2014 FRM Parr I Practice Exams How To Use Tir FRM Practice Exans Practice Exam 1 Practice Exant 1 ANswERs Practice Exan 2 Practice Exam 2 ANSWERS Disrrisutioy Tastes Dana Rapin Te PagetPage 2 (02014 Kapa, nc, db, Kaplan hve Al igh ered. ined inthe United Santer of Americ, SBN: 978.1475425018/ 16475623012 PPX: 300.4602 lage, promote, vem o wart the acy a the prac oF series feed by Kaplan Scheer of FRM ned information oor dct nde ay prs ied bythe provider Pare GARD® isnot eaponl foray feo cs pa by the set Kaplan Scene "cs GARD responsible for anys rcs of ty pron o ny proving any seve to Kaplan, ‘Schwese. FRM, GARD®, and Global Auction f Rk Prfeiona™ ae tamale by the (Global Anociion of Rk Protein lnc hse musa may noe pied who weven prison rom the ur, The nator dpliton sf the nts i vin ofl opt Your aiane oping peal le hen ‘pet appecined Dialaimey: The chee Paci xa shouldbe en conjnstion with she gal ang fo ‘by GARD®. The nferton conan in the Pace Ee elon the igi angen blr robe scare Homey ther sey aot be pune ot tay waranty come ro ot anaes ‘Banepa reHow To Use THE FRM Practice Exams “Test yourself with these practice xams only afcr you have completed all signed reading. ‘The purpose of these practice questions isto make sure tha you know mos ofthe concepts and ideas that are in the assigned readings. IFyou ealy know the material you wil do well fn the acsual exam. While our practice questions cove the material, they are not the actual ‘exam questions. Ou practice exam ate not designed to predict your score onthe actual FRM Exam. Usethese exams ro identify thote area for which you need additional work [Remember that GARP eis very hard every year to develop new and innovative ways ro test you, Your oly defense aging a tricky exarn writer isto actually know the materi Learning and recalling the materi i what our questions ae designed to help you do. “The Patt | FRM Exam contains 100 mulkipl-choice questions, You wil have four hours to complete the entire exam (240 minutes). Our practice exams are weighted aconding tothe 2014 topic area coverage and weightings assigned by GARP: i Ae ‘Baan Wig Esa Qu 1 ‘ourdaions of Risk Management 2086 20 2 Quanciaive Anais 20% 20 3 nancial Marke and Products 20% 30 4 Waawion and Ri Modes 20% 20 ‘The actual exam questions, however, ae not presented by category (e, Foundations of Risk Managemen fist then Quantitative Analysis). According to GARP, FRM candidates are expeced to beable ro recognize and deal with rik-related topics in an all-encompassing manner. On the exam, che presentation of questions will et his abit. Our practice exams are designed to prepare you for this posible exam format. ‘Whatever you de, dont memorize these questions, Instead, len the logic behind each of the questions. GARD isnt going ro ask you our questions, but chey wil ask you questions thar address che sme conceps logic, and definitions necessary answer these practice exam questions ‘Sata e PagePRACTICE Exam 1 [FRM Exam Parc contains 100 muleple-choice questions. You must answer the questions ky fling in a seantron sheee with 2 number 2 or HB pencil, For realism, we sugges that you use tis answer sheet and darken the bubbles corresponding ro your answers. You have 240 minutes (hours) to complete this exam. That equates to 24 minutes p uestion, so budger your time well, Good luck! ©} ) 1e) 1 1) Ol (o} » @®@ © © @ x @ © © | 2 @ OO'@ ROTO OQ OROQLOL® EORONO™) 2 @ ® © @ 7% @® © © EEDA SONOVOL@ COON IO EE OLOTO OD # @ © © @ 2 @ © © ROD ROAD BE@GOR@ «1 4a @ © © @ a @ © © | BIO OLOL® SOLO SOT OLOT® nom 2 @ © © @ 2 @ © © | ROOM BP@r OMe” 4 @ ® © @ a @ © © | & @O OLO7@ SO De® SAG MED 7 @ © © @ 2 @ © © | BOLOLOO@D eerOmam » @ © © @ a © O © 2. @ OOr@ ROO LO me ON Oso SOOmOMe 2 @ © © @ 7 @ © © | BDO RORD 4 @ © © @ 2 @ © © 8 OOO@ EOD OS 8. OAOIOL@ 7 @©@ © © @ 8 QOr@r@ 9 © © @Page Practice Exam 1 expected retutn for a common stock. The invertor uses thefllowing factor betas and faetor risk prem Factor Factor Beta Factor Rick Premio T oF 13% 2 12 40% 3 an 5.0% Ifthe risk-free rat is 386, what is the expected recur for this stock using the arbitrage pricing theory (APT) model? a. 5.35%, b. 8.3506 9.5086, 10.37%, 2 $1,000 par corporate bond carries a coupon rate of 6%, pays coupons ‘semiannually, and hasten coupon payments remaining ro maturny. Marker rates are currently 5%. There are 90 days between settlement ané the next coupon payment. The dirsy and clean prices of the bond, respective, are closest 0: a $1,043.76, $1,013.76. b, $1,043.76, $1,028.76. ©, $1,056.73, $1,041.73 4 $1,069.70, $1,054.70. 3. Which of che following sarements regarding option *Grees” is incorrect? ‘a. Vegn is highest when options are ar-the-money. b. Forward instruments cannot be used ro create gamma-newral positions Rho is higher for at-the-money versus in-the-money options. <4. Gamma represents the expected change in delta for a change inthe value of | the underlying insteument. 4. Abankehasa USD 4 millon portfolio available for investing. The cos of funds for che $4 milion is 5.5%. The bank lends 509 of the asset to domestic customers for an average loan rate of 7.3586. The ret of the portfolio is lent co some UK clients a 896 ata current exchange rate of USDI.62/GBP. Af the same time, the bank sells a forward coneract eliminate exchange rate risk equal to the expected receipts one year from nove. The forward rate is USDI.S2/GBR. ‘The ne interest margin on the bank's invesment balance set is closest t a 1.1686, b. 1.93%. 