FRM Exam2000

2000 Financial Risk Manager Examination
Saturday, November 18, 2000
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Copyright 2000
2000 Financial Risk Manager Examination 1

© 2000 GARP
Table of Contents
Capital Markets Risk Management (20 Questions) Page 4
Legal, Accounting and Tax (6 Questions) Page 11
Credit Risk Management (36 Questions) Page 14
Operational Risk Management (8 Questions) Page 27
Market Risk Management (35 Questions) Page 31
Quantitative Analysis (23 Questions) Page 45
Regulation and Compliance (12 Questions) Page 53
Answer Key Page 57

© 2000 GARP
The Global Association of Risk Professionals would like to
thank the following individuals for their generous
contributions of professional time and effort in the
compilation of the 2000 Financial Risk Manager
Examination:
Kanwardee Ahluwalia, Jean-Martin Aussant,

Lev Borodovsky, Michael Brosnan, Umberto Cherubini,
Christopher Cummings, Adam Davids, Dawie de Jongh,
David Dubofsky, Neels Erasmus, Lisa Godar, Ian Hawkins,
Kenneth Kapner, Darren Langer, Mark Larson, Steve Lerit,
Yong Li, Elliot Noma, Søren Plesner, Daniel Rosen,
Nawal K. Roy, Prodyot Samantha, Peruyemba Satish,
Scott Schleifer, Lars Soderlind, Lara Swann, Paul Styger,
Thomas Traub, Kurt Wilhelm
and
The Members of the Education Committee of GARP

© 2000 GARP
Capital Markets
1. The Long Term Capital Management (LTCM) fiasco was an example of:
a) Extreme derivatives mispricing.
b) Lack of VaR process at LTCM.
c) Extreme leverage by LTCM.
d) All of the above.
2. Loans are securitized to:
a) Reduce regulatory capital.
b) Reduce credit concentrations.
c) Provide access to loan products for investors.
3. How would you describe the typical price behavior of a low premium
mortgage pass-through security?
a) It is similar to a U.S. Treasury bond.
b) It is similar to a plain vanilla corporate bond.
c) When interest rates fall, its price increase would exceed that of a
comparable duration U.S. Treasury.
d) When interest rates fall, its price increase would lag that of a
comparable duration U.S. Treasury.

© 2000 GARP
4. On Friday, October 4, the spot price of gold was $378.85 per troy ounce.
The price of an April gold futures contract was $387.20 per troy ounce.
(Note: Each gold futures contract is for 100 troy ounces.) Assume that a
Treasury bill maturing in April with an “ask yield” of 5.28 percent provides
the relevant financing (borrowing or lending rate). Use 180 days as the
term to maturity. Also assume that warehousing and delivery costs are
negligible and ignore convenience yields. What is the theoretically correct
price for the April futures contract and what is the potential arbitrage profit
per contract?
a) $379.85 and $156.59
b) $318.05 and $615.00
c) $387.84 and $163.25
d) $388.84 and $164.00
5. Consider a bullish spread option strategy of buying one call option with a
$30 exercise price at a premium of $3 and writing a call option with a $40
exercise price at a premium of $1.50. If the price of the stock increases to
$42 at expiration and the option is exercised on the expiration date, the net
profit per share at expiration (ignoring transaction costs) will be:
a) $8.50
b) $9.00
c) $9.50
d) $12.50
6. A 90-day Eurodollar futures contract has a constant PVBP of $25.00 per

million. The 90-day bank bill futures contract on the Sydney Futures
Exchange trades on a discount basis and the Price Value of a Basis Point
(PVBP) is different for each yield level. Assuming non-negative yields, the
PVBP for the bank bill contract will be:
a) Always less than the Eurodollar contract.
b) Always greater than the Eurodollar contract.
c) Dependent on the market yield.
d) $27.00 per million.

© 2000 GARP
7. For assets that are strongly positively correlated with interest rates, which
one of the following is TRUE?
a) Long-dated forward contracts will have higher prices than long-dated

futures contracts.
b) Long-dated futures contracts will have higher prices than long-dated

forward contracts.
c) Long-dated forward and long-dated futures prices are always the same.
d) The “convexity effect” can be ignored for long-dated futures contracts

on that asset.
8. A counterparty default before maturity will cause a credit loss in which one
of the following situations?
a) You are short JPY in a 1-year USD/JPY forward FX contract and the
JPY has appreciated.
b) You are long JPY in a 1-year USD/JPY forward FX contract and the
JPY has depreciated.
c) You purchased a 1-year OTC JPY call option and the JPY has
appreciated.
d) You sell a 1-year OTC JPY call option and the JPY has depreciated
9. An investment in a callable bond can be analytically decomposed into a:
a) Long position in a non-callable bond and a short position in a put

option.
b) Short position in a non-callable bond and a long position in a call

option.
c) Long position in a non-callable bond and a long position in a call

option.
d) Long position in a non-callable and a short position in a call option.

© 2000 GARP
10. Consider a 2 into 3-year Bermudan swaption (i.e., an option to obtain a
swap that starts in 2 years and matures in 5 years). Consider the following
statements:
I. A lower bound on the Bermudan price is a 2 into 3 year European

swaption.
II. An upper bound on the Bermudan price is a cap that starts in 2 years
and matures in 5 years.
III. A lower bound on the Bermudan price is a 2 into 5 year European

option
Which of the following statements is(are) TRUE?
a) I only
b) II only
c) I and II
d) III only
11. The Chicago Board of Trade has reduced the notional coupon of its
Treasury futures contracts from 8% to 6%. Which of the following
statements are likely to be TRUE as a result of the change?
a) The cheapest to deliver status will become more unstable if yields hover
near the 6% range.
b) When yields fall below 6%, higher duration bonds will become
cheapest to deliver, while lower duration bonds will become cheapest to
deliver when yields range above 6%.
c) The 6% coupon would decrease the duration of the contract, making it a

more effective hedge for the long end of the yield curve.
d) There will be no impact at all by the change.

© 2000 GARP
12. Suppose the price for a 6-month S&P index futures contract is 552.3. If the
risk-free interest rate is 7.5% per year and the dividend yield on the stock
index is 4.2% per year, and the market is complete and there is no arbitrage,
what is the price of the index today?
a) 543.26
b) 552.11
c) 555.78
d) 560.02
13. A CLO is generally:
a) A set of loans that can individually be traded in the market.
b) A pass-through.
c) A set of bonds backed by a loan portfolio.
d) None of the above.
14. Which statement is FALSE about the value of an option?
a) At expiration, its premium equals intrinsic value.
b) Before expiration, its premium is the sum of time and intrinsic value.
c) It is determined by an option-pricing model.
d) Intrinsic value is the difference between the market price and the strike
price.

