Wiley 2015
FRM Exam Review
INTRODUCTION
l Success will take a lot of hard work, around 200 hours of study
time, and intuition and understanding of the topics rather than
just wrote memory.
l Wileys FRM Exam Review lectures have as much information as
the Study Guides. Dont neglect them. Read the study notes but
then put them aside and focus on the tips in the lectures. Make
sure you are really comfortable with the calculate learning
objectives and focus mostly on what lead author Christian Cooper
tells you is important.
l The FRM Exam Review program has been created in a way that
connects as many of the dots as possible to reduce memorization,
increase understanding, and give you the confidence to rely on
your best guess. Weve all taken tests where two answers are
obviously wrong but those last two could be 50/50. This is where
you will pass the test, using intuition to increase your odds
beyond a random guess.
THE SYSTEM
l The class/lecture notes provide the basis for the lectures.
Students should underline, highlight, circle, as well as annotate
in the margins any examples, insights, tips and so forth given by
Christian.
l The act of writing will greatly enhance retention, so it is an
integral part of the approach.
l The importance of practice to retain the material until exam day
cannot be overstated. We are going to focus on topics that can
be connected, the calculate learning objectives, and the must
know 80% to get you to a passing score on exam day.
THE WINNING STRATEGY
l Set up a study plan, follow it, and reach out to Christian for
anything you are stuck on. No question is dumb and if you are
having a problem, a big chunk of the other students are, too,
and that is something Christian can focus on to explain better.
Christian is your partner in passing and wants to help in anyway
he can. Sometimes the dreaded duo of personal and professional
responsibilities often conspire to disrupt study plans. At some
point, intelligent compromises may have to be made (e.g., reduce
trips to the gym from 5 to 3 days per week, install Web browser
extensions that block Reddit, Recode, ZeroHedge etc.)
FRM TOPIC WEIGHTS
l In the morning session of the FRM exam, there are 100 multiple-
choice questions (in 3 hours) on the Part I FRM Exam. Thats
just under 2 minutes per question, so pace and stamina are
important. You should time yourself when you are taking the
practice exams.
l The following table outlines the most important topics in terms
of the Weight to Study Session (SS) Ratio; it helps FRM candidates
determine where theyll get the best bang for their buck.
Foundations of Risk ManagementPart I Exam Weight: 20%
Quantitative AnalysisPart I Exam Weight: 20%
Financial Markets and ProductsPart I Exam Weight: 30%
Valuation and Risk ModelsPart I Exam Weight: 30%
efficientlearning.com/frm
l GARP does not disclose passing score, only passing percent of
the test taking population. Our best guest from the data GARP
provides is the passing population is a double-hump normal
distribution. That is, there is a large population under the passing
score that is normally distributed and also a normal distribution
among those who meet the passing grade. This would imply that
GARP first decides on a passing percent of the population and
that then informs the passing grade, which can change from year
to year. Instead of trying to game the exam, we are going to focus
on the parts of the exam you must know, but also stop short of
making you a complete expert in every subject area. We want to
to be sure you are going to pass but pretty sure you arent going
to get a perfect score and that is OK.
TIPS
FOUNDATIONS OF RISK MANAGEMENTPART I
EXAM WEIGHT 20%
(FRM) 14 total readings in the 2016 curriculum
RISK MANAGEMENT SECTION WITHIN
FOUNDATIONS OF RISK MANAGEMENT
Basic risk types, measurement and management tools
Creating value with risk management
The role of risk management in corporate governance
Enterprise Risk Management (ERM)
Financial disasters and risk management failures
l Pay particular attention to hot topics such as the financial
disaster section.
l This section begins what is a top-down approach to risk
management. These sections are very light on formulas and are
a qualitative introduction to best practices across firms. More
importantly, this section begins to focus on how risk management
actually creates firm value as opposed to the cost center it is
normally seen as.
PORTFOLIO MANAGEMENT SECTION WITHIN
FOUNDATIONS OF RISK MANAGEMENT
The Capital Asset Pricing Model (CAPM)
Risk-adjusted performance measurement
Multi-factor models
Information risk and data quality management