218%, 43496Parc Bob James sells « March 2010 call on XYZ stock with an exercise price of $45, fora $3 premium. He also buys a March 2010 call on the same stock with an exercise orice of $40 fora $5 premium. Identify ths opcion strategy and the ‘maximum profit and lst for the investor. 8, Bearcall spread, maximum profi is $3, maximum loss is $2. 1 Balleal spread, maximam profits $3, maximum los is unlimited. ©. Bearcall spread, maximum prof is unlimited, maximum los is $2. 4 Bulleal spread, maximum prof is $3, maximum losis 82 [Based or a sample size of 100 and sample mean of $30, you estimate a 95% confidence interval for the mean weekly soft drink expendituses of students ata local colege. Your estimate ofthe confidence interval is $26.77 ro $33.23. Since you knew the standard deviation beforehand, your confidence interval was based fon a standard deviation closest co a 165, b 6.59, © 1158. 1648. CConside: a 1-yeat European call option with a sike price of $27.50 that is curren valued at $4.10 on a $25 stock. The I-year risk-free rate is 6% ‘compounded annually: Which of the following is closest ro the value of the corresponding pur option (assume continuous compounding)? a. $0.00, b $495. c. $5.00. a. $5.04, ‘Which of che following statemenes comparing VaR with expected shorefill is , Exprted shorfl is sub-addicve while VaR is aot 1. Both VaR and expected shorefll measure the amount of eapital an Jnveor can expect co lose over a given time period and ar, therefore, inerchangeable ae rise mearues «Both VaR and expected shorfill depend on che assumption of 2 normal diseibution of return. 4. VaRean vary acording tothe confidence level selected, but expected shostall will noc. Corr coma Page?Part Pracce Exam 1 Page (Cooper Induses (Cooper is he pay fixed counterparty in an interest rate "svap. The swap is based on a notional valu of $2,000,000, and Cooper recsves 4 floating rate based on the G-mont Hong Kong inteank Offered Rate CFIBOR). Cooper pays a fixed rat of 79 semiannually. Aswap payment bas juse been made, The swap haa remaining lie of 18 months, wich pay dates st 6, 12,and 18 months. Continuously compounded spot HIBOR rates are shown in the table below 6-month HIBOR 6.5% 12-month HIBOR 6.8% 18-month HIBOR 7.5% 24-month HIBOR 7.7% ‘The value ofthe swap to Cooper is closes to: a $0, b. $6,346. e. $17,093 4. $72.86. Merallgesellichafe Refining and Marketing (MGRM) offered customers ‘contracts to buy fixed amounts of heating oil and gatoline ats fixed price over 4 5-or 10-year petiod. The customer contract effectively gave MGRM a short position. MGRM hedged exposure using a stack-and-rol Fedging strategy. A stack-and-roll hedge is best described as 1 buying farures contacts of different expiraions and allowing them to expire in sequence. buying farures contacts of different expirations and clsing out the position shorly before expiration. using shoreterm futures to hedge a long-term risk expenue by replacing them with longer-term coneractschorlyhefare rey expire <4.using shore-trm futures contract with a larger notiond value than the Tongeterm vs they are meant eo hedge Assume an investor holds a portfolio of bonds as follows ‘+ $2,000,000 par value of 10-year bonds witha duration of 6.95 priced at 95.5000. + $3,000,000 par value of 15-year bonds witha duration of9.77 priced at 38.6275, + $5,000,000 par value of 30-year bonds with a duration of 14.81 priced at 114.8750, ‘The duration of this portolio is closes to a 10.64, b. 12206. © 1328. 4. 1357. ‘Saar Kapln oe13. 15. Past Pratce Exam 1 [A porefalio manager wishes to leverage her equity postion using index Futures to ‘beta of 1.5, She currently has a well-divesfied $250 milion equcy portfolio ‘witha beta correlated coche marke, The current value ofthe S&P futures index is 1,600 (multiplier of 250). How many contacts ae necesary to adjust che beet ofthis portfolio? ‘Shor 313 contract ‘Short 781 contract. Long 313 contract, Long 781 contracts Nevin Woodcomb is a portfolio manager fo the Matix Tactical Growth Fund, 41940 Ace mutual fund with roral assets of $225 millon. The mandate ofthe ‘mutual find is ro make active tactical shifts in long and short exposure based on current views of stock market ation. Recently, Woodcomb has been cauious ‘on stocks and has positioned the fund with a bet of -0.30; however, che most ‘ecent jebless claims were more positive chan Woodcomb expected, and he expect he stock market co elly strongly when che monthly non-farm payroll data is leased, Woodcomb would lke to take advancage ofthis market rally using S&P 500 index farutes and increase the fund's ber to 1.25. Currently, S&P 50) futures ae erading at 1,540 and the multiplier 250, How can ‘Woodcamb achive his objective for his fund? a. Sell 135 contracrs. Db. Buy'55 contrac. € Buy788 contrac. 