© 2000 GARP
15. A six-month call option sells for $30, with a strike price of $120. If the
stock price is $100 per share and the risk-free interest rate is 5 percent, what
is the price of a 6-month put option with a strike price of $120?
a) $39.20
b) $44.53
c) $46.28
d) $47.04
16. Assume that the spot exchange rate for EUR/USD is 1.15 (i.e., One Euro
buys 1.15 U.S. dollars). A U.S. bank pays 5.5 percent annual interest rate
for a dollar deposit and a German bank pays 3.1 percent annual interest rate
for a Euro deposit. Both rates are compounded annually. If the interest-
rate parity theory holds, what will be the forward exchange rate for
EUR/USD one year from now?
a) 1.1584
b) 1.1653
c) 1.1779
d) 1.1826
17. Which one of the following statements is MOST correct?
a) When holding a portfolio of stocks, the portfolio’s value can be fully

hedged by purchasing a stock index futures contract.
b) Speculators play an important role in the futures market by providing

the liquidity that makes hedging possible and assuming the risk that
hedgers are trying to eliminate.
c) Someone generally using futures contracts for hedging does not bear the
basis risk.
d) Cross hedging involves an additional source of basis risk because the

asset being hedged is exactly the same as the asset underlying the
futures.

© 2000 GARP
18. According to Put-Call parity, buying a call option on a stock is equivalent
to:
a) Writing a put, buying the stock, and selling short bonds (borrowing).
b) Writing a put, selling the stock, and buying bonds (lending).
c) Buying a put, selling the stock, and buying bonds (lending).
d) Buying a put, buying the stock, and selling short bonds (borrowing).
19. What are the duration and convexity of a two-year bond that pays an annual
coupon of 10 percent and whose current yield to maturity is 14 percent?
Use $1,000 as the face value.
a) 1.637 years and 3.3491
b) 1.732 years and 4.0283
c) 1.892 years and 4.2276
d) 1.906 years and 4.3278
20. Roughly, how many 3-month LIBOR Eurodollar Futures contracts are
needed to hedge a short 150M position in one-year US Treasury Bills?
a) Short 600
b) Long 150
c) Long 600
d) Long 1500

© 2000 GARP
Legal, Accounting and Tax Risk
21. Which one of the following statements about SFAS 133 is NOT TRUE?
a) Fair value is the relevant measure for derivatives.
b) Even though derivatives are assets and liabilities, they should be

recorded off the balance sheet.
c) Derivatives are assets and liabilities and should be reported on the

balance sheet.
d) Special hedge accounting is limited to offsetting changes in fair value or

cash flows for the risk being hedged.
22. A typical master netting agreement as established by ISDA will contain all
of the following EXCEPT a list of:
a) Obligations.
b) Historical market prices.
c) Credit provisions.
d) Contractual boilerplate statements.
23. Hedging transactions are taxed as:
a) Capital gains.
b) Dividend income.
c) Ordinary income.
d) Interest income.

© 2000 GARP
24. According to a provision in FAS 133, under which of the following
conditions should embedded derivatives be split between the host contract
and the embedded derivative?
I. The economic characteristics of the contract and embedded

derivative are not “clearly and closely related.”
II. The fair market value for the hybrid contract otherwise would not
be reported on the balance sheet.
III. The embedded derivative would meet the definition of a derivative

on a stand-alone basis.
IV. The payoff is not a function of the return on a linked instrument.
a) I and II
b) II and III
c) I, II and III
d) I, II, III, and IV
25. Marking-to-market on a futures contract that is long in London and short in

Chicago can be handled by which of the following?
I. Recording the close price in both locations.
II. Recording market prices at the same instant, regardless of time

zones.
III. Recording market prices at the same local time in both locations.
IV. Forecasting the London price at 4 p.m. Chicago time
a) I or II
b) II or IV
c) I, II or IV
d) I, II, III or IV

© 2000 GARP
26. The ISDA Master Agreement and other similar agreements for derivative
contracts address primarily:
a) Legal and credit risk.
b) Legal and operations risk.
c) Legal and market risk.
d) Legal and liquidity risk.

© 2000 GARP
Credit Risk Management
27. In order to combine the risk of individual obligors into a credit portfolio,
the Creditmetrics ™ model uses:
a) S&P ratings
b) Moody’s ratings
c) Bond spreads
d) Equity correlations
28. Bilateral closeout netting agreements:
a) Are rarely used because they are difficult to enforce.
b) Provide for the settlement of foreign exchange.
c) Have been replaced by master swap agreements.
d) Provide for the netting across a set of contacts.
29. Determine at what point in the future a derivatives’ portfolio will reach its
maximum potential exposure. All the derivatives are on one underlying,
which is assumed to move in a stochastic fashion (variance in the
underlying’s value increases linearly with time passage). The derivatives’
portfolio sensitivity to the underlying is expected to drop off as (T-t)2
(square of the time left to maturity), where T is the time from today the last
contract in the portfolio rolls off and, t is the time from today.
a) T/5
b) T/3
c) T/2
d) None of the above

© 2000 GARP
30. Which one of the following statements is NOT an application of credit
derivatives for banks?
a) Reduction in economic and regulatory capital usage.
b) Reduction in counterparty concentrations.
c) Management of the risk profile of the loan portfolio.
d) Credit protection of private banking deposits.
31. According to Standard and Poor’s, the 5-year cumulative probability default
for AAA-rated debt is 15%. If the marginal probability of default for AAA
debt from year 5 to year 6 (conditional on no prior default) is 10%, then
what is the 6-year cumulative probability default for AAA-rated debt?
a) 25%
b) 16.55%
c) 15%
d) 22.65%
32. Assume the one-year T-bill yield is 6.25 percent and the risk neutral default
probability of one-year Commercial Paper is 0.85 percent. What should the
yield of one-year Commercial Paper be assuming a 50 percent recovery
rate?
a) 6.7 percent
b) 6.9 percent
c) 7.2 percent
d) 7.5 percent

© 2000 GARP
33. Which one of the following statement is MOST correct?
a) Payment in a total return swap is contingent upon a future credit event.
b) Investing in a risky (credit-sensitive) bond is similar to investing in a

risk-free bond plus selling a credit default swap.
c) In the first-to-default swap, the default event is a default on two or more

assets in the basket.
d) Payment in a credit swap is contingent only upon the bankruptcy of the

counterparty.
34. What is the difference between the marginal default probability and the
cumulative default probability?
a) Marginal default probability is the probability that a borrower will

default in any given year, while the cumulative default probability is
over a specified multi-year period.
b) Marginal default probability is the probability that a borrower will

default due to a particular credit event, while the cumulative default
probability is for all possible credit events.
c) Marginal default probability is the minimum probability that a borrower

will default, while the cumulative default probability is the maximum
probability.
d) Both a and c.