Ethics and the GARP Code of Conduct
Here, we move into a more quantitative treatment of risk
management by looking at the return of some asset relative to the
risk (expressed as standard deviation) and the theoretical bounds we
place around the pricing of risky assets.
The Capital Asset Pricing Model (CAPM) introduces the idea of a single
parameter to define risk and then any investor can use leverage to
increase or decrease their exposure to the market portfolio as they
wish. This notion of a single measure of risk is then extended in the
Wiley 2015
FRM Exam Review
later readings to include additional factors to explain asset returns.
It is important to note that both of these require assumptions to be
made about future volatility and future expected returns so they
dont have predictive uses, just risk management and portfolio
allocation uses.
QUANTITATIVE ANALYSISPART I
EXAM WEIGHT 20%
(QA) 15 total reading in the 2016 curriculum
Discrete and continuous probability distributions
Estimating the parameters of distributions
Population and sample statistics
Bayesian analysis
Statistical inference and hypothesis testing
Correlations and copulas
Estimating correlation and volatility using EWMA and GARCH
models
Volatility term structures
Linear regression with single and multiple regressors
Time series analysis
Simulation methods
l Quantitative Methods may seem intimidating. Practice will help
you master this topic! FRM candidates should be prepared to use
calculations in otherwise what might be an explain learning
objective. GARP likes to combine topics especially in the longer
vignette style questions to be prepared for quantitative analysis
to pop up anywhere.
l Most importantly, understand relationships between the concepts
because sometimes you can easily eliminate clearly wrong
answers.
l The following topics will always be on the exam, make sure you
know these cold.
HYPOTHESIS TESTING
l A question that appears with great regularity is a typical
hypothesis test to draw conclusions about a sample. Because
we can never prove something to be true, the next best thing is
to try and prove that something is not true, then by default, we
can conclude that the opposite is true given a specified level
of confidence. Be sure to practice the procedures for performing
hypothesis tests:
1. State the hypothesis.
2. Identify the test statistic for the hypothesis test.
3. Specify the level of significance for the hypothesis test.
4. State the decision rule.
5. Collect the data and perform all necessary calculations.
6. Make the statistical decision.
l With practice, FRM candidates hypothesis testing can be tackled
easily. Key things to notice from these problems are:
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One-tailed test or two-tailed test: For a level of significance
(alpha) of 5%, we use p = 0.05 for a one-tailed test and 0.025 for
a two-tailed test.
We use the t-statistic instead of the Z-score when:
The sample size is small (< 30), and
The population standard deviation is unknown.
When practicing these types of questions, be sure to
understand what the interpretation of the results are. These
questions can ask for an interpretation rather than whether
the null can be rejected.
l Regarding conceptual hypothesis testing questions on Type I and
Type II errors, note the following:
Because hypothesis acceptance depends on probabilities,
Type I and Type II errors may very well result.
The probability of a Type I error is equal to the level of
significance (alpha). FYI, the probability of a Type II error is not
1the probability of a Type I error.
When doing a test of a hypothesis, there are four possible
outcomes:
Not reject a true null No error, good
Reject a true null Type I error
Reject a false null No error, good
Not reject a false null Type II error
The only way to reduce the risk of Type I and Type II errors is to
increase the sample size.
The power of the hypothesis test is the probability of rejecting
a false null hypothesis.
There is typically at least one question directly or indirectly on
Type I and Type II errors on the exam. Be sure you understand
this concept.
l A diagram often helps answer hypothesis questions, whether
conceptual or involving calculating acceptance ranges. By
sketching the diagram and the indicated change in level of
significance, FRM candidates can easily see the effect of a change.
For example, by increasing the level of significance from 5%
to 10%, the fail-to-reject-null zone becomes narrower and the
rejection zone becomes wider. A wider rejection zone will increase
the chances of incorrectly rejecting the null hypothesis (increase