4. Buy906 contracts. ‘A hedge fund is considering using one ofthe following three methods for ‘estimating value at esk (VaR): traditional historical simulation, multivariate density estimation, ora hybrid method (.c.,age-weighted historical simulation). ‘Which ofthe following statements isan advantage ofthese methods compared to parametric methods for eximating VaR? ‘4. Themulkivariate density estimation ie very exible in introducing dependence on economic sae vatiable, Deviations fom normality may be a concern fr che historical simulation, ‘multivariate density estimation, or hybrid methods. Dats is used more efciently with historical simelation, multivariate densiy cextmation, and hybeid methods than with parametric method’. 4. Thebybrid approach requires disebusion assumptions asc financial disasters have resulted when a fm allows a rader to have dual roles ar doth the head of rading and the head ofthe back-ofice support functor. Which ofthe following casestudies did noc involve this parccular coperatinal risk oversight? 1. led Irish Bank. TL Bangs. a. Losly b. Mealy Both I and IL Neither T nor IL ‘BaoTe Kaplan Tre PagePa Pracice Exam 1 Page 10 1. ‘An analysts concerned with the symmetry and peakednes of a distribution of returns over a period of time for & company she is examining. She does some calculations and finds tha che median tecurn i 4.2% the riean recur i 4.89%, and the modal return is 3.7%, She also finds thatthe measure of exces kurtosis is 2. Based on ths information, che correct characterization of che distribution ‘of recurne overtime ie Showness Kurtoss Positive Leprokursic Positive Plaeykuric Negative Plarykurtic Negative Leprokurtie eee “Tip"Top, Inc, (Tip-Top) has a commitmene with SuperSize Bank for $10 milion, ‘The terms ofthe loan are fixed and cannot be changed overit life. Tip-Top experiences an unexpected change init credit rating from Ba ro Baa, Explain ‘the mos likely effect on expected loss and actual loss. 4. Supersize Bank will increase the estimate of expected lss but not actual loss, b._ SuperSize Bank will increase the estimate of expected lss and increase its escimate of actual loss, SuperSize Bank will decrease the estimate of expected las but no actual loss ‘4. SuperSize Bank will decrease the estimate of expected lss and increase ts ‘estimate of accu los, ‘The capital ase pricing model (CAPM) is based on several limiting assumptions. Which ofthe following statements is correct garding che CAPM? ‘The CAPM: 14 does not assume tha the expected excess returns forthe matket are known, 1b. assumes cha che marker poreflio should be che one withthe highere Sharpe Taio of ll pouible portfolios. does aot assume chat investors have acces to the same information assumes thar investoes' expectations regarding risk and return are not identical Bu normaly decributed. ‘The spot rate for a commodity is $19. The annual lease rate for the commodity {i 5%. The appropriate continuously compounded annual risk-free sate is 6.5%. ‘Which ofthe following amounts is closest co the 3-monch commodity forward price? a. $18.46. b. $1893, ©. $19.07, a $19.55,20, a. 2, 23. Past Practice Esa 1 [A buf farmer is concemed thatthe price he can get fo his builo herd will be les than he as forecased. To protec himself fom price declines in the herd, the farmer has decided to hedge with live carte furures, Specifically, he has “entered into the appropriate aumber of eatle Future postions for Seprember delivery chat he believes will help ofier any buffalo price declines ding the Winter shugheer season. The appropriate postion and the likely sources of bass Hisein the hedge at, eespectively: 4. shons choice of fuures delivery date. 1. show: choice of Furures asset hom; choice offuures delivery date and asst. 44 long, choice of futures delivery date and asset, “Trudy Bakes, FRM, and Steven Phillipe, FRM, are conducting regression analysis. As par of cheir preliminary analysis, Baker and Philips plan co employ ‘8 scatergram aswell as examine residual, Baker suggests that a scatergram will indicate ifthe relationship of inerest i positive or negative. Philips suggests ‘thatthe residual ofa sample regression fr a large sample will noc equal the correspending population eror term. With respect ro Baker's and Phillipe’ plans and asteions ‘both Baker and Phillips ate wrong, 1. botk Baker and Philips are correct. Philips ie wrong and Baker is correc. 4d. Baker is wrong and Philips is correc. [A forward contract on an asset was created three months ago. The curren price fof the aset is $1,100. Expressed on a continuously compounded annual basis, the rakes rate of interest is 496 and theater pays dividend of 28. The ‘contract requires delivery ehree month from today at price of $1,080. The value ofthe contract is closest to: a $8.57, be sida, ©. $2526. 4. $3044 In building a portfolio of fixed income curtis for one of your clients, you determine that the use of STRIPS (separate trading of egistered interest and principal securities issued by she Treasury would asist in eeducing reinvestment rink, Which ofthe following statements regarding STRIPS is correct? STRIPS tend co ade a premium. Shoxter-cerm C-STRIPS (coupon) tend to trade a a discount Longer-term C-STRIPS (coupon) tend to trade ata premium. STRIPS tend 0 have significant sskof illiquid. ‘Sane Page LtPar Practiee Exam 1 Page 12 2s. 26. 