© 2000 GARP
35. Contracts such as interest-rate swaps that are private arrangements between
two parties entail credit risks. Consider a financial institution that has
entered into offsetting interest-rate swap contracts with two manufacturing
companies, General Equipment and Universal Tools. In which one of the
following situations is the financial institution exposed to credit risk from
the swap position? The most likely possibility is:
a) A default by General Equipment when the value of the swap to the

financial institution is positive.
b) A default by Universal Tools when the value of the swap to the

financial institution is negative.
c) That the interest-rates will move so that the value of the swap to
Universal Tools becomes negative.
d) That the interest-rates will move so that the value of the swap to
General Equipment becomes positive.
36. Settlement risk in foreign exchange is generally due to:
a) Notionals being exchanged.
b) Net value being exchanged.
c) Multiple currencies and countries involved.
d) High volatility of exchange rates.
37. A company has a constant 30% per year probability of default. What is the
probability the company will be in default after three years?
a) 34%
b) 48%
c) 66%
d) 90%

© 2000 GARP
38. A portfolio consists of two (long) assets £100 million each. The probability
of default over the next year is 10% for the first asset, 20% for the second
asset, and the joint probability of default is 3%. Estimate the expected loss
on this portfolio due to credit defaults over the next year assuming zero
recovery rate.
a) £30 million
b) £32 million
c) £36 million
d) £66 million
39. A portfolio consists of one (long) £100 million asset and a default
protection contract on this asset. The probability of default over the next
year is 10% for the asset, 20% for the counterparty that wrote the default
protection. The joint probability of default for the asset and the contract
counterparty is 3%. Estimate the expected loss on this portfolio due to
credit defaults over the next year assuming 40% recovery rate on the asset
and 0% recovery rate for the contract counterparty.
a) £3.0 million
b) £2.2 million
c) £1.8 million
40. Determine at what point in the future a derivatives’ portfolio will reach its
maximum potential exposure. All the derivatives are on one underlying,
which is assumed to move in a stochastic fashion (variance in the
underlying’s value increases linearly with time passage). The derivatives’
portfolio sensitivity to the underlying is expected to drop off as (T-t), where
T is the time from today the last contract in the portfolio rolls off, and t is
the time from today.
a) T
b) T/2
c) T/3
d) T/5

© 2000 GARP
41. When determining credit exposure of OTC derivative transactions, the
“add-on” usually means:
a) Replacement value
b) Mark to market
c) Counterparty credit rating
42. A “AAA Derivatives subsidiary” (also known as “Derivatives Products

Company” or DPC):
a) Is only allowed to trade derivatives.
b) Generally deals only in AAA corporate and bank debt.
c) Is an organization that is bankruptcy-remote from its parent.
43. The marginal default rates (conditional on no previous default) for a BB-
rated firm during the first, second, and third years are 3, 4, and 5 percent,
respectively. What is the cumulative probability of defaulting over the next
three years?
a) 10.78 percent
b) 11.54 percent
c) 12.00 percent
d) 12.78 percent

© 2000 GARP
44. Which one of the following statements regarding credit risk models is
MOST correct?
a) The CreditRisk+ model decomposes all the instruments by their

exposure and assesses the effect of movements in risk factors on the
distribution of potential exposure.
b) The CreditMetrics model provides a quick analytical solution to the

distribution of credit losses with minimal data input.
c) The KMV model requires the historical probability of default based on

the credit rating of the firm.
d) The Credit Portfolio View (McKinsey) model conditions the default rate
on the state of the economy.
45. For a 10-year, $100 million notional amount, which one of the following
swap positions has the highest potential future credit exposure at the time
specified?
a) Currency swap (US dollars vs. Japanese Yen) three years after
inception.
b) Currency swap (US dollars vs. Japanese Yen) five years after inception.
c) Interest-rate swap (US dollar, fixed rate vs. floating rate) three years
after inception.
d) Interest-rate swap (US dollar, fixed rate vs. floating rate) five years after
inception.
46. An investor holds a portfolio of $50 million. This portfolio consists of A-

rated bonds ($20 million) and BBB-rated bonds ($30 million). Assume that
the one-year probabilities of default for A-rated and BBB-rated bonds are 2
and 4 percent, respectively, and that they are independent. If the recovery
value for A-rated bonds in the event of default is 60 percent and the
recovery value for BBB-rated bonds is 40 percent, what is the one-year
expected credit loss from this portfolio?
a) $672,000
b) $742,000
c) $880,000
d) $923,000

© 2000 GARP
47. Which one of the following deals would have the largest credit exposure for
a $1,000,000 deal size (assume the counterparty in each deal is a AAA-
rated bank and has no settlement risk)?
a) Pay fixed in an AUD interest rate swap for 1 year.
b) Sell USD against AUD in a 1-year forward foreign exchange contract.
c) Sell a 1-year AUD Cap.
d) Purchase a 1-year Certificate of Deposit.
48. Cumulative default rates for B-rated corporate bonds in the United States
are about:
a) 5% after 1Y and 30% after 10Y.
b) 1% after 1Y and 6% after 10Y.
c) 2% after 1Y and 20% after 10Y.
d) 2% after 1Y and 40% after 10Y.
49. The yield on a zero-coupon Treasury bond with a one-year maturity is

currently 6 percent per annum. The Treasury zero-coupon yield curve is
assumed to be flat. The spread over Treasuries for an AA-rated corporate
bond with a maturity of three years is 70 basis points. What is the expected
of loss from default as a percentage of the non-default value for the
corporate bond?
a) 1.278
b) 1.763
c) 2.078
d) 2.215

© 2000 GARP
50. The TRANSITION MATRIX in credit risk measurement generally
represents:
a) Probabilities of migrating from one rating quality to another over the

lifetime of the loan.
b) Correlations among the transitions for the various rating quality assets
within one year.
c) Correlations of various market movements that impact rating quality for

a 10-day holding period.
d) Probabilities of migrating from one rating quality to another within one

year.
51. A portfolio consists of two (long) assets £100 million each. The probability
of default over the next year is 10% for the first asset, 20% for the second
asset, and the joint probability of default is 3%. Estimate the expected loss
on this portfolio due to credit defaults over the next year assuming 40%
recovery rate for both assets.
a) £19 million
b) £22 million
c) £30 million
52. One difference between a credit default swap and a total return swap is:
a) One is a credit derivative; the other is not.
b) One provides a reduction in capital; the other does not.
c) One provides an enhanced return to the investor; the other does not.

© 2000 GARP
53. A “first-to-default put”
a) Compensates the buyer in case one of the assets in a specified pool

defaults.
b) Returns the maximum of the difference between the strike level and the
remaining market value of the first to default loan or zero.
c) Is valued by obtaining the implied default volatilities in the broker

market.
54. Banks hold capital against assets based upon risk weights specified in the
Basel Accord. All of the following are subject to a 100% risk weight
EXCEPT:
a) Investment grade corporate bonds.
b) Commercial real estate loans.
c) A two-year swap with a UK-based corporation.
d) Claims on OECD banks.
55. Bank One enters into a 5-year swap contract with Mervin Co. to pay
LIBOR in return for a fixed 8% rate on a nominal principal of $100 million.
Two years from now, the market rate on three-year swaps at LIBOR is 7%;
at this time Mervin Co. declares bankruptcy and defaults on its swap
obligation. Assume that the net payment is made only at the end of each
year for the swap contract period. What is the market value of the loss
incurred by Bank One as result of the default?
a) $1.927 million
b) $2.245 million
c) $2.624 million
d) $3.011 million

© 2000 GARP
56. The ratio of the marginal probability of default for a B-rated bond over the
marginal probability of default for an AA-rated bond:
a) Generally increases with time to maturity.
b) Generally decreases with time to maturity.
c) Remains roughly the same with time to maturity.
d) Depends on the correlation of default rates between a B-rated and AA-

rated bond.
57. Assume Global Funds manages an equity portfolio worth $50,000,000 with
a beta of 1.8. Further, assume that there exists an index call option contract
with a delta of 0.623 and a value of $500,000. How many options contracts
are needed to hedge the portfolio?
a) 169
b) 289
c) 306
d) 321
58. When measuring credit risk, for the same counterparty:
a) A loan obligation is generally rated higher than a bond obligation.
b) A bond obligation is generally rated higher than a loan obligation.
c) A bond obligation is generally rated the same as a loan obligation.
d) Loans are never rated so it’s impossible to compare.