the chance of a Type I error). However, the risk of a Type II error
(failing to reject a false null hypothesis) will decrease.
l Remember that in statistics, one can never really prove a
null hypothesis is true; we can only infer that an alternative
hypothesis is true by proving that the null hypothesis is not true.
Therefore, we should be setting up the null and alternative such
that the alternative hypothesis is what we are really trying to
prove. If our calculations can lead us to reject the null hypothesis,
then we can say with a level of confidence that the alternative is
true.
CONFIDENCE INTERVALS
l A typical confidence interval question involves a confidence
interval of 95%. What often throws FRM candidates off is a
confidence interval that is not common (80%). An 80% confidence
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FRM Exam Review
interval is bound by 10% on either side under the normal curve,
so the appropriate Z-score for an 80% interval will actually be
found with the area representing 90% cumulative probability (an
area of 0.9000). Further, the exact Z-score corresponding to 0.9000
is not in the table. This unusual outcome, combined with the
stresses on exam day, can be distracting
l For questions asking for the confidence interval of a sample,
the first thing is to identify what the question is really asking,
and then be able to pick out the data that is required for the
calculations while ignoring the distracters. For example, because
the sample size of 16 is small (< 30), we know that we must use
the t-score and can ignore any information given regarding the
Z-scores. From there, plug in the relevant inputs into the formula
and calculate the confidence interval. FRM candidates should also
be prepared to notice whether one-tailed or two-tailed probability
tables are given and use the appropriate figures.
FINANCIAL MARKETS AND PRODUCTSPART I
EXAM WEIGHT 30%
(FMP) 20 total readings
YIELD CURVES (PAR, SPOT, FORWARD)
GENERAL POINTERS
l
This is a huge chunk of the reading and much of the exam will
draw from this section.
The readings for the Part I exam focus on the basic definitions
of the product first then extend those ideas into pricing
methodology using replicating portfolios
FRM candidates will need this base knowledge in order to
understand the securitized product and credit risk readings in
Part II of the exam:
Structure and mechanics of OTC and exchange markets
Structure, mechanics, and valuation of forwards, futures,
swaps and options
Hedging with derivatives
Interest rates and measures of interest rate sensitivity
Foreign exchange risk
Corporate bonds
Mortgage-backed securities
Rating agencies
TERM STRUCTURE OF INTEREST RATE THEORIES
l FRM candidates should know the theories on the slope of the
term structure of interest rates:
The pure expectations theory says that the yield curve reflects
the markets expectation of future interest rates. If the market
consensus is that yields will be rising, then a longer maturity
bond must have a higher yield than a shorter maturity bond
(i.e., the yield curve is upward sloping).
The liquidity preference theory (biased expectations theory)
says that longer-maturity bonds must offer a higher yield
compared to shorter-maturity bonds to compensate investors
for reducing their liquidity. According to the theory, this
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additional yield (called a term premium) increases with
maturity. Hence, the yield curve should normally be biased
upward.
The market segmentation theory hypothesizes that groups of
investors and issuers are restricted to specific maturity regions
of the yield curve. It argues that the shape of the yield curve
will reflect the relative supply and demand in various maturity
regions of the yield curve. If there is excess demand for bonds
at the shorter maturities and excess supply at the longer
maturities, then the yield curve will be upward sloping. The
market segmentation theory can potentially explain any shape
of the yield curve.
The preferred habitat theory is a variant of the market
segmentation theory, but is less restrictive. It posits that,
while particular groups of investors prefer to invest in specific
segments along the yield curve, they can be lured away from
their normal market segment, or preferred habitat, by higher
yields offered in other maturities. The preferred habitat theory
accommodates any shape the yield curve might take.
In order to answer more complex problems about the slope or
level of the various yield curves, FRM candidates first need to
know the basics:

Par yield curve:
The par yield curve is the coupon yield of newly issued, on-
the-run securities trading at par (which can be approximated
by the yield to maturity).
Effectively, par yields are the compounded total of the
appropriate spot rates for each cash flow on a bond.

Spot yield curve:
Spot rates apply to a single future cash flow (and therefore can
be used to value a bond).
Not all spot rates can be directly observed, but par yields are
observable. It is possible to use a sectors par yield curve to
determine the sectors spot rate curve through a process called
bootstrapping, which is where we calculate the implied
spot rates (rates that apply to a single cash flow) from the par
rates. FRM candidates should be prepared to do the math. The
assigned reading spends a lot of time on notation, but notation
itself is not important. The only important item is getting the
correct answer.

Forward yield curve:
Once we have the spot rates, it is possible to use them to find
the implied forward rates. A forward rate is a future rate, such
as the six-month rate, one year from now. Using the spot rates,
find forward rates by determining what the market is implying
the future rate will be. For example, the six-month forward rate
in one year is found based on an equivalency: Aninvestor should
be indifferent between investing in the 1.5-year zero-coupon
bond or investing in a 1-year zero-coupon bond and rolling the
proceeds in one year into a six-month zero-coupon bond.
There is a trick that can save time if a forward rate is re-
quested. With very short compounding periods (five periods
or less), the forward rate can be estimated as being the simple
Wiley 2015
FRM Exam Review
average. This allows for a quicker answer and does not require
the use of a calculator. For example, if the two- year spot is
7.0% and the one-year forward is 6.0%, then the two-year
forward has to be approximately 8.0% [(6.0 + 8.0)
/ 2 = 7]. The 7.0% is for two periods, so approximately 14.0%
isearned.
l With the basics out of the way, we can answer more complex
questions such as:
Whether the spot rate curve will be upward or downward
sloping and lower or higher, given an upward-sloping par yield
curve. The par yield curve can be viewed as weighted average
of spot rates. As a result, the slope of the spot rate curve
determines the slope of the par yield curve. The spot rate curve
is steeper than the par yield curve.
Accordingly, when the par yield curve slopes upward, the spot
yield curve will reside above it, and when the par yield curve
slopes downward, the spot yield curve resides below it.
Whether the implied one-year forward rates will increase at a
slower, same, or faster rate than the annualized spot rates are
increasing. The two-year spot rate is effectively the average of
the one- year spot rate and the one-year forward rate one year
from now.
Accordingly, if the two-year spot rate is larger than the one-
year spot rate, then the one-year forward rate one year from
now must be even larger.
PAR, PREMIUM, DISCOUNT
l FRM candidates should know that given an assumption of
constant YTM that discount bonds will increase to par value at
maturity, premium bonds will decrease to par value at maturity,
and par bonds will remain about the same price until maturity.
For example, in the case of a discount bond, the discount
amortizes over the life of the bond such that it will be worth par
at maturity. Thus, because it was sold below its par value, it must
increase in price to be worth par at maturity.
l FRM candidates should know that zero-coupon bonds are valued
based on their bond-equivalent yield. That requires discounting
the one bond cash flow at maturity by the semiannual yield and
number of compounding periods. For example, for a five-year
zero-coupon bond, the number of discounting periods would be
10 periods in order to compare it to a semiannual-pay five-year
bond. The rate would be half the yield-to-maturity.
l FRM candidates need to understand that the required yield, or
YTM, is the discount rate. If a bond pays a higher rate of interest
than the discount rate, then it will sell at a premium to its par
value. This is really just time value of money.
FORWARD CONTRACTS
l FRM candidates need to remember the basics:
A forward contract is an agreement to enter into a future trans-
action at a price specified at the contracts initiation. The basic
forward contract terminology is as follows:
The party obligated to deliver the underlying is the seller, or
short position.
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The party obligated to make payment and take delivery is the
buyer, or long position.
The quantity of the underlying asset to be delivered is the
contract size.
The date of delivery is the expiration, maturity, or
settlementdate.
Advantages/disadvantages for forwards are:
Customized to meet specific needs (advantage).
No money exchanges until contract expiration (advantage,
except for credit risk).
Credit risk that the counterparty will default (disadvantage).
Early exit requires negotiation with the counterparty (dis-
advantage).
Private transaction that provides little transparency (can be
advantage or disadvantage).
FRM candidates should be able to understand currency
movements and read the exchange rate quotes closely with
forward contracts (and swaps, forwards, options).
With a forward rate agreement (FRA), the buyer pays fixed and
receives floating. For example, with a 7 10 month FRA, the
buyer has agreed to pay the fixed rate. The floating rate it will
receive in return is the three-month rate of interest that exists
in seven months. The amount to be paid by the insurance
company is the difference in the rates times the notional
amount. But instead of paying the interest differential three
months after the seven months, the amount is paid immediately