27 ‘A company is considering entering into a joine venture chat wil require an investment of $10 million. The projeceis expected to genemte cashflows of $4 rilion, $3 million, and $4 million in each ofthe nex thre years, respectively. ‘Assuming a discount cate of 10%, what is che projects net present value (NPV)? &. ~$879,000. 6, $309,000. © +8100,000. 4. +8243,000. Analyst Joseph Lockwood examines asingle-fictor regeesion fora hedge Fund and males the fllowing rwo statements: Statement I; Hereroskedasticity exists ifthe regression resid sal are correlated with dei lagged values, ‘Statement 2: Heteoskedastciy causes the statistics of che egrssion to be incorrectly calculated using ordinary least squares methods. ‘Which of Lockwood's claims are correct? Statement I is correct and Seatement 2 is correct. 1. Statement | is correct and Seatement 2 is incorrect. Statement | is incorrect and Seatement 2 is correct. Statement |isincorece and Statement 2is incorrect ‘A scock currently trades at $10. Ar the end of three months, the stock will either be S11 or $9. The continuously compounded rsk-fiee rate of interest i 3.59% per year. The value ofa 3-month European cal option witha stike price of $10 fs elses to: a $0.1 b. $0.54 3065, . $101 Isabelle Burns, FRM, is an investment advisor fora firm whose clint base is ‘composed of high net worth individuals. Inher personal portfolio, Burns has an investment in Tore, a company that has developed software to speed up internet, browsing. Burns has thoroughly researched Torex and believes the company is financially strong yet currently significantly undervalued. According to che GARP Code of Conduct, Burns may: ‘not recommend Torex as long as she has a personal investment in the stock, not recommend Trex toa client unless her employe gives writen consent to doo, recommend Torex to client, but she must disclose her investment in Trex to the client commend Torex a client without disclosure as longas ite a suitable invesement for the client. ‘Daa Repl.28 2. 30, Part Pracsice Esa 1 Donaldson Capieal Management, a regional money management frm, manages nearly $400 million allocated among thre investment managers. All portfolios have the same objective, which eto produce superior rsk-adjused retuens (by beat the market) for their cients. You have been hired asa consultant to measure the performance ofthe portfolio managers. You have collected the following information based on the last ten years of retuens. Seandard Porfolio Mean Annualized Deviation of Manager ‘Rate of Return Bees Rear A 018 135 024 B oat 195 025 c 0m 210 22 During the same time period che average anual rate of return on the market poreflio was 13% with a standard deviation of 1996. In order to asess the porefolio performance of che above managers, you should use: the Tieynor mesture of performance. b. the Sharpe meature of performance. the Jensen measure of performance. 4. the Sortino measure of performance. ‘Which of che following statements about sampling and che central limit theorem is lease key correct? . Thevariance ofthe distribution of sample means is o%/n. 'b. The central limit theorem may be used fr large sample sizes for skewed disuibutions «¢. Themean ofthe population and the mean ofall posible sample means are always equal 44. Thestandard deviation of che mean of many observations is more than the standard deviation ofa single observation, Bank regulators are examining the loan portfolio ofa lage, diversified lender "The regulator! main concern is that the bank remains solvent during turbulent ‘econome times. Which ofthe following is mos likely the area on which the regulators will wane to focue? a, Expected los, since each asser can expect, on average, to decline in value from a positive probabiley of defaule Expected loss, given the decrease in underwriting standards of new loans. ©. Unexpected los, since th bank wll ned to set aside addtional capital for the anlkely event that recovery rates are smaller than expected. 4. Unexpected los, since the bank wll ced to st aide addtional capeal for the anlikely event that usage given defale i smaller than expected rca Page 13Past Page 14 31. 32. 33, ‘An analyse develops che following probabilcy distribution bout the state ofthe economy and the market Tal Probabiley PAD Conditional Prbabiey POBAD Bull marker 50% Good economy 60% [Normal maker 30% Bar makes 20% Bull marker 20% Poor economy 4096 Nona mater 30% Beat make 50% ‘Which ofthe following statements about this probabilcy dseribuion is least likely accurate? ‘The probability of normal marker is 0.30 ‘The probability of having a good economy and a bear atke is 0.12. ‘Given that the economy is good, the chance ofa poor economy and a bull market i 0.15, Given tha the economy is poor, the combined probabiisy of normal ora Dull maskee is 0.50. Multidimensional scenario analysis can ake ewo general forms: historical or prospective. The historical aproach is backward looking, while the prospective Approach is forward looking. Which ofthe following statement ie cocrect, regarding prospective and historical scenario approaches? 