1. What are the different types of outcome analysis recommended in SR 11-7 for the third core element of the validation process? Explain in brief. Is Back-testing one of the methods of outcomes analysis? What is expected when model outcomes fall outside the confidence intervals or expected thresholds from the back-test?

2. Are vendor products required to be included in model risk management framework? Should the same principles apply to vendor products as that for in-house models? [4] If the whole model or certain components are implemented in MATLAB (a third-party vendor), do you need to conduct additional or less testing, to comply with SR 11-7?

3. Complete the sentence, Benchmarking is the comparison of a given models inputs and outputs to estimates from . . Should the model be rejected if discrepancies are noted between model outputs and benchmarks?

4. SR 11-7 states that validation should ensure that judgement exercised in model design and construction is well-informed carefully considered and consistent with published research and industry practice. a. Do you find the simple trading strategy developed using the Kalman-Filter (KF) as an indicator (without the hedged portfolio), to be a conceptually sound model? Explain reasons.

b. Mention what additional changes in the model and/or its testing would you expect to be done by the developer of the KF Strategy for you to be able to validate the model.

c. If the developers made the changes you recommended, and now you independently agree that the revised model is conceptually sound, and you can validate the model, what additional ongoing monitoring would you require, to maintain that the model is implemented appropriately and performing as intended?

5. Derive the following relations for the valuation of swaps:

1. Show that the Swap is a linear interest-rate derivative in terms of the swap rate, by deriving that the present value of a vanilla fixed-vs-float receiver2 swap can be expressed as a linear function of the difference of the swap rate (S) and the corresponding break-even swap rate (or also referred as the par-swap rate, S0), as shown below

where A0 is referred as the Annuity function of the fixed leg, with N as the Notional amount, as the accrual period and Di being the discount factors. {Hint: Instead of using the value of the swap to start with, use the value of the combination of: (1) the swap, and (2) a reverse3 par-swap (since par swap is 0 valued)}

2.Extend the above relation using the fact that the break-even/par swap rates can be written as a linear weighted average of the current forward rates (the forward values of the floating rate, typically the Libor_3M). Express the Partial PV01 of the swap with respect to any of the forward rates, assuming the discount factors are independent of the forward rates (we use a different discounting rate say OIS discounting)

PVA0=A0(SS0)=iNDi