CAIA - 35 - Structured Products I: Fixed Income Derivatives and Asset Backed Securities Flashcards
There are 2 broad approaches to model the term structure of interest rates:
1.
2.
There are 2 broad approaches to model the term structure of interest rates:
- Equilibrium
- Arbitrage-free
___ models for modeling the term structure for interest rates assume a process for short-term interest rates and then use that process to look at the expected path of future interest rates.
Equilibrium models for modeling the term structure for interest rates assume a process for short-term interest rates and then use that process to look at the expected path of future interest rates.
___-___models for modeling future interest rates project future interest rates in such a way that they are consistent with the observed term structure.
Arbitrage-free models for modeling future interest rates project future interest rates in such a way that they are consistent with the observed term structure.
___ term structure model is a single-factor model that assumes that the short-term interest rate drifts toward a specific long-term mean.
Vasicek’s term structure model is a single-factor model that assumes that the short-term interest rate drifts toward a specific long-term mean.
Vasicek’s Model
Yield to Maturity in Vasicek
CIR Model (Equation)
A criticism of the Vasicek model is that it assumes the ___ of changes in the interest rates is constant as the ___ of interest rate changes.
A criticism of the Vasicek model is that it assumes the volatility of changes in the interest rates is constant as the level of interest rate changes.
Ho and Lee Model
Conditional Prepayment Rate (CPR)
Absolute Prepayment Speed (ABS)
Single Monthly Mortality (SMM)
The ___, ___and ___ model modified the Vasicek model so that the variance of the short-term rate is proportional to the rate itself.
The Cox, Ingersoll and Ross (CIR) model modified the Vasicek model so that the variance of the short-term rate is proportional to the rate itself.
___-___models of the term structure generate bonds that do not allow for arbitrage opportunities.
Arbitrage-free models of the term structure generate bonds that do not allow for arbitrage opportunities.
The ___ and ___model assumes that the short-term interest rate follows a normally distributed process, with a drift parameter selected so that the modeled interest rates fit the observed structure of interest rates.
The Ho and Lee model assumes that the short-term interest rate follows a normally distributed process, with a drift parameter selected so that the modeled interest rates fit the observed structure of interest rates.
The key disadvantage of the Ho and Lee model are that it assumes a very simple ___ process for bond prices and it can produce ___interest rates.
The key disadvantage of the Ho and Lee model are that it assumes a very simple binomial process for bond prices and it can produce negative interest rates.
An ___ ___ ___is an interest rate derivative in which one party pays the other party when a specified reference rate exceeds a specific cap rate.
An interest rate cap is an interest rate derivative in which one party pays the other party when a specified reference rate exceeds a specific cap rate.
A ___ is an interest rate cap that is guaranteed for one specific date.
A caplet is an interest rate cap that is guaranteed for one specific date.
A ___ is a series of caplets and its price equals the sum of the caplet prices.
A cap is a series of caplets and its price equals the sum of the caplet prices.
An ___ ___ ___ is an interest rate derivative in which one party pays the other when a specified reference rate is below a floor rate.
An interest rate floor is an interest rate derivative in which one party pays the other when a specified reference rate is below a floor rate.
A ___ is an interest rate floor guaranteed for one specific date.
A floorlet is an interest rate floor guaranteed for one specific date.
A ___ is a series of floorlets and its price equals the sum of the floorlet prices.
A floor is a series of floorlets and its price equals the sum of the floorlet prices.
Issuers of floating rate debt can buy interest rate ___ to hedge their exposure.
Issuers of floating rate debt can buy interest rate caps to hedge their exposure.
Lenders of floating-rate debt can buy interest rate ___ to hedge their exposure.
Lenders of floating-rate debt can buy interest rate floors to hedge their exposure.
Since caps and floors are not typically exchange-traded instruments, buyers of these derivatives are exposed to ___ risk.
Since caps and floors are not typically exchange-traded instruments, buyers of these derivatives are exposed to counterparty risk.
___ ___are bonds that can be redeemed by the bond issuer before maturity by making a set payment to the investor in a designated period.
Callable bonds are bonds that can be redeemed by the bond issuer before maturity by making a set payment to the investor in a designated period.
Bond pricing models should account not only for interest rate risk but also for ___ risk.
Bond pricing models should account not only for interest rate risk but also for credit risk.
Ignoring counterparty risk, payers in vanilla swaps benefit from ___ rates and suffer when rates ___.
Ignoring counterparty risk, payers in vanilla swaps benefit from increased rates and suffer when rates decline.
Ignoring counterparty risk, receivers in vanilla swaps benefit from ___ rates and suffer when rates ___.
Ignoring counterparty risk, receivers in vanilla swaps benefit from declining rates and suffer when rates increase.
Pension funds can use ___ ___ ___ or ___-___ ___ to reduce their interest rate risk.
Pension funds can use interest rates swaps or long-term bonds to reduce their interest rate risk.
The ___ ___ ___ is a graphical representation of the relationship between swap rates and the maturities of their contracts.
The swap rate curve is a graphical representation of the relationship between swap rates and the maturities of their contracts.
Prepayment risk is fairly ___ for auto loan backed securities.
Prepayment risk is fairly low for auto loan backed securities.
Prepayment for most ABSs is measured by the ___ ___ ___ .
Prepayment for most ABSs is measured by the conditional prepayment rate (CPR).
Auto Loan Backed Securities prepayment risk is typically measured using the ___ ___ ___.
Auto Loan Backed Securities prepayment risk is typically measured using the absolute prepayment speed (ABS).
___-___ loans mean that lenders can collect only the loan collateral.
Non-recourse loans mean that lenders can collect only the loan collateral.
Credit card and auto loans are (recourse/non-recourse) loans
Credit card and auto loans are recourse loans
A ___ ___ ___ is an ABS that is secured by and receives cash flows from a pool of credit card receivables.
A credit card receivable is an ABS that is secured by and receives cash flows from a pool of credit card receivables.