4 The historical approach uses an exponential smoothing model to weight marker data over the relevant time “The prospective approach ignores corclations between risk factors. «The fieror push method of historical scenario analysis ues a constant multiple of historic correlations o forecast correlations during an economic criss 4. None ofthe above sarements are correct Jenay Caldwell, FRM, i using a moving average model in which she assumes ‘weights decline exponentially back through time, The orgial volatility was ealeulated at 1.59, However, she believes a decay factor of 0.96 for an ‘exponentially weighted moving average (EWMA) model is appropriate for ‘modeling a more realistic variznce measure I the stock maker recur is 1% today, what is the new estimate of volatility using the EWMA model? 0.97%. 131%. 1486. 15896 b 434 3s. 36 37 Pat James Telsma, FRM, is analyzing a publicly traded frm and is using the ‘companys bea, che risk-free rate of return, and the expected eecurn on the marker estimate the company’s required rate of return. He is somewhat concerned thatthe underlying assumptions of this technique are not realistic ‘Which ofthe fllowing statements isan assumption ofthe capital ase pricing ‘model (CAPM)? ‘Investors minimize their expected uslty of wealth ac the end of the period. 1. nvestors are vskeneuteal, Investors ae only concerned withthe mean and standard deviation of 4d, Arscs are not divisible, AA buttery spread involves transactions in different options. Iccan be created by buying 14. scall option with alow strike price and then selling a call option with a higher seike price b. a puroption with a high strike price and chen selling 2 pur option with a Tower strike price. apur option with alow sike price, buying another pus option with 2 higher strike price, and sling ewo put options witha srk price halfway ‘beeneen the low and high strike options. 4. call option with «high serike price, buying another all option wich a higher strike price and buying two call options with a strike price halfway between the low and high strike options {An analyst is concemed thatthe trading strategy she recently idencfed hat generate a statieicaly insignificant result and has asked for guidance in feessing the strategy. A reel ie eatsticaly significance 1 unlicely co have occurred merely by chance, and the p-value is lss than the significance level, likely ro have occurred merely by chance, andthe paluc is lest than the sign cance level . unliely to have occurred merely by chance, and che p-value is greater chan the significance level, 4. likly eo have occurred merely by chance, and the p-value is greater than the sigatficance level “To equitze the ath portion of asets under management, portfolio manager centers irto long futures positon on a stock index with 2 multiplier of 250. The ‘cath postion is $5,000,000, which a che current Fuures value of 1,000 requires ‘the manager to be long 20 coneracts. IF che curren intial margin is $12,500 per contract, and the current maintenance margin is $10,000 per contract, the ‘variation margin the portfolio manager needs to advance ifthe furues contract valu fas to 985 a the end ofthe fet day f che position is losest ro: a $25000, $3000. «$5000. 4. $7500. Saieiae Page 15Pare Page 16 38 39. 40, 41 Assume chat che euttent 1-year forward exchange rate is 1.200 USD per EUR. ‘An American bank pays a 2.49% annual interest rate on a I-year deposit and a 4.096 annual interest rate on a 3-yeat USD deposit. A European bank pays a 1.5% annual interest rae for 2 1-year deposc anda 2.0% annual interest ate for 1 3.year EUR deporit. The forward exchange rate in USD per EUR for exchange she years from today is closest co: a 1.204. be 1269, ©. 1261 4. 1286 WEB, an investment-banking frm, isthe principal underwriter for MTEX’s upcoming debentareisue. Lyan Black, FRM, isan analyse with WEB, and she learned fom an employee in MTEX's programming deparenent that serious problem was recently discovered in the software program ofits major new product line Infact, the problem isso bad that many custcmers have canceled theie orders with MTEX. Black checked the debentures prespectus and found rho mention ofthis development. The re herring prospectus has already been dlisribuced. According tothe GARP Code of Conduct, Black's bert course of inform her immediate supervisor at WEB of her discovery. ep quiet because this is material nonpublic inside information. notify potential investors of the omission on a fir and equitable bass, report her discovery ro the Division of Corporation Fiance ofthe Securities and Exchange Commission. ‘Which ofthe following theories often used eo explain the term structure of | inceres ates is based on the idea that most investors prefer short-erm deposis, all else equal? Liquidity preference theory. 1b. Supply-demand sheory {& Marker segmentation theory 4. Unbiased expectations theory. ‘Which of the following statements regarding the general elects of maturity on bond prices and returns is moe likely coveec? 1. Bond prices will vend to increase with maturity when coupon rates are above the relevant forward cates. I, When short-term sates are above forward races utilized by bond prices, ‘then long-term investments will end to ourperform short-term investments a Lonly b. Wonly, Both [and IL 4. Neither I nor I DaePuc Practice Exam 1 Questions 42 ard 43 use the following information. ‘Matuiy (Year) STRIP Price Spot Rate_—_‘Forwand Rate 05 99.2856 15086 1.5086 10 98.2240 18086 210% 13 96.7713, 220% : 20 5.1504 > 340% 42, The G-month forward rae on an investment that matures in 1.5 years is closest 43 45, a 25006 be 27596 e308. 