MTGE4, MTGE7 and MTGE10 are mortgage-backed securities (MBS) that pay 4%, 7% and10% coupon, respectively prevailing mortgage rates are 10%. Assuming these securities havethe same maturity and coupon frequency, which of the following is correct?

A.In most cases, convexity is sufficient to approximate MBS price changes resulting fromyield changes for the purpose of estimating VaR.

B.In most cases, duration is sufficient to approximate MBS price changes resulting fromyield changes for the purpose of estimating VaR.

C.The option embedded in a MBS makes the implementation of the duration-convexitymethod less appropriate for the purpose of estimating VaR.

28-30

D.As rates fall, MTGE10 price change approximations using the duration-convexitymethod are likely to be better than MTGE4 price change approximations.

A risk manager for Bank XYZ is considering writing a 6-month American put option on anon-dividend paying stock ABC. The current stock price is USD 50, and the strike price ofthe option is USD 52. In order to find the no-arbitrage price of the option, the manager uses atwo-step binomial tree model. The stock price can go up or down by 20% each period. Themanager's view is that the stock price has an 80% probability of going up each period and a20% probability of going down. The annual risk-free rate is 12% with continuouscompounding. The no-arbitrage price of the option is closest to:

A.USD 2.00

B.USD 2.93

C.USD 5.22

D.USD 5.86