This is from reading #24.
In addition to his CIO responsibilities, Choo is also responsible for managing the funding liabilities for a new wing at the local hospital, which is currently fully funded utilizing a standard immunization approach with noncallable bonds. However, he is concerned about the various risks associated with the liabilities including interest rate risk, contingent claim risk, and cap risk. Are Choo’s concerns regarding various risks of funding the hospital liability correct?
- No, because interest rate risk is not a factor.
- No, because contingent claim risk is not a factor
I answered C because the bonds are noncallable and Contingent claim risk applies to callable bonds.
The CFAI answer is A. Can someone explain why it would still be a factor with noncallable bonds?
They’re talking about the liabilities of the hospital, not the non-callable bonds which are the assets.
It’s a poorly worded question. Choo’s concerns are regarding the liabilities not the assets. No details are given regarding the liabilities so we can assume it’s asking a general question regarding whether those three factors need to be considered, which they do.
Remember getting caught for the same reason. I make many mistakes due to reading Qs too fast.
So as long as the question states that there are LIABILITIES that are being hedged (regardless of the type of product being used to hedge the liabilities), we should know that those liabilities contain contingent claim risk because somebody has a claim to those liabilities. Correct?
claim risk arises from prepayments - think MBS / mortgage prepayments -> increase when interest rates fall due to refinancing (pay in full, refinance at lower interest rate).
Not sure where you’re getting the hedge portion from?