Explanation:
Mapping is particularly useful when the characteristics of a financial instrument change over time. This is because the risk profile of such instruments, such as bonds and options, can change rapidly. For instance, as bonds age, their risk profile changes, necessitating a mapping onto yields that best represent their current profiles. Similarly, the risk profile of options can change very quickly, requiring them to be mapped onto their primary risk factors. Therefore, when the characteristics of an instrument change over time, mapping provides a practical solution to accurately assess and manage the associated risks.
Choice A is incorrect. Mapping is not most effective when the characteristics of an instrument do not change over time. In such cases, historical prices can be used to construct a risk profile, making mapping less necessary.
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Q.1512 Mapping is a useful process and also an instructive one because it provides useful judgments about risk drivers of derivatives. Financial institutions cannot always use historical prices to develop a risk profile for the instrument. In addition, they cannot develop risk profiles of options on the basis of historic values. Therefore, mapping gives us a way to handle these practical problems when:
A
characteristics of instrument do not change over time.
B
characteristics of instrument change over time.
C
a large number of factors needs to be measured separately for each position.
D
the characteristics of the instrument are only exposed to a single major risk factor.