contingent claim risk not a factor ... or is it?

“choo is responsible for managing the funding liabilities for a hospital which is currently fully funded utilising a standard immunisation approach with NONCALLABLE BONDS” then… contingent claim risk should NOT be a factor and question27’s answer would be “C”, not “A” right? thank you!! (will need some panadol soon) :frowning: volume 4 p142-143

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Oh snap - I literally just signed in to post about this question.

Basically the question is:

“Choo is responsible for managing the funding liabilities for a new wing at the local hospital, which is currently fully funded utilizing a standard immiunization approach using noncallable bonds. However, he is concerned about the various risks associated with the liabilites including interest rate risk, contingent claim risk, and cap risk”.

Are Choo’s concerns correct regarding the various risks of funding the hospital liabilities?

A. Yes

B. No, because interest rate risk is not a factor.

C. No, because contingent claim risk is not a factor.

CFA books say the answer is A but surely it must be C?

Thanks guys.

It says it is non callable. Does it say anything about it being non put able.

that sucka might be putable so you choo has a put option

vol goes down he takes a hit

Thus he does have contingent claim risk

The three risks of managing to a liability structure are:

Interest rate risk

Cap risk

Contingent claims risk

This question tricked me too, but I think we can assume that if it specifically mentions funding liabilities, then all of these would apply.

theblackswan, putable bonds exhibit positive convexity, which is désirable… padniacki, the question applied specifically to said portfolio, so am still tempted to believe that contingent claim risk do not apply. Ilikecupcakes, did you send an email to CFAI? (i did, but am sûre that if they see this question popping up from more than one candidate, they’ll pay attention) thanks!

If you have Any option and vol goes down, you suffer.

all long options exhibit convexity

there may be contingent claim risk in the liabilities he is considering funding, and that is DISTINCT FROM HOW HE FUNDS those liabilities.

Hi cpk123, thanks for this… I didn’t see it that way!! :slight_smile:

question was poorly constructed or intended to trip people up. The reason why that;s the case is because someone who doesnt know the relationship between contingent claim risk and callable bonds would get that answer correct.

As cpk123 says: the question’s about contingent claims risk on the liabilitites, not on the assets. There are all sorts of contingent claims for construction of a new hospital wing.

Just wanted to clarify “Cap risk”

  1. If following immunisation approach i.e. using income stream on bonds held as assets to fund liabilitiy payments.

  2. 8% floating rate loan receipts and pay 8% floating rate loan payments - all good.

  3. if floating rate loan rates rise to 12% but you have entered into an agreement to cap rates at 10% you will only receive 10% BUT floating rate liability payments have risen to 12% (in line with assets).

  4. Therefore are 12%019% = 2% short on liability payments.

Is this an accurate example of cap risk?