© 2000 GARP
59. A diversified portfolio of OTC derivatives with a single counterparty has a
net mark-to-market value of $29 million and a gross (sum of absolute
values) mark-to-market value of $75 million. If there are no netting
agreements in place with the counterparty, what is the current credit
exposure to the counterparty?
a) Less than or equal to $45 million.
b) Greater than $45 million but less than or equal to $55 million.
c) Greater than $55 million but less than or equal to $65 million.
d) Greater than $65 million.
60. The KMV credit risk model generates an estimated default frequency
(EDF) based on the distance between the current value of assets and the
book value of liabilities. Suppose that the current value of a firm’s assets
and the book value of its liabilities are $500 million and $300 million,
respectively. Assume that the standard deviation of returns on the assets is
$100 million, and that the returns on the assets are normally distributed.
Assuming a standard Merton Model, what is the approximate default
frequency (EDF) for this firm?
a) 0.010
b) 0.015
c) 0.020
d) 0.030
61. A credit-spread option has a notional amount of $50 million with a maturity
of one year. The underlying security is a 10-year, semi-annual bond with a
7% coupon and a $1,000 face value. The current spread is 120 basis points
against 10-year Treasuries. The option is a European option with a strike of
130 basis points. If at expiration, Treasury yields have moved from 6% to
6.3% and the credit-spread has widened to 150 basis points, what will be
the payout to the buyer of this credit-spread option?
a) $587,352
b) $611,893
c) $622,426
d) $639,023

© 2000 GARP
62. Bank One has made a $200 million loan to a software company at a fixed
rate of 12 percent. The bank wants to hedge its exposure by entering into a
Total Return Swap with a counterparty, Interloan Co., in which Bank One
promises to pay the interest on the loan plus the change in the market value
of the loan in exchange for LIBOR plus 40 basis points. If after one year,
the market value of the loan has decreased by 3 percent and LIBOR is 11
percent, what will be the net obligation of Bank One?
a) Net receipt of $4.8 million.
b) Net payment of $4.8 million.
c) Net receipt of $5.2 million.
d) Net payment of $5.2 million.

© 2000 GARP
Operational Risk Management
63. Which one of the following statements about operations risk is NOT
correct?
a) The operations unit for derivatives activities, consistent with other

trading and investment activities should report to an independent unit
and should be managed independently of the business unit.
b) It is essential that operational units be able to capture all relevant details

of transactions, identify errors and process payments or move assets
quickly and accurately.
c) Because the business unit is responsible for the profitability of a

derivatives function, it should be responsible for ensuring proper
reconciliation of front and back office databases on a regular basis.
d) Institutions should establish a process through which documentation

exceptions are monitored, resolved and appropriately reviewed by
senior management and legal counsel.
64. Which statement about operational risk is TRUE?
a) Measuring operational risk requires both estimating the probability of

an operational loss event and the potential size of the loss.
b) Measurement of operational risk is well developed, given the general

agreement among institutions about the definition of this risk.
c) The operational risk manager has the primary responsibility for

management of operational risk.
d) Operational risks are clearly separate from other risks, such as credit
and market.

© 2000 GARP
65. Which one of the following cases or events can be considered as resulting
from an operational risk?
a) A bank reports losses on a diversified portfolio of stocks during the

stock market decline.
b) The bank becomes embroiled in a high-profile lawsuit with a customer

that accuses it of improper selling practices.
c) The bank reports the loss of $1.5 billion due to rises in interest rates.
d) A US investor makes a loss as Japanese Yen depreciates relative to the

dollar.
66. Operational risk type losses range from high frequency, low severity to low
frequency, high severity often seen as a lognormal distribution. The
allocation of an institution’s capital should be applied against:
I. High Frequency, low severity (expected losses)
II. Low Frequency, high severity (unexpected Losses)
III. Extreme ‘tail’ events (high-stress losses)
a) I only
b) II only
c) III only
d) II and III
67. What does netting permit a firm to do?
a) Pay only the losses due to unfavorable market prices.
b) Net all of its gains against all of its losses.
c) Net its transaction with a given counterparty against each other.
d) Pay the losses only if the counterpart defaults.

© 2000 GARP
68. What is the reason for undertaking a Vega hedging? To minimize the:
a) Possibility of counterparty default risk.
b) Potential loss as a result of a change in the volatility of the underlying

source of risk.
c) Adverse effect due to the government regulation.
d) Potential loss as a result of a large movement in the underlying source

of risk.
69. Which of the following strategies can contribute to minimizing operational

risk?
I. Individual responsible for committing to transaction should

perform clearance and accounting functions.
II. To value current positions, price information should be obtained

from external sources.
III. Compensation scheme for trader should be directly linked to

calendar revenues.
IV. Trade tickets need to be confirmed with the counterparty.
a) I and II
b) II and IV
c) III and IV
d) I, II, and III

© 2000 GARP
70. A bond trader deals in $100 million in a market with very high volatility of
20 percent per annum. He yields $10 million profit. The Risk Capital (RC)
is computed as a Value-at-Risk (VaR) measure at the 99 percent level over
a year. Assuming normal distribution of return, calculate the Risk-Adjusted
Performance (RAPM).
a) 15.35%
b) 19.13%
c) 21.46%
d) 25.02%

© 2000 GARP
Market Risk Management
71. Computer Package Co. considers the following swap contracts to hedge its
interest rate exposure.
Initiation Date: June 15, 1999

Termination Date: June 15, 2001
Notional Amount: $10 million
Maturity: 1 years
Floating Index: Six-month LIBOR
Payment Frequency: Semiannual
Day Count: 30/360 for fixed and actual/360 for
floating
LIBOR Determination: Determined in advance, paid in arrears
Assume that the spot LIBOR yield curve at the origination of the swap
provides the following (annualized) rates:
0R6 = 4% and 0R12 = 4.5%
And that the day count for each settlement date is as follows:
First Settlement December 15, 1999 Number of Days = 183
Second Settlement June 15, 2000 Number of Days = 182
What is the fixed rate to be used in the swap contract?
a) 4.55 percent
b) 4.77 percent
c) 4.89 percent
d) 4.92 percent

© 2000 GARP
72. Hanwha Investment is underwriting a 30-year zero coupon corporate bond
issue with a face value of $50 million and a current market value of
$2,676,776 (a yield of 5% per six-month period). The firm must hold the
bonds for a few days before issuing them to the public, which exposes them to
interest rate risk. Hanwha Investment wishes to hedge its position by using T-
bond futures contracts. The current T-bond futures price is $90.80 per $100
par value, and the T-bond contract will be settled using a 20-year, 8 percent
coupon bond paying interest semiannually. The contract is due to expire in a
few days, so the T-bond price and the T-bond futures price are virtually
identical. Assume that the yield curve is flat and that the corporate bond will
continue to yield 0.5% more that T-bond per six-month period, even if the
general level of market rates should change. What hedge ratio should
Hanhwa Investment use to hedge its bond holdings against possible interest
rate fluctuations over the next few days?
a) 72 contracts held short to hedge.
b) 85 contracts held short to hedge.
c) 88 contracts held short to hedge.
d) 93 contracts held short to hedge.
73. What assumptions does a duration-based hedging scheme make about the way
in which interest rates move?
a) All interest rates change by the same amount.
b) A small parallel shift in the yield curve.
c) Any parallel shift in the term structure.
d) Interest rates movements are highly correlated.