3.2506, “The price fa $1,000 par value Treasury bond (T-bond) with 2 3% coupon that ‘matures in 1.5 years is closest to $1,010.02, b sicin.ss $1,013.68, 4. siicissi Many different rypes of ewape exist, Examples of ewape include: interest rate swaps, curency swaps, commodity swaps, equity swaps, and volatility swaps. ‘A-swapcon isan option which gives the holder che right ro enter into as. ‘Which ofthe fllowing statements about swaps and swaptions is mos likly Eni swap pymens may befoningon both sides| inlke options, premiums for swaprions ae not dependent on the svike rate spectied inthe swaption. «. Themost common reason for entering into commodity swap agreements is to speculate on commodities price. 4. Forthe fixed-rate payer in an S&P 500 Index swap, a negative index return does not require a payment from the fixed-rate payer [An option sraderisatempting ro judge whether an option’ premium ie cheap or expersive. To do so, he employs a GARCH(I,1) model to forecast volaiicg ‘The paricular model he estimates has an intercept rerm equal to 0.000005, a parameae estimate on the latest estimate of variance of .85, and a parameter estimate on the latest innovation of 0.13. IF the latest volatility estimate fom the model were 2.2% per day and the optiorls underlying assex changed 3%, the ttader' estimate of the nexe period’ standard deviation is clorest ro 0.07%, be 231%. 5.26, 2.60% coma Page 17Pact Practice Bam 1 Page 18 46. 4. 48. 4 “The current price ofa stock is $25. put option with a $20 erke price that expires in six months is availabe. N(d}) = 0.9737 and N(d,) = 0.9651. Ifthe underlying stock exhibits an annual standard deviation of 35%, and che current continuously compounded risk-free rate is 4.25%, the Black-Scholes-Merton value ofthe put is closest co: a. $0.01 b. $0.03 © $033. 4. $036, John Bone isa junior bond analyst for XYZ. investments. He is examining both investment grade bonds and speculative grade bonds. In particular, hei looking for bonds located below the separation between these two bond clasifiato Which ofthe following bonds would be clsifed ava speculative grade bond? a. FHLMC discount note b. ACC nll bond rated Baa « OMC Corp. MTN rated BB. Travelers foating-ate note rated Aa ‘An analysis esting the hypothesis hat the variance of monthly returns for Index A equals the variance of moachly returns for Index B based on simples ‘of 50 monthly observations. The sample variance of Index A returns i 0.085, ‘whereas the sample variance of Index B recurs is 0.084. Asuming che samples are independent and the returns are normally distributed, which ofthe following ‘epresents the most appropriate text statistic? sample variance of Index A sample variance of Index B sample variance of Index A ~ sample variance of Index B ‘standard eror of sample waste sample variance of Index B ‘ample variance of Index A «4_Smplevatae of nes B—sample variance ofndex A standard cor of sample snc For a given porflio, the expected sera is 1096 witha standard deviation of 1596, The bet ofthe portfolio is 0.75. The expected return ofthe market is 1196 with a standard deviation of 18%. The risk-free rate i486. The porfli's “Treynor meatue is closes to 2 0.0075. b. 0.0120. «0.0400. 4. 0.0800. oer50. St 32. 33. Par Practice Exam 1 Suppote Rick Caldwel simulates a random value berween O and 1 from a dlisrere cumulative probability distribution (CDF). Caldwell uses «random ‘number generator beeween 0 snd I in order to create the CDE, which rakes on the value of 10 with a probability of 30%, the value of 20 witha probability of| 35%, andthe value of 50 with a probability of 35%. Whar is che corresponding ‘value frm the inverse CDF ifthe random number generated from the uniform Aiserbuion (0,1) i 0.592 a 0. b 10. 20. 4 50. (Canadian Bank Inc. (CBI has the following annual gross income amounts in its busines lines over ite most recent three years 2009 2008 2007 Rec banking $380 million $344 million $326 milion Commercial banking $712 million $645 million $599 milion Investment banking” $846 million $777 million $687 milion Using the sandardized approach, which ofthe following amounes represents (CBI operational risk capital requirement for 2010? $253.2 millon b. $265.8 milion © $2749 million 4. $2784 million ‘The 3ronth furues contrac ofa cerain assets priced at $1,020. Its underying is valued a $1,010 and pays a continuous dividend rate of 19. I the ‘current risk-free rate is 2.75%, the arbitrage profc opportunity is closest: a $0.8, b $597 $7.8. 4. $9.96. “The objective ofa risk appetie statement isto provide a guideline for risk ‘management within che organization This statement needs to be clearly conveyed tothe staffin order for the organization ro operate within the accepted risk constrains. In practice, an effective risk appetite staement contain ll of| the following characterstis except: 4. congruenewith che organization's goals. 