2016-FRR Leak Questions

A currency swap typically involves four components: an initial exchange of notional amounts in different currencies, periodic exchange of interest payments in different currencies, and a final exchange of notional amounts at maturity. The denomination of the original notional amount into a foreign currency is not a standalone component of a currency swap; it is part of the initial and final exchanges.

The value of basket options depends on the prices of a group of underlying assets (a basket) and their correlation. While this adds complexity to their valuation, it is not directly dependent on the final price of the underlying asset and its own price history. Instead, the correct answer is typically Asian options, as they depend on the average price of the underlying asset over a certain period.

To determine the appropriate interest rate to charge, Alpha Bank needs to cover the risk-free rate, the spread, and the expected loss due to default. The formula used is: Risk-free rate + Spread + (Probability of Default x Loss Given Default). Substituting the given values: 6% (risk-free rate) + 3% (spread) + (0.02 x 0.50) = 6% + 3% + 1% = 10%.

When Delta Bank sells off the lower-risk portions of its credit portfolio, it retains the higher-risk residual pieces. This process inherently increases the risk associated with the remaining portfolio because the lower-risk assets, which provided a cushion, are no longer part of the portfolio. As the risk increases, the potential return on these higher-risk assets also increases to compensate for the additional risk taken on by the bank. Consequently, this higher risk and potential return increase the bank's return on equity (ROE), as the bank is now leveraging more volatile assets that have higher potential returns.

References

Verified information on risk and return from the document ​