Question 15
Part C, don't understand the answer.
in part a, we are using the same liq premium derived from ref port and added it to the rf rate...
For C:
how is a fixed % + c of excess (asset port - rf) tell you the difference of liq characteristics between asset port vs ins contract directly, is it because we are assuming we know market and credit risk?
Comments
That's the definition of a hybrid approach. You calculate the reference portfolio liquidity premium once and then add it to the risk free rate on roll-forwards.
For part C, you are making adjustments to market and credit risk to make them compatible. This is how it is done for all methods and is no different for the hybrid approach. We don't "know" market or credit risk, we estimate it based on spreads of other instruments in the market