© 2000 GARP
74. In a market crash the following are usually TRUE?
I. Fixed income portfolios hedged with short US Government Bonds

and futures lose less than those hedged with interest rate swaps
given equivalent durations.
II. Bid offer spreads widen due to less liquidity.
III. The spread between off the run bonds and the benchmark issues
widen
a) I, II & III
b) II & III
c) I & III
75. If portfolio A has a VaR of 100 and portfolio B has a VaR of 200, then the
VaR of the portfolio C=A+ B (perhaps under non-normal conditions):”
a) Will certainly be smaller than or equal to 300.
b) Will be exactly equal to 300.
c) Can be greater or smaller than 300.
d) Will be greater than 300.
76. How can a trader produce a short vega, long gamma position?
a) Buy short-maturity options, sell long-maturity options.
b) Buy long-maturity options, sell short-maturity options.
c) Buy and sell options of long maturity.
d) Buy and sell options of short maturity.

© 2000 GARP
77. A trader has put on a long position in a 2-year call on a stock whose strike
will be determined by the value of the stock in 1 year's time. You can
expect this position:
a) To have no delta, no gamma, and no vega.
b) To have no delta, no gamma, and appreciable vega.
c) To have small delta, no gamma, and appreciable vega.
d) To have small delta, no gamma, no vega.
78. What feature of cash and futures prices tend to make hedging possible?
a) They always move together in the same direction and by the same
amount
b) They move in opposite directions by the same amount
c) They tend to move together generally in the same direction and by the
same amount
d) They move in the same direction by different amounts.
79. Under which scenario is basis risk likely to exist?
a) A hedge (which was initially matched to the maturity of the underlying)

is lifted before expiration.
b) The correlation of the underlying and the hedge vehicle is less than one
and their volatilities are unequal.
c) The underlying instrument and the hedge vehicle are dissimilar.
d) All of the above

© 2000 GARP
80. Suppose that a value-at-risk estimate at a 95% confidence interval is $10.
What would be the approximate level of the value-at-risk if the confidence
level were raised to 99% (assume a one-tailed normal distribution)?
a) 10.4
b) 9.6
c) 14.1
d) 12.8
81. Which one of the following statements about the correlation coefficient is
FALSE?
a) It always ranges from –1 to +1.
b) A correlation coefficient of zero means that two random variables are

independent.
c) It is a measure of linear relationship between two random variables.
d) It can be calculated by scaling the covariance between two random

variables.
82. Which one of the following statements about credit risk from derivatives
instruments is NOT correct?
a) If credit limits are exceeded, exceptions should be resolved according to

the institution’s policies and procedures.
b) Credit exposures should always be computed net of risk-reducing

features such as master netting agreements and collateral or third party
guarantees.
c) Credit limits that consider both settlement and pre-settlement exposures

should be established for all counterparties with whom the institution
conducts business.
d) Prior to settlement, credit risk is measured as the sum of the

replacement cost of the position plus an estimate of the institution’s
potential future exposure from the instrument as a result of market
changes.

© 2000 GARP
83. Which one of the following statements about liquidity risk in derivatives
instruments is NOT TRUE?
a) Liquidity risk is the risk that an institution may not be able to, or cannot
easily, unwind or offset a particular position at or near the previous
market price because of inadequate market depth or disruptions in the
marketplace.
b) Liquidity risk is the risk that the institution will be unable to meet its
payment obligations on settlement dates or in the event of margin calls.
c) Early termination agreements can adversely impact liquidity because an

institution may be required to deliver collateral or settle a contract early,
possibly at a time when the institution may face other funding and
liquidity pressures.
d) An institution that participates in the exchange-traded derivatives

markets has potential liquidity risks associated with the early
termination of derivatives contracts.
84. Which one of the following statements about contract netting is NOT
correct?
a) By reducing the number and overall value of payments between

financial institutions, netting can enhance the efficiency of national
payment systems and reduce settlement costs associated with the large
and growing volume of foreign exchange transactions.
b) Netting can also contribute to an increase in systemic risk if, instead of

achieving reductions in participants’ true exposures, it merely obscures
the level of exposures.
c) Netting can reduce the size of credit and liquidity exposures incurred by
market participants and, thereby, contribute to the containment of
systemic risk.
d) Netting provides for effective reduction in credit exposures because of

the certainty provided by contract law throughout the world.

© 2000 GARP
85. Which one of the following statements about multilateral netting systems is
NOT accurate?
a) Systemic risks can actually increase because they concentrate risks on

the central counterparty, the failure of which exposes all participants to
risk.
b) The concentration of risks on the central counterparty eliminates risk

because of the high quality of the central counterparty.
c) By altering settlement costs and credit exposures, multilateral netting

systems for foreign exchange contracts could alter the structure of credit
relations and affect competition in the foreign exchange markets.
d) In payment netting systems participants with net-debit positions will be

obligated to make a net settlement payment to the central counterparty
that, in turn, is obligated to pay those participants with net credit
positions.
86. A bank’s capital requirements for market risk are based upon their own risk
measurement models. When computing Value-at-Risk (VaR), which one
of the following quantitative inputs is correct?
a) A horizon of 20 trading days, or four calendar weeks.
b) A 97.5% confidence interval.
c) An observation period based on at least six months of historical data.
d) Historical data updated at least once a quarter.
87. The capital charge for market risk for banks subject to the market risk rule
is:
a) Three times the calculated VaR
b) The average VaR over the last 50 days.
c) The higher of the previous day’s VaR, or three times the average
calculated VaR over the past 60 business days.
d) A minimum multiplicative factor of 3 times the higher of the previous

day’s VaR the average VaR over the last 60 business days.

© 2000 GARP
88. All of the following are examples of “moral hazard” EXCEPT:
a) Government guarantees of deposit insurance, which reduce incentives

for depositors to evaluate carefully the credit standing of banks.
b) The implied “put” option owned by bank shareholders, who realize the
benefits of risk taking but have limited liability for losses, which are
insured by the government.
c) Deposit insurance costs that are not related to the riskiness of the bank’s
activities, since the absence of risk-based costs provide perverse
incentives to take additional risk.
d) The use of internal models to allocate “economic” capital, since such

models permit banks to align capital requirements more closely with the
actual risks taken.
89. Regulators should be wary of establishing market risk capital requirements

for banks and securities firms that are too high for all of the following
reasons EXCEPT:
a) Shareholders need to earn a competitive return on capital at risk, and

returns are adversely affected by high capital requirements.
b) In times of stress, firms can take steps to reduce their exposure to risks.
c) When market forces break loose of economic fundamentals, sound

policy actions from supervisory bodies, not just capital, are necessary to
preserve financial stability.
d) Excessive capital requirements provide an incentive for a firm to adjust

their economic capital allocation models to reflect greater shareholder
value added (SVA) in particular business lines.