1. suliienly specific yet alto clear enough to be conveyed within the organization, cc asins with secting reasonable rs limite and achieving the organizations goal within chose ini 44. shoold not be revised after seting the organization’ inital isk and return goal, Sate e Page 19Parc Page 20, 34 55. 56. 37 Howard Pats, FRM, is an investor with a short positon and is preparing ro median > mode ie consistent witha dirbuion that positively skewed. For al normal dibutions kurtosis = 3. Excess karo = hurts = 3, hich {sO fora normal dstibuion. In eis ee, excess toss» 2, wich means karts = 5 This meane that che disbution being examined ie more peaked than the mortal Aisibation and is ad 0 be lepeokuri (See Book 2, Topi 11) ‘A change from 2 Bato Bas rating ran example of cred parade. A creic upgrade wil deteate the expected deft Fequeney (EDF) seducing exerted loss, Note that fxpected os isan estimate of average future lst. Actual lou i by definition equal to eto unt a redi event occu. (ee Book 4, Tapie 52) ‘The CAPM assumes tha the market portfolio shouldbe the porlio wih the highest ‘Sharpe rato of ll posible portfolios and shoud include all ivesable ses. I also samumes tha the expeced ecet retro forthe market ate asm ce known in that invertors have Seon f the same information, As well i aseee hat eu a6 noemlly diseibuted and investor! expecations fr risk and retum re denis. (See Book, Topic 2) “The 3-month forward rate is calculated follows Tor _Gr!—H $19 nc000-0083— g19 47 (See Book 3, Topi 33) ‘The farmer ace tobe short the futures contrac. The two sources of bass ise confronting the Famer wil vale rom the fat tht he i uring act contact 0 ier the price movement af his blll herd. Cattle price and tla pricee may not be pene positively coveted. As tesa, the eoeeation between blo and atl prices will have an in)pact onthe bisi ofthe cate futures contest and spot bul ‘meat, The delivery dat is problem in this situation, because the farmers ede sion ‘sinter which probably will no commence until December ox anuay In nde to ‘maintains hedge during this perio, che farmer wil have o enter into anor Sutures, Contact, which wil ineoduce an addtional yource of base isk, (See Book. 3, Topi 25) ‘A scatesgram can help determine whether atlatonshp is positive or negative, Since the population and sample coeEcent ar almost always differen the residual will ery rarely equal the corespanding population eror erm, (Sce Book , Topi 11) Se Ke = 1100€ 98225) 0804-04025 «$95.26 (eBook 3, Topic 27) SaoriMWe 2. 26.6 ae 28 b 30 Pare Pratice Exam I Answers Because ofthe eos involved with ssiping/econnitting STRIPS, invexors generally aya premium for STRIPS, Shorerterm C-STRIPS tend to trade aa premium and Tongerieam C-STRIPS tend to tade aa dicoune. There i no evidence that STRIPS have gion ris of liquids hey canbe ign, though (See Book 4, Tope 43) NPV- 411.10 6 3/(.10}2+ 4 (1.10)8~ $10 = -$0.879038 milion, or $879,038, CClealatrapproch: CFO «10; CF] = 4; CF2 «3; CF 4“ 1=10 NPV. 0.879038 (milion) (Gee Book 1, Topic 1) “Heterotklacey xn if he variance ofthe residuals isnot constant. Ina Ieterokedatierprention, che esas wl be incoreal aleuated using ordinary least squares methods (Se Book 2, Tapic 16) In thiseae, U= 1.1, D = 0.9 = 0.035, and che value ofthe option is $1 ifthe sock incteaes nd $0 ifthe stock decreases. The probability of an wp moverent, ty canbe calelatee a (€®°*3"8)— 0.9) J (1.1 ~0.8) = 0.5439. The value of the ell ption is ‘thereon (0.5439 x $1) /<®5*3 $1.54, (See Book 4, Topi 40) Standards 2.1 and 2.2—Conflis of lnteret. Members and candidates must ct fly inal dations and mut fully dsloe any actual or potential cont ro all affected, pastes. Side members and candidates should discos tothe client any ownecsip Ina secuy tha they ae recommending, (See Book I, Topic 9) “The Tieynor measure i moss appropriate for comparing well-dvenied portfolios. That, ithe Tryor meanie i the Best o compare the eet rena per unit of systematic ‘ik eared by porflio managers, provided al portfolio are wel- diverse. {All he ortflios manage by Donaldson Capital Management at lly les Aliveriied than the market porto, Sandad deviation of recurs foreach ofthe thee perl ig dha hada devin of he ace pri reecing sow lof dverieation “Jeosens apa the mos appropriate measure fr comparing porti tha ave the same bets The Sharpe mestie canbe applied ro al porfolios because It ses oa sk ‘nd it ie more widely ued han the other wo mensates. Alu, eh Shape ratio evaluates the por performance based on realized urns and divensifestion. A lew-dversifed portoliwill have higher cota sis and vee versa (See Book 1, Topic 4) “The cent mie theorem hold foray distribution (gkewed oot as long asthe samples is arg (se« n> 30), The mean ofthe population andthe mean ofthe Aiton ofall sample means ae equal, The endard deviation of the mean of many bserains sess han the standard devintion of single observation. (See Bok 2, Topic 12) ‘Unexpected loa it measure ofthe visiaton in expected lous. Av precaution, the bank need om ade sficient capil in the even that actual lone exeed expected loses with reapeable likelihood. For example smaller covery rates would be indaive of auger seal loses. (See Book 4, Tope 53), DG Page 37Part Pracce Exam I Answers 31 2 33. 