Contingent claim risk with non callable bond portfolio - true ?

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janardhanc

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Volume 4 page 155 Q27. Answer A.
If the portfolio has non callable bonds I believe there is no contingent claim risk. I believe answer is C.
Any thoughts?
 
answer is A.
Though the portfolio has non-callable bonds - this is how the liabilities are being funded.
His Contingent claim risk is in the payment of the liabilities themselves. Somebody may make a claim against those liabilities. Duration of the liabilities that Choo is funding may change at a very different rate from the Assets being used by him to fund the liabilties. During that process the contingent claim risk arises.
 
The liability of the hospital could include putable Bonds which have contingent claim risk. When rates are volatile , the value of the fixed rate loan would decrease to the issuer ( i.e the hospital ) because of the embedded put option which increases in value.
 
Sorry in advance :)
There some difference in other question in CFAI Mock2011 Q34. I post full question:
Statement2 - “I am concern that certain types of securities in the portfolio pose a risk of not providing sufficient cash flow to pay liabilities when they come due. The allocation to MBS in the portfilio, for instance, expose us to contingent claim risk. We should therefor increase the allocation to non-callable fixed rate corp bond, which do not expose us to contingent claims risk”
Ques: Is statement 2 mostly likely correct
A: yes
B: No, she is incorrect about corporate bonds
C: No, she is incorrect about MBS
And the correct answer is A
is there any mis ?
 
It looks from both of the above … Choo Problem in the book
and the 2011 Mock question
there is contingent claim risk from both sides.
1. From the Liability side - when the assets duration is not the same as the liabilities duration. So insufficient funds when the liabilities become due - can result in Manager bankruptcy - and contingent claims from the creditors of the Portfolio Manager … risk that Choo faces.
2. From the Asset side - you have invested in Callable Mortgage back securities - when rates fall - the MBS experience prepayment risk - funds need to be reinvested at a lower rate as well. Your asset duration again gets affected.
In Q 27 Pg 155 of the book - Choo avoids the 2nd risk - by investing in the non-callable bonds - but the 1st risk is still present.
 
What is exactly the liabilities in Q27? Future payment or a bond issued?
 
Q27 only thing that is stated:
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 non- callable bonds. However, he is concerned about the various risks associated with the liabilities including interest rate risk, contingent claim risk, and cap risk.
He is trying to use Standard Immunization using Non-callable bonds to fund the liability. But they do not state what the liabilities are.
 
I’m reviewing this section. Q27 is asking about the risk of the liability, not the bond(noncallable, so there is no contigent call risk) that fund the liability. Since there is no details of the liab, it could have all three types of risk. Make sense?
 
the_tank wrote:I’m reviewing this section. Q27 is asking about the risk of the liability, not the bond(noncallable, so there is no contigent call risk) that fund the liability. Since there is no details of the liab, it could have all three types of risk. Make sense?
Click to expand...
Where, exactly, is this question now?
 
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