EXAM 9 Formula Sheet PDF

EXAM 9 Formula Sheet
BKM 6
1. Utility Function
2. CAL
3. Sharpe Ratio
4. Equation for the optimal ratio,
1.
2.
3.
4. Take the derivative of U w.r.t
with the

BKM 7
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
Equation to determine the total variance (risk) of a portfolio of equally weighted assets
Expected Value of two assets
Variance of two assets
Proportion perfect hedging with perfectly negative correlation assets
Weight for minimum variance portfolioTwo risky assets
Weights for optimal investment proportionsTwo risky assets
Weights for optimal investment proportionsTwo risky assets and a risk free asset
Formulas for the expected return any risk portfolio
Formulas for the Variance of any risk portfolio
Risk Premium, Standard Deviation, and Sharpe Ratio of Risk Pooling
Risk Premium, Standard Deviation, and Sharpe Ratio of Risk Sharing
1.
2.
3.
4.
5.
6.
7.
8.
9.
10. Risk Pooling: Portfolio A has y in
a. Risk Premium:
i.
b. Standard Dev:
i.
c. Sharpe:
d.
We know
the following:
i.
ii.
iii.
(new asset) creating a new portfolio Z
and
, and
we get
Higher Returns
Higher Risk
Higher Sharpe Ratios
11. Risk Sharing: Portfolio A has y in

portfolio Z
a. Risk Premium:
i.
b. Standard Dev:
i.
c. Sharpe:
We know
the following:
i.
ii.
(risk free), then adds z in
no risk premium for a risk free asset, setting with z=y,
iii.
d.
and (1-y) in
and (1-y) in
(risk free), then sell z of
and add z in
(new asset) creating a new
and
no risk premium for a risk free asset, setting with z=y/2,

Same Returns
Lower Risk
Higher Sharpe Ratios: same as the risk pooling
, and
we get

BKM 8
1. Single Factor Model
2. Single Index Model
3. Variance of Returns for a Single Factor/Index Model
4. Covariance of Returns for a Single Factor/Index Model
5. Correlation of Returns for a Single Factor/Index Model
6. Expected Return-Beta relationship of a Single Index model
7. Optimization Procedure for the Single Index Model
1.
2.
3.
4.
5.
6.
7. Optimization
a. Compute the initial position of each security in the active portfolio
b. Scale those initial positions
c. Compute the alpha of the active portfolio:
d. Compute the residual variance of the active portfolio:
e. Compute the initial position in the active portfolio:
f. Compute the beta of the active portfolio:
g. Adjust the initial position in the active portfolio:
h. Optimal risky portfolio has weight:
i. Calculate the risk premium:
j.
Compute the variance:

BKM 9
1. Derivation of CAPM
2. Zero Beta CAPM
3. Extension of CAPM that accounts for labor income
4. ICAPM Expected Return-Beta Equation
1. We have n stocks and market portfolio M, find
For any stock :
:
where
The reward to risk ratio for investments in can be express as:

The reward to risk ratio for investments in
can be express as:
(AKA the market price of risk)

Given the basic equilibrium principle, all investment should off the same reward to risk. We get:
We set
and get the CAPM:
2.
3.
Where
4.
Where
is the beta on the market index portfolio and
is the beta on the kth hedge portfolio

BKM 10
1. Two Factor model
2. Total Risk Premium for portfolio with different factor sensitivities
3. Well diversified Portfolio
4. Well diversified portfolio with expected return
and that deviations of its return from
expectation can serve as the systematic factor
1.
2.
Where
is the
risk premium
3. A portfolio that is diversified over a large enough number of securities, with each weight,
enough that for practical purposed the nonsystematic variance,
negligible.
where
4.
we actually expect
then
BKM 11/12
1. Abnormal return from an event study
2. Trin Statistic
3. Confidence Index
4. Put/Call Ratio
1.
--Solve for
2.
3.
4. Ratio of outstanding put options to outstanding call options
, small

BKM15/Hull 4
1.
2.
3.
4.
5.
6.
7.
8.
9.
Equating the
Forward Rate
Forward Rate for Continuous Distribution
Instantaneous Forward Rate
Liquidity Premium
Cash flow and Payoff with a FRA(X is lending to Y)
Value of a FRA
BootStrap Method
Par Yield on the a bond
1.
2.
3.
4.
where
is the zero rate for maturity
5.
6. Company X is agreeing to lend money to Company Y for the period of time between
Define:
Extra Interest that it earns by entering the agreement is

