The question asks whether the manager should be concerned about interest rate risk, contingent claim risk, and cap risk when managing the funding liability using noncallable bonds. The answer says he should be concerned about both interest rate and contingent claim risk. Shouldn’t contingent claim risk not be a factor since the bonds are non callable and not MBS?
I had thought the same thing and got that question wrong
i got it wrong for the same reason. still think non-callables do not have contngent claim risk.
i asked the same question a while ago http://www.analystforum.com/phorums/read.php?13,1144523,1145370#msg-1145370 didn’t really get an answer though.
Contingent claims risk would only apply to callable bonds or MBS. Maybe the question deals with general concerns someone would have when trying to manage liabilities and the current holdings are irrelevant? If that’s the case the question is very poorly written.
Bradleyz Wrote: ------------------------------------------------------- > Contingent claims risk would only apply to > callable bonds or MBS. Maybe the question deals > with general concerns someone would have when > trying to manage liabilities and the current > holdings are irrelevant? If that’s the case the > question is very poorly written. CFAI text: “Contingent claim risk. When a security has a contingent claim provision, explicit or IMPLICIT, there is an associated risk.” Explicit: callable or MBS. Implicit: corporate bonds since corporate liabilities are contingent claims on the assets of a firm. The text does not specifically mentions corporate bonds, but it says active management and the bonds do not have embedded options --> cannot be pure T bonds which do not have contingent claim risk.
From a question in sample exam 1 - “fixed rate corporate bullet bonds do not have contingent claims risk”. In contrast to the EOC reading question, here they are not considering implicit costs (that corp liabilities are contingent claims on the assets of a firm). Is this an inconsistency or am I missing something? “A is correct because when securities have a contingent claim provision, explicit or implicit, there is an associated risk. In a falling rate scenario, the manager may have higher coupon payments halted and receive principal, as is the case with mortgage-backed securities. Mortgage-backed securities therefore have contingent claims risk. Fixed-rate corporate bullet bonds do not have contingent claims risk.”
Suggest you send an inquiry to CFAI requesting for clarification.
I think here, that explicit would be the callable bond (callable at par) and implicit is the MBS (which faces prepayment risk that could speed up return of principal, but does not have an “explicit” call price). I think that the example from the EOC is incorrect and the sample has it right. Why would the fact that you would have claims on the company’s assets be a risk for the bondholder? Its actually a positive for you, not a risk…
This one threw me too. I think the key is that choo is “concerned about the various risks assiciated with the LIABILITIES including…contingent claim risk” His assets don
t have contingent claim risk as youve pointed out, but his liabilities may well have contingent claim risk if the required cashlows for the hospital wing are uncertain.