
10. Put call parity.
11. types of duration.
12. calculator mastery.
13. currency.
14. correlation matrix.
15. technical analysis.
16. Black Swarm (Movie and book).
17. VB and excel modeling for Risk.
18. Poisson and pareto distribution.
19. Dollar value.
20. LTCM Russian default.
21. Interest for AAA AA A.
22. UBS false trading of billion.

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