Cash flows to Company X at time is
Cash flows to Company Y at time is
Payoff for Company X at time
is
Payoff for Company Y at time
is
7. If
If
If
FRA can be valued if we:
Calculate the payoff on the assumption that forward rates are realized(i.e.
Discount this payoff at the risk free rate
The Risk Free rate is the Zero Rate for an investment at time
8. We need to solve for each , the Zero Coupon Rate, iteratively:
9. It is the coupon rate that causes the bonds price to equal its par value

BKM16/Hull 7
1. Macualay Duration with Compounding
2. Modified Duration with Compounding
3. Modified Duration with Continuous
4. Duration of a Perpetuity
5. Effective Duration
6. Convexity with Compounding
7. Convexity with Continuous
8. Bond Price change with Duration and Convexity
9. Interest rate SwapTransforming a Liability
10. Interest rate SwapTransforming a Asset
11. Comparative Advantage
12. Value as an Exchange of Bonds
1.
2.
3.
4.
5.
where
is the price of the bond if interest rates rise
is the price of the bond if interest rates fall
6.
7.
8.
9.
I+M
I-F
LIBOR
10.
I-M
I+F
LIBOR
11.
12.
Financial
Institution
I+F
X
LIBOR +N
LIBOR
Financial
Institution
I-F
X
LIBOR -N
LIBOR

Feldblum Asset
1. Duration of Reserves
1.
Noris
1.
2.
3.
4.
1.
2.
3.
4.
Duration Market Value of Surplus/Duration Gap of Surplus

Stock duration
Duration of Total Return on Surplus
Duration Gap of Leverage

Panning
1. Untaxed Net Income
2. Formula for Premium
3. Current Economic Value
4. Franchise Value(perpetuity)
5. Franchise Value(Fixed Periods)
6. Target Rate of Return
7. Franchise Duration
8. Duration of Total Economic Value
1.
2.
3.
4.
5.
6.
7.
8.
----

Hull 23
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Probability of Default
Unconditional Default Probability
Survival Probability Function
Conditional Default Probability
Approximate Calc for Default Probabilities from Bond Prices
Black Sholes Merton Formula
Credit Value Adjustment
Gaussian Copula
Factor Based Correlation Structure(Probability of default at time T for a given F)
Gaussian Copula Model for Credit VaR
1.
2.
3.
4.
--Default intensity for period
5.
Where
Then use:
6.
Where
The risk neutral probability that the company will default is

From Itos Lemma:
We can solve for

simultaneously using the equation for
and Itos Lemma
where
and
=value today of an instrument that pays off the exposure on the derivative under consideration at time
is the value of the derivative, this means than the expression
8. Define:
=the time to default for company 1
=the time to default for company 2
Transformation:
7.
9.
10.
---correlations are assumed to be all equal
then

Hull 24
1.
2.
3.
4.
CDS-Bond Basis
CDS Spread
Value of CDS to the seller( is negotiated)
Value of CDS to buyer( is negotiated)
1.
2. Assume defaults can always happen halfway through the year

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Three steps:
Calculate the PV of expected Payments(Buyers Payments):
1)
We assume defaults happen halfway through, so we calculate the PV of accrual payments (Buyers
Payments):
2)
Calculate the PV of expected payoff(Sellers Payments):
3)
Set the PV of expected and accrual payments equal to the expected payoff and solve for : (1)+(2)=(3)
Value of the swap should be zero
3.
4.

Butsic
1.
2.
3.
4.
5.
6.
EPD Discrete Assets Certain

EPD Discrete Losses Certain
EPD Continuous Certain Assets Uncertain Liabilities
EPD Assuming Normal distribution
EPD Assuming LogNormal distribution
Square Root rule
1.
2.
3.
4.
5.
Where:
6.
Where:
7.

Cummins Capital
1. EVA
2. EVAOC
3. Exceedence Probability
4. Allocating Capital with Exceedence Probabilities
5. Target RAROC for Multiple Periods
6. EPD Ratio as an Insolvency
1.
2.
3.
4.
5.
Goldfarb
1. RAROC
2. Myers Read Method
3. Set price such that RAROC is above a specified target
4. RAROC over multiple periods
1.
2.
3.
4.

