FRM Exam2000
FRM Exam2000
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Copyright 2000
1. The Long Term Capital Management (LTCM) fiasco was an example of:
3. How would you describe the typical price behavior of a low premium
mortgage pass-through security?
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.
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
c) Long-dated forward and long-dated futures prices are always the same.
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
II. An upper bound on the Bermudan price is a cap that starts in 2 years
and matures in 5 years.
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%.
a) 543.26
b) 552.11
c) 555.78
d) 560.02
b) A pass-through.
b) Before expiration, its premium is the sum of time and intrinsic value.
d) Intrinsic value is the difference between the market price and the strike
price.
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
c) Someone generally using futures contracts for hedging does not bear the
basis risk.
a) Writing a put, buying the stock, and selling short bonds (borrowing).
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.
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
21. Which one of the following statements about SFAS 133 is NOT TRUE?
22. A typical master netting agreement as established by ISDA will contain all
of the following EXCEPT a list of:
a) Obligations.
c) Credit provisions.
a) Capital gains.
b) Dividend income.
c) Ordinary income.
d) Interest income.
II. The fair market value for the hybrid contract otherwise would not
be reported on the balance sheet.
a) I and II
b) II and III
c) I, II and III
III. Recording market prices at the same local time in both locations.
a) I or II
b) II or IV
c) I, II or IV
d) I, II, III or IV
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
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
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
34. What is the difference between the marginal default probability and the
cumulative default probability?
d) Both a and c.
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.
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%
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
a) Replacement value
b) Mark to market
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
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.
a) $672,000
b) $742,000
c) $880,000
d) $923,000
48. Cumulative default rates for B-rated corporate bonds in the United States
are about:
a) 1.278
b) 1.763
c) 2.078
d) 2.215
b) Correlations among the transitions for the various rating quality assets
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:
c) One provides an enhanced return to the investor; the other does not.
b) Returns the maximum of the difference between the strike level and the
remaining market value of the first to default loan or zero.
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:
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
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
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.
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
63. Which one of the following statements about operations risk is NOT
correct?
d) Operational risks are clearly separate from other risks, such as credit
and market.
c) The bank reports the loss of $1.5 billion due to rises in interest rates.
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:
a) I only
b) II only
c) III only
d) II and III
a) I and II
b) II and IV
c) III and IV
a) 15.35%
b) 19.13%
c) 21.46%
d) 25.02%
71. Computer Package Co. considers the following swap contracts to hedge its
interest rate exposure.
Assume that the spot LIBOR yield curve at the origination of the swap
provides the following (annualized) rates:
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
a) 4.55 percent
b) 4.77 percent
c) 4.89 percent
d) 4.92 percent
73. What assumptions does a duration-based hedging scheme make about the way
in which interest rates move?
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):”
76. How can a trader produce a short vega, long gamma position?
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
c) They tend to move together generally in the same direction and by the
same amount
b) The correlation of the underlying and the hedge vehicle is less than one
and their volatilities are unequal.
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?
82. Which one of the following statements about credit risk from derivatives
instruments is NOT correct?
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.
84. Which one of the following statements about contract netting is NOT
correct?
c) Netting can reduce the size of credit and liquidity exposures incurred by
market participants and, thereby, contribute to the containment of
systemic risk.
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?
87. The capital charge for market risk for banks subject to the market risk rule
is:
c) The higher of the previous day’s VaR, or three times the average
calculated VaR over the past 60 business days.
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.
b) In times of stress, firms can take steps to reduce their exposure to risks.
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
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
c) Someone hedging with a futures contract does not bear the basis risk.
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?
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?
b) The underlying price steadily rising over the life of the option.
c) The underlying price steadily decreasing 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) 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
a) $3.713 million.
b) $4.792 million.
c) $5.590 million.
d) Cannot be determined
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.
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%
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
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.
a) I only
b) I and II only
c) I and V only
a) 0.0383
b) 0.0373
c) 0.0414
d) 0.0360
c) Both A and B
a) 80 points
b) 72 points
c) 62 points
d) 74 points
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
a) Stratification
b) Multicollinearity
c) Heteroscedasticity
d) Autocorrelation
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
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?
d) The Cox-Ingersol-Ross
121. Which one of the following long positions is more exposed to an increase in
interest rates?
a) A treasury bill
c) 10-year 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
b) Some bonds in the index rollover from long to mid, and some from mid
to short.
124. Which one of the following is NOT a broad market impact of contract
netting?
125. If the F-test shows that the set of X variables explain a significant amount of
variation in the Y variable, then:
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?
b) Shares its bank supervisory and audit role with the FSA.
a) Korea
b) France
c) Mexico
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) Greece
b) Sweden
c) Denmark
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)?
b) 3 x (Credit VaR)
a) The same
b) Half
c) A quarter
d) Zero
c) Technology risk.
b) Common stock.
d) Disclosed reserves.
a) $300
b) $316
c) $949
d) $979
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
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
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
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
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
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