(at the end of the seven months when the rate has been set).
FUTURES
l Be sure to know the basics on futures:
Futures contracts are standardized, which provides less
flexibility but more liquidity.
They are exchange traded with a clearinghouse acting as the
intermediary between the longs and the shorts. The clearing-
house guarantees performance and this minimizes credit risk.
The clearinghouse requires each participant to deposit initial
margin before entering a trade. This deposit is not a cost of the
contract.
Futures positions are marked-to-market daily.
If the margin balance falls below the maintenance margin, a
margin call will be generated. As discussed earlier, the futures
investor must bring the margin balance back up to the initial
margin level.
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FRM Exam Review
OPTIONS
l Covered call strategy:
This strategy entails buying the stock (that are likely to remain
unchanged or appreciate over the next 30 days) and writing a
call option (that are slightly in the money) on the stock.
The risk of loss exists and it occurs as the stock price falls.
The investors breakeven stock price is equal to the cost per
share for the stock bought less the premium per share received
for writing the calls.
The maximum loss will occur when the stock falls to $0, and
will equal the cost of the stock less the call premium.
This strategy should only be used if the outlook suggests the
stocks price will stay relatively unchanged or fall slightly.
It should not be used if the stock could rise or fall by a
substantial amount.
l Another common strategy is a protective (covered) put, also
known as portfolio insurance.
This strategy entails buying the stock and buying a put option
on the stock.
This allows the investor to retain the upside potential of the
portfolio and limit the downside risk.
There is the cost of the put, which reduces the investors profit
if the stock rises.
The investors maximum loss is equal to the price paid for the
stock and put, less the strike price for the put. The maximum
gain is unlimited and the breakeven point is equal to the sum
of the per share prices paid for the stock and the put.
Portfolio insurance is an attractive strategy if the stock might
rise or fall significantly. It performs poorly if the stock price re-
mains relatively flat.
l Under the heading of Volatility Risk in the Fixed Income
section above, you were told to remember that an options value
increases when the underlying instruments volatility increases.
If the value rises, the writer (seller) of the option will receive
a higher option premium. Thus, higher volatility will cause an
option to sell at a higher premium.
l For options, FRM candidates should know the difference between
American and European options. An American option, which does
not mean it is only traded in North America, can be exercised
at any time until expiration. In contrast, a European option can
be exercised only at expiration. Given the higher flexibility, an
American option should sell for a price equal to or greater than a
European option with the same terms.
l Also, you should know how other factors affect an options value.
FRM candidates should also know the following DIVUTS cheat
sheet by heart; it is simple, quick, and a great reference guide
that can be used across all three levels.
Dividends Call Put
Volatility Call Put
Interest Rate Call Put
Underlying Asset Price Call Put
Time to Expiration Call Put
Strike Price Call Put
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VALUATION AND RISK MODELSPART I
EXAM WEIGHT 30%
(VRM) 17 readings in total
l This is a deep dive into risk management building on all the
previous concepts within the FRM curriculum and builds strongly
upon the properties of the normal distribution and correlation
with respect to quantifying risk and the way to hedge that risk to
desired levels.
Value-at-Risk (VaR)
Expected shortfall (ES)
Stress testing and scenario analysis
Option valuation
Fixed income valuation
Hedging
Country and sovereign risk models and management
External and internal credit ratings
Expected and unexpected losses
Operational risk
l Make sure you are very comfortable with correlation problems,
especially how changing correlation impacts risk. Lastly, make
sure you are very clear on hedging with options and other
derivatives. This section continues into a little bit of content on
credit but the vast majority of credit readings will appear in PartII.
COVARIANCE AND CORRELATION
l While it may be more likely to be tested on concepts (most
questions ask for an interpretation, e.g. its role in diversification)
rather than straight calculations, you should know the formula for
calculating covariance.
Note that the data required to solve for covariance can also
be used for several other calculations (variance, standard
deviation, coefficient of variation, correlation, and coefficient
of determination). Case in point: Remember that correlation
is a standardized measure of the relationship between two
assets. It is dependent on the covariance between two assets.
So with that in mind, be ready for a 2 3 format question like
this one on exam day:
Covariance Correlation
a. 2.5 0.3
b. 2.5 0.60
c. 11.6 0.60
We interpret that there is a high likelihood of these concepts
(co- variance, correlation, etc.) appearing on the exam for the
following reasons:
There is overlap here with the material in Quantitative
Methods.
These concepts underlie much of what is done by portfolio
managers. In addition, it is critical at Part II and is included in
the Part I curriculum as well. We also interpret that as meaning
there is a greater likelihood of this concept appearing on the
exam.
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FRM Exam Review efficientlearning.com/frm