Feldblum IRR
1. Model Setup
1.
0
1
2
3
4=1-Sum(2:3)
Premium
Payment
Loss Payment
Expense Payment
U/W Cash Flow
5=i*Ending Assets
6
7=5-6
Investment Income
Tax Payment
Total Other
8=7+4
Total Cash Flow
9= Total 2 - Pd to
Date
10=Some Basis
11=sum(9:10)
Reserves
Required Surplus
Required Assets
12=8+14 Prior
13=11-12
14=12+13
Beginning Assets
Equity Flow
Ending Assets

Ferrari
1. Return on Equity Formula
2.
Roth
1.
2.
3.
4.
Actual Surplus Change

Required Surplus Change
Actual Rate of Return
Required Rate of Return
1. Actual Surplus change=Retained Return on Capital +Surplus paid in

2. Required Surplus change=Expense & claims inflation + Increase in demand for insurance
+ increase in reserves
3. Actual Rate of Return=Stockholder dividends + Retained Return on Capital
4. Required Rate of Return=Required Surplus change + Stockholder Dividends - Surplus
Paid in

Robbin
1. Policyholder Supplied Funds
2. Calendar Year Investment Offset Procedure
3. Present Value offset Procedure
4. Calendar Year Return on Equity Method
5. Present Value of Income over the Present Value of Equity Method
6. Present Value Return on Cash Flow Model
7. Risk Adjusted Discounted Cash Flow Method
8. The Internal Rate of Return on Equity Flows Algorithm
1.
2.
3.
where
and
4.
,
5.
6.
where
EQ=Equity
r =Target Rate of Return
i =investment rate used for discounting cash flow
7.
8.

Mango
1.
2.
3.
4.
5.
6.
7.
8.
Modeled Event
Expected Loss Occurrence Loss distribution
Variance of Occurrence Loss distribution
Covariance of Occurrence Loss distribution
Total Variance of two Accounts
Marginal Surplus Method
Marginal Variance Method
Generalized Covariance Share Formual
1.
Employ a Binomial approximation with probability of occurrence
2.
3.
4.
5.
6.
;
;
is the needed surplus; y is the return on Marginal surplus; is a distribution percentage point corresponding
to the acceptable probability that the actual result will require even more surplus than allocated
Marginal Surplus Requirement is then:

Based on the required return, , on that marginal surplus(which is based on Management goals, market forces
and risk appetite) the MS risk load would be:
7. For an existing portfolio
and new account , the MV risk load would be:
Where is a multiplier similar to
from the MS method although dimensioned to apply to variance rather
than standard deviation.

Footnote: A variance based risk load multiplier can be developed by converting a standard deviation-based
multiplier using the following formula:
In example
8. Use a weight
account Y for event i:
, to simply the difficulty in selecting a variance based multiplier.

to determine an account Xs share of the mutual covariance between itself and another
Then Ys share of that mutual covariance would simply imply:

Total Covariance share allocation for account X over all events would be:
Where

Bault
1. Derive the Marginal risk approach from the ruin theory equation
2. Leverage Approach
1.
-Prob. Of Ruin
Standardizing
produces:
(R+V)/S
Equation for Marginal Surplus required for a new risk x:
2.4:
2.5:
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2.
Consider the following Return on Equity equation:

where

Kreps
1. Premium Equation
2. Loss Safety Constraint
3. Investment Variance Constraint
4. Asset equation for Loss Safety Constraint-Swap Technique
5. Risk Load for Loss Safety Constraint-Swap Technique
6. Asset equation for Variance Constraint-Swap Technique
7. Risk Load for Variance Constraint-Swap Technique
8. Asset equation for Loss Safety Constraint-Put Technique
9. Risk Load for Loss Safety Constraint- Put Technique
10. Asset equation for Variance Constraint- Put Technique
11. Risk Load for Variance Constraint- Put Technique
12. High Exess Layere/Finite rate event, non-zero rate on line
1.
2.
: The final value of the initial investment (F) at year end must be large enough to
cover the losses at a specified safety level (s)
3.
, because the reinsurer does not want higher volatility from the contract compared to the
target return
4.
5.
6.
7.
8.
9.
Where
10.
Where
11.
12.
Option Case: Rate on line in the limit as

Set
Swap Version:
Let
goes to zero

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