© 2000 GARP
90. Double gearing occurs whenever one entity holds regulatory capital issued
by another entity within the same group/organization, and the issuer is
allowed to count the capital in its own balance sheet. The principal issue
raised by double or multiple gearing is:
a) The impact on the ownership structure, which becomes unclear because

of reciprocal capital holdings.
b) When multiple gearing is present, assessments of group capital for a

financial conglomerate that are based on the capital of individual
entities within the group are likely to overstate the external capital of
the group.
c) The arbitrariness of excluding intra-group holdings from assessments of

group capital.
d) When multiple gearing is present, it permits firms within the corporate

family to borrow capital from one another, thereby increasing market
transparency and increasing systemic risk.
91. A six-month call option sells for $30, with a strike price of $120. If the
stock price is $100 per share and the risk-free interest rate is 5 percent, what
is the price of a 6-month put option with a strike price of $120?
a) $39.20
b) $44.53
c) $46.28
d) $47.04

© 2000 GARP
92. The hedge ratio is the ratio of derivatives to a spot position (or vice versa)
that achieves an objective such as minimizing or eliminating risk. Suppose
that the standard deviation of quarterly changes in the price of a commodity
is 0.57, the standard deviation of quarterly changes in the price of a futures
contract on the commodity is 0.85, and the covariance between the two
changes is 0.3876. What is the optimal hedge ratio for a three-month
contract?
a) 0.1893
b) 0.2135
c) 0.2381
d) 0.2599
93. Assume Global Funds manages an equity portfolio worth $50,000,000 with
a beta of 1.8. Further, assume that there exists an index call option contract
with a delta of 0.623 and a value of $500,000. How many options contracts
are needed to hedge the portfolio?
a) 169
b) 289
c) 306
d) 321
94. Which one of the following statement is MOST correct?
a) When holding a portfolio of stocks, the portfolio’s value can be hedged

by purchasing a stock index futures contract.
b) Speculators play an important role in the futures market by providing

the liquidity that makes hedging possible and assuming the risk that
hedgers are trying to eliminate.
c) Someone hedging with a futures contract does not bear the basis risk.
d) Cross hedging involves an additional source of basis risk arising from

that fact that the asset being hedged is exactly same as the asset
underlying the futures.

© 2000 GARP
95. Consider a bullish spread option strategy of buying a call option with a $30
exercise price at a cost of $3 and writing a call option with a $40 exercise
price at a premium of $1.50. If the price of the stock increases to $42 at
expiration and the option is exercised on the expiration date, the net profit
per share at expiration (ignoring transaction costs) will be:
a) $8.50
b) $9.00
c) $9.50
d) $12.50
96. Which one of the following statements about historic U.S. Treasury yield
curve changes is TRUE?
a) Changes in long-term yields tend to be larger than in short-term yields.
b) Changes in long-term yields tend to be of approximately the same size

as changes in short-term yields.
c) The same size yield change in both long-term and short-term rates tends
to produce a larger price change in short-term instruments when all
securities are trading near par.
d) The largest part of total return variability of spot rates is due to parallel
changes with a smaller portion due to slope changes and the residual
due to curvature changes.
97. A trader buys an at-the-money call option with the intention of delta-
hedging it to maturity. Which one of the following is likely to be the most
profitable over the life of the option?
a) An increase in implied volatility.
b) The underlying price steadily rising over the life of the option.
c) The underlying price steadily decreasing over the life of the option.

© 2000 GARP
d) The underlying price drifting back and forth around the strike over the
life of the option.
98. A 90-day Eurodollar futures contract has a constant PVBP of $25.00 per
million. The 90-day bank bill futures contract on the Sydney Futures
Exchange trades on a discount basis and the Price Value of a Basis Point
(PVBP) is different for each yield level. In this example, what are the two
major risks associated with using 90-day bank bill futures to hedge a
Eurodollar futures position?
a) Basis Risk and Credit Risk
b) Credit Risk and Currency Risk
c) Currency Risk and Basis Risk
d) Liquidity Risk and Credit Risk
99. The Black-Scholes yield volatility of an at-the-money 2 into 3-year

European swaption struck at 7% is 15%. The swap payment frequency is
semi-annual and the yield curve is flat. What is the volatility of an at the
money swaption, identical in all respects, expect that the payment
frequency is quarterly:
a) 15%
b) Somewhat higher than 15%
c) Somewhat lower than 15%
d) 22%
100. Unlike stock prices, interest rates appear to be pulled back to some long-run
average level. What is the name of this phenomenon?
a) Regression
b) Mean reversion
c) Inversion
d) Conversion

© 2000 GARP
101. According to the expectation hypothesis future levels of interest rates can
be read off of the current yield curve. What is this information called?
a) Implicit conversion factors
b) Indexed forward rates
c) Implied forward rates
d) Forward rates reduction procedures
102. A commodity-trading firm has an options portfolio with a two-day Value-

at-Risk (VaR) of $2.5 million. What would be an appropriate translation of
this VaR to a ten-day horizon under normal conditions?
a) $3.713 million.
b) $4.792 million.
c) $5.590 million.
d) Cannot be determined
103. What is the correct interpretation of a $3 million overnight Value-at-Risk

(VaR) figure with a 95% confidence level? The institution can be expected
to lose:
a) At least $3 million in 5 out of next 100 days.
b) At least $3 million in 95 out of next 100 days.
c) A maximum of $3 million with a 5% chance.
d) A minimum of $3 million with a 95% chance.

© 2000 GARP
104. The following are the net currency positions of a financial institution. Net
currency positions are defined as foreign exchange bought minus foreign
exchange sold restated in U.S. dollar terms.
Currency Net Position Standard

Deviation
Deutsche Mark -$250,000 1.5%
Japanese Yen $530,000 1.3%

British Pound -$455,350 1.4%
Swiss Franc $230,670 1.7%
How would you characterize the risk exposure of the financial institution to
fluctuations in the foreign currencies to U.S. dollar exchange rate?
a) The financial institution is net short in the Deutsche Mark and therefore
faces the risk that the Deutsche mark will rise in value against the U.S.
dollar.
b) The financial institution is net short in the Japanese Yen and therefore
faces the risk that the Japanese Yen will fall in value against the U.S.
dollar.
c) The financial institution is net long in the British Pound and therefore
faces the risk that the British Pound will fall in value against the U.S.
dollar.
d) The financial institution is net long in the Swiss Franc and therefore
faces the risk that the Swiss Franc will rise in value against the U.S.
dollar.
105. Value-at-Risk (VaR) analysis should be complemented by stress-testing

because stress testing:
a) Provides a maximum loss, expressed in dollars.
b) Summarizes the expected loss over a target horizon within a minimum

confidence interval.
c) Assesses the behavior of portfolio at a 99 percent confidence level.
d) Identifies losses that go beyond the normal losses measured by VaR.