These concepts can be indirectly embedded in other

questions.
Accordingly, understanding these concepts is by far more

Smarter Test Prep

valuable than memorizing them.

SWAPS
l FRM candidates should understand the basics of swaps.
www.efficientlearning.com/frm
A swap agreement is a private over-the-counter contract,
where both parties agree to enter into a transaction at some
future date and at an agreed upon price at initiation. Often, Sign Up
no money changes hands at the initiation of the contract (true for Free
for interest rate swaps; not true for currency swaps). Swaps Resources
involve a commitment by both parties and normally involve a and Tips
series of transactions. Today!
Typically, one party to a swap agrees to pay a fixed set of cash
flows in return for a variable set of cash flows from another
party. For example, in an interest rate swap, the fixed-rate
payer agrees to pay a fixed amount each period based on a
fixed interest rate and notional amount determined today.
In return, the counterparty (the floating-rate payer) agrees to
pay a variable amount each period based on a reference rate
applied to the same notional amount agreed to today.
The exam might have FRM candidates estimate the payment
on a swap and maybe even one where the return is negative. It
Everything you need
is important to review the basics of swaps and not be confused
by negative numbers. The trick is to understand that the payer
to pass the FRM Exam
of a negative return in a swap can be interpreted as receiving
the return. For example, by agreeing to pay the S&P 500 return, While I am only one third of the way through volume 1,
the firm has effectively shorted the market. If the market I must say it is splendid! Ironically, it is the most
indeed falls, the firm benefits from the decline because it is informative and I might say tactical, of all the curricula available,
short the market. Often, FRM candidates find drawing a swap yet without being pedantic. A truly valuable resource
diagram to see the swaps flows very helpful. that would aid anyone involved in nance, not just FRM
candidates. Again, bravo! - Mike Mcdonnell, USA

I am very impressed with the quality of the

material from Christian Cooper for FRM part I. Not only they
Free FRM Resources are comprehensive and complete as compared to
Schweser Study Notes or Pristine FRM handbook (Total of 300
To find out more about FRM Exam Review and to access pages) they are easy and convenient to read which
free practice questions, webcasts, our blog, tips and makes dealing with the whole thing a lot easier.
tools visit www.eicientlearning.com/frm. - Ashish Natu, India

We look forward to being your partner in passing After comparing your books with Kaplan, I feel that your
the FRM exam. material is more comprehensive, exam focused
and straight to the point. You wrote your books as a
mentor and practitioner who is guiding the candidate through the
www.eicientlearning.com/frm syllabus in a more eicient and eective way. You
helped me understand what I should focus on and emphasized
www.twitter.com/wiley_nance the most important concepts for the exam...
www.facebook.com/wileyglobalnance - Yu Junli, Singapore

GARP does not endorse, promote, review, or warrant the accuracy of the products or services oered by Wiley of FRM related information, nor
does it endorse any pass rates claimed by the provider. Further, GARP is not responsible for any fees or costs paid by the user to Wiley, nor is GARP
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are trademarks owned by the Global Association of Risk Professionals, Inc. Wiley 2015