© 2000 GARP
Quantitative Analysis
106. Consider the following bonds:
Bond Number Maturity (yrs) Coupon Rate Frequency Yield (ABB)

1 10 6% 1 6%
2 10 6% 2 6%
3 10 0% 1 6%
4 10 6% 1 5%
5 9 6% 1 6%
How would you rank the bonds from the shortest to longest duration?
a) 5-2-1-4-3
b) 1-2-3-4-5
c) 5-4-3-1-2
d) 2-4-5-1-3
107. A bond portfolio manager invests $20 million in a bond issued at par that
matures in 30 years, and which promises to pay an annual interest rate of
9%. The interest is paid once per year, and the payments are reinvested at
an annual interest rate of 8%. The first payment is one year from today.
What is the annual yield on this investment?
a) 8.185%
b) 8.285%
c) 8.385%
d) 8.415%

© 2000 GARP
108. The distribution of one-year returns for a portfolio of securities is normally
distributed with an expected value of €45 million, and a standard deviation of
€16 million. What is the probability that the value of the portfolio, one year
hence, will be between €39 million and €43 million?
a) 8.6%
b) 9.6%
c) 10.6%
d) 11.6%
109. If X(t) follows a lognormal process then the correlation between X(t) and
1/X(t) is:
a) –1
b) –1/2
c) 1
d) ½
110. Which of the following statements are TRUE?
I. The convexity of a 10-year zero coupon bond is higher than the

convexity of a 10-year, 6% bond.
II. The convexity of a 10-year zero coupon bond is higher than the
convexity of a 6% bond with a duration of 10 years.
III. Convexity grows proportionately with the maturity of the bond.
IV. Convexity is always positive for all types of bonds.
V. Convexity is always positive for “straight” bonds.
a) I only
b) I and II only
c) I and V only
d) II, III, and V only

© 2000 GARP
111. A 4.5-year 6% straight bond with annual coupon payments is traded at a
clean price of 103.50. Calendar convention is 30E/360. The modified
duration of the bond is 3.6%. The PVBP (Price value of a Basis Point) is:
a) 0.0383
b) 0.0373
c) 0.0414
d) 0.0360
112. Positive autocorrelation in prices can be defined as:
a) An upward movement in price is more than likely to be followed by

another upward movement in price.
b) A downward movement in price is more than likely to be followed by

another downward movement in price.
c) Both A and B
d) Historic prices have no correlation with futures prices.
113. If we say that commodity returns follow a lognormal distribution, we mean

that over time:
a) The natural logarithm of the price is normally distributed.
b) The change in the price is normally distributed.
c) The change in the natural logarithm of the price is normally distributed

over time.
d) The reciprocal of the price is normally distributed.

© 2000 GARP
114. A stock trading at a price of 90 has a (lognormal) price volatility of 40%.
The range of prices covered by a 1 standard deviation move up and a 1
standard deviation move down over one year is about:
a) 80 points
b) 72 points
c) 62 points
d) 74 points
115. Consider the following estimated linear regression model:
Y = 0.08 – 0.5X + e
R2 = coefficient of determination = 0.64
You also know that the standard deviation of the independent variable is
0.4, and the variance of the dependent variable is 0.09. What is cov(X,Y)?
a) 0.01152
b) 0.0288
c) 0.0768
d) 0.096
116. Many statistical problems arise when estimating relationships using

regression analysis. Some of these problems are due to the assumptions
behind the regression model. Which one of the following is NOT one of
these problems?
a) Stratification
b) Multicollinearity
c) Heteroscedasticity
d) Autocorrelation

© 2000 GARP
117. The return on a portfolio is normally distributed with an expected rate of
return of 10%, and a standard deviation of 20%. What is the probability that
the return will be between 0% and 5%?
a) 7%
b) 9%
c) 11%
d) 13%
118. Which group of term structure models do the Ho-Lee, Hull-White and
Heath, Jarrow & Morton models belong to?
a) No-arbitrage models
b) Two-factor models
c) Log normal models
d) Deterministic models
119. A plausible stochastic process for the short-term rate is often considered to
be one where the rate is pulled back to some long-run average level. Which
one of the following term structure models does NOT include this
characteristic?
a) The Vasicek model
b) The Ho-Lee model
c) The Hull-White model
d) The Cox-Ingersol-Ross

© 2000 GARP
120. In a market risk management system, a long position in a 6-month floating
coupon will reset one year from now and mature 18 months from now for a
nominal amount of 1 million Euro can be mapped as a:
a) Long position in 1 million Euro on the one-year bucket and a short

position on the 18-month bucket.
b) Long position in the current coupon rate on the 1-year bucket.
c) Long position in the current coupon rate on the 18-month bucket.
d) Short position in 1 million Euro on the one-year bucket and a long

position on the 18-month bucket.
121. Which one of the following long positions is more exposed to an increase in
interest rates?
a) A treasury bill
b) 10-year fixed coupon bond
c) 10-year floater
d) 10-year reverse floater
122. Which concept gives a measure of historical value added per unit of risk
taken and can be useful, among other tools, to risk managers?
a) Tracking error
b) Model alpha
c) Information ratio
d) Heteroskedasticity

© 2000 GARP
123. What can cause the total duration of a bond index to decrease even as the
durations of each subsector (short, mid, and long) increase?
a) There is a coupon payment on the largest bond in the index.
b) Some bonds in the index rollover from long to mid, and some from mid
to short.
c) The whole yield curve shifts down by a substantial amount.
d) This cannot happen.
124. Which one of the following is NOT a broad market impact of contract
netting?
a) An increase in market liquidity which could affect prices stability,

though the direction and magnitude of the effect is not obvious.
b) Reductions in credit exposures incurred in foreign exchange trading

which could induce market participants to shift credit and capital
resources to different markets.
c) The reduction in participants’ credit exposures and

settlement/processing costs which will reduce the incremental costs of
transactions, and therefore may prompt expanded trading activities and
enhanced market liquidity.
d) A reduction of systemic risk which satisfies central banks’ interest in

avoiding instability of exchange markets. This arises from a clearly
lower market volatility in a netting environment.
125. If the F-test shows that the set of X variables explain a significant amount of
variation in the Y variable, then:
a) Another linear regression model should be tried.
b) A t-test should be used to test which of the individual X variables, if

any, should be discarded
c) A transformation of the Y variable should be made.
d) Another test could be done using an indicator variable to test the

significance level of the model.

© 2000 GARP
126. A firm has just issued $1,000 face value bonds with a coupon rate of 8
percent, paid semi-annually, and a maturity of 15 years. If the issue price
for this bond is $785.50, what is the yield-to-maturity, stated annually?
a) 9.872 percent
b) 10.365 percent
c) 10.942 percent
d) 11.120 percent
127. You are given that X and Y are random variables each of which follows a
standard normal distribution with a covariance, σX,Y, of 0.6. What is the
variance of (3X+4Y)?
a) 35.0
b) 36.3
c) 37.5
d) 39.4
128. For a lognormal variable X, we know that ln(X) has a normal distribution
with a mean of 0 and a standard deviation of 0.5. What are the expected
value and the variance of X?
a) 1.025 and 0.187
b) 1.126 and 0.217
c) 1.133 and 0.365
d) 1.203 and 0.399

© 2000 GARP
Regulation and Compliance
129. The Bank of Japan:
a) Is the primary Japanese bank authorized to review risk management

practices of foreign investment banks and brokers in Japan.
b) Shares its bank supervisory and audit role with the FSA.
c) Has no supervisory or audit responsibilities with regard to financial

institutions.
d) Is authorized to supervise broker-dealer entities only.
130. Which country is a part of OECD?
a) Korea
b) France
c) Mexico
d) All of the above
131. The June 1999 Basle Committee on Banking Supervision issued proposals
for reform of its 1988 Capital Accord (the Basel II Proposals). An
implication of these proposed reforms is the possibility of:
a) using internal models or external ratings in the computation of

minimum capital requirements.
b) Allocating capital based on an internal VaR model.
c) Including credit risk the overall internal model framework to compute

BIS capital requirement.

© 2000 GARP
132. Which country is currently (as of November 2000) part of the European
Monetary Union (adopted EUR as its currency)?
a) Greece
b) Sweden
c) Denmark
133. FAS133 requires that firms listed in the US:
a) Use VaR for their internal models.
b) Mark all the derivatives in the banking book to market.
c) Prove “hedge effectiveness” in order to apply accrual accounting to

derivatives.
134. BIS capital requirement for an unfunded, short-term (under one year) credit
commitment is:
a) 0%
b) 4%
c) 8%
d) 100%
135. As of November 2000, which one of the following will generally receive
8% BIS capital charge (100% asset weight)?
a) Investment in a publicly traded stock for trading purposes.
b) Investment in a US government bond.
c) Investment in a Venture Capital fund for speculation purposes.

© 2000 GARP
136. The BIS regulatory capital treatment for the credit risk of OTC derivatives
is:
a) (Net Replacement Value) x 8%
b) 3 x (Credit VaR)
c) (potential exposure) - (current exposure)
137. The BIS requirement for capital charge of an unfunded commitment of

original maturity of greater than one year, as compared to an equivalent
funded commitment (or loan) is:
a) The same
b) Half
c) A quarter
d) Zero
138. Systemic Risk is:
a) VaR of a traded portfolio.
b) Credit risk of a traded portfolio.
c) Technology risk.
139. Tier 1 capital includes all of the following EXCEPT:
a) Asset revaluation reserves.
b) Common stock.
c) Noncumulative preferred shares.
d) Disclosed reserves.

© 2000 GARP
140. What would be the market risk capital requirement for a bank with a one-
day VaR of $100 and a specific risk surcharge of $30, based on the current
BIS minimum capital requirements?
a) $300
b) $316
c) $949
d) $979

© 2000 GARP
Answer Key
1 C
2 D
3 D
4 D
5 A
6 A
7 B
8 D
9 D
10 C
11 A
12 A
13 C
14 C
15 D
16 C
17 B
18 D
19 D
20 C
21 B
22 B
23 C

© 2000 GARP
24 C
25 B
26 A
27 D
28 D
29 A
30 D
31 D
32 A
33 B
34 A
35 A
36 A
37 C
38 B
39 C
40 C
41 D
42 C
43 B
44 D
45 B
46 C
47 D
48 A

© 2000 GARP
49 C
50 D
51 A
52 D
53 A
54 D
55 C
56 B
57 B
58 A
59 B
60 C
61 C
62 A
63 C
64 A
65 B
66 D
67 C
68 B
69 B
70 C
71 A
72 C
73 B

© 2000 GARP
74 B
75 A
76 A
77 C
78 C
79 D
80 C
81 B
82 B
83 D
84 D
85 B
86 D
87 D
88 D
89 D
90 B
91 D
92 D
93 B
94 B
95 A
96 D
97 D
98 C

© 2000 GARP
99 A
100 B
101 C
102 C
103 A
104 A
105 D
106 A
107 C
108 B
109 A
110 C
111 A
112 C
113 C
114 B
115 D
116 A
117 B
118 A
119 B
120 A
121 D
122 C
123 B

© 2000 GARP
124 D
125 B
126 C
127 D
128 C
129 B
130 D
131 A
132 D
133 C
134 A
135 C
136 D
137 B
138 D
139 A
140 D

© 2000 GARP

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2000 Financial Risk Manager Examination

Saturday, November 18, 2000

2000 Financial Risk Manager Examination 1

Capital Markets Risk Management (20 Questions) Page 4

Legal, Accounting and Tax (6 Questions) Page 11

Credit Risk Management (36 Questions) Page 14

Operational Risk Management (8 Questions) Page 27

Market Risk Management (35 Questions) Page 31

Quantitative Analysis (23 Questions) Page 45

Regulation and Compliance (12 Questions) Page 53

Answer Key Page 57

2000 Financial Risk Manager Examination 2

Kanwardee Ahluwalia, Jean-Martin Aussant,

2000 Financial Risk Manager Examination 3

a) Extreme derivatives mispricing.

b) Lack of VaR process at LTCM.

c) Extreme leverage by LTCM.

d) All of the above.

2. Loans are securitized to:

a) Reduce regulatory capital.

b) Reduce credit concentrations.

c) Provide access to loan products for investors.

d) All of the above.

a) It is similar to a U.S. Treasury bond.

b) It is similar to a plain vanilla corporate bond.

2000 Financial Risk Manager Examination 4

a) $379.85 and $156.59

b) $318.05 and $615.00

c) $387.84 and $163.25

d) $388.84 and $164.00

6. A 90-day Eurodollar futures contract has a constant PVBP of $25.00 per

a) Always less than the Eurodollar contract.

b) Always greater than the Eurodollar contract.

c) Dependent on the market yield.

d) $27.00 per million.

2000 Financial Risk Manager Examination 5

a) Long-dated forward contracts will have higher prices than long-dated

b) Long-dated futures contracts will have higher prices than long-dated

d) The “convexity effect” can be ignored for long-dated futures contracts

9. An investment in a callable bond can be analytically decomposed into a:

a) Long position in a non-callable bond and a short position in a put

b) Short position in a non-callable bond and a long position in a call

c) Long position in a non-callable bond and a long position in a call

d) Long position in a non-callable and a short position in a call option.

2000 Financial Risk Manager Examination 6

I. A lower bound on the Bermudan price is a 2 into 3 year European

III. A lower bound on the Bermudan price is a 2 into 5 year European

Which of the following statements is(are) TRUE?

c) The 6% coupon would decrease the duration of the contract, making it a

d) There will be no impact at all by the change.

2000 Financial Risk Manager Examination 7

13. A CLO is generally:

a) A set of loans that can individually be traded in the market.

c) A set of bonds backed by a loan portfolio.

d) None of the above.

14. Which statement is FALSE about the value of an option?

a) At expiration, its premium equals intrinsic value.

c) It is determined by an option-pricing model.

2000 Financial Risk Manager Examination 8

17. Which one of the following statements is MOST correct?

a) When holding a portfolio of stocks, the portfolio’s value can be fully

b) Speculators play an important role in the futures market by providing

d) Cross hedging involves an additional source of basis risk because the