3 a. Page 38 Given that the economy is good the probability of poor economy and bull market, inzero The other saement ate eve The P(normal market = (0.60 » 0.3) + (040 = (0.30) = 0.30. P(good economy and bear market) = 0.60 «0.20 =0.12. Given thatthe conomny spoon che probability of «normal or bull maker = 0.30 + 0.20 = 0.50, (See Book 2 Topic 10) None of he statements ae coret The historical approach ues aor data om pat za event: the prospecive scenario conditional approach inciues correlations between ik tors and the factor push method is a prospective approach not hiorial spproach, (Se Book 4, Topi 55) eh Dot. 4(1-Det, = 09610015") + 0-096)00%) ii2i6-rodaddos = 0.00022 = VOOR = 0.01483 014896 (See Book 2, Topic 19) ‘The capa prcng model (CAPM) ames he lloning Tvestors desir to maximize thee expeed wily of wealth athe end ofthe net period 4+ verona risk aver + Investorsare only concemed with the mean and andar deviation of resus, + Asses are filly divisible (See Book 1, Topic 2) Buying cll (put) option with alow ske price, buying another cal (pu) option swith higher srk pie, and selling two call put) options with sie pre halfay ‘eween he lw and high tke opcions wil genecate the bute payment pattern “Two of te wrong answer choices deal with bl and bear spcads which ean alo be seplcated with ether calls or puts. Abul spread involves purchaing cal (ut) option witha Low srike price and sling 2 cal (pt) option with higher exerci price. A bear Spread isthe exact opposite ofthe bal spread (See Book 3, Topic 31) A resale is sail sigacan iis ule to have happened by chance. The decision rule ero reer the all hypothesis if the pai esta thesgificance lev the pre ese chan the sgificancs level, then we conclude tat the sample estimate is incall diferent than the hypothesized value See Book 2, Topic 15), “The fates contac ended 2 985 onthe ise day. This epee decease in value in the positon of (1,000 ~ 985) x $250 20 ~ $75,000, The inal margin placed by the manager was $1250 20 = $250,000. The maincerance margin fot this poston requis $10,000» 20» $200,00. Since the value of the poston declined $75,000 ‘on the fs day the margin accoun is now worth $175,000 (below the $200,000 rainenance margin) and wil equze a raraion margin of $75,0 to bring the postion back eo the nial marin Ie not aaicient jus o bring the position back co {thermaincenance magin. See Book 3, Topic 24) ‘Danan ae,ake aa8 fon 4a ae 43.6 Ae 45.6 Pac Practice Esam | Answers ‘Weare gen that the forward exchange rtm one yea i 1.200 and ae asked tnd the echange atin ue years. This ncans we need to apply the 2-year forward rte ‘one yeat fom coday ‘The 2yer forward eae in the Unied States fro a585 = or 4.8196 1A = SIDBRS = 10481-1048 “The 2 year forward cate in Earope it jroo ois inal we can apply interes rte pry DAES = 1.02251, 02.25% Loser? 200%: Tos? 1261 (See Book 4, Topi 44) Standards 3.1 and 3.2 relate othe preservation of confidently. The simples, mos contrvative, and mos fective way o comply with these Standards isto avid Gisclosing any information recived from a client, except authorized fellow employes ‘who ae so working forthe eine the information concer ileal actives by [MTEX, lack ma be obligated vo report sce to authorises (See Book 1, Tope 9) The liquide preference theory suggest thatthe shape ofthe erm teucrure is decried by the fact hat mos investors prefer shorter quid assets, holding return fenstant. (See Book 3, Topi 2) In genera, bond prices will tend to increase with maturity when coupon rates ae abose relevant farward ates, When shore-term rater ae bel che forward ater wind by bond pres, he inves wh inert in longer investment wil tnd w uperoem, {tween who rll aver dhrrererm Irene (Se Book 4, Topic 4). The fora eate can be calcalated a (98.2240 / 96.713) 1] « (Gee Book 4, Topi 44) 1. ‘The prices calculated as $15 (0.992856) + $15 (0.982240) + $1,015 (0.96713) = $1011.85 (See Book 4, Topi 4) Unique among swaps, eqley wap payments may be Housing on both sides and che payments not known until the end ofthe element petod). Similar to options, preums fr rwapsons are dependent onthe ake rate specie inthe eaption. The {ost common reson for entering into emnmodity swap agreement to conta the ‘cots of purchasing sarc, ich sll and cleric. A negative inderrecra reguiter ‘he finedat payer copay the percentage decline in the inden, (See Book 3, Topi 29) ‘The GARCH(I,1) eximate of oat wll be 0.000005 +- (0.130.037 + (085)(00227 = 0.000533, olay = ODOURS = 0.008 (Gee Book 2, Topic 19) 23196 ‘SK re Tage 29Patt Practice Era 1 Answert Page 40 46 ne aa aod soe sid 52.6 sad = (s20e-®25 o.0349) ~(625 0.0263) = $0.02582 ~ $003 (See Book 4 Topic 4) ‘Any sccsty with «rating below BBB by S&P or Baa by Moody ea speculative or non-investment grade instrument. (See Book 3, Topi 39) “The appropriate testis an Fes wher the larger sample variance (Index A) x placed in ‘thenumeraor. (Se Book 2, Topi 13) The fmf he agnor mee [2B | Po thea rh Tages measure in chi cae (0.10 0.08) 0.75 = 0.08. (See Book 1, Topic 4) ‘The unit intra 0,1] on the y-ai, which repretens the CDF, can be split ino shee segments based on the cumulative probabilities of 30%, 65%, and 100% corresponding tervals of 10, 20, and 50, These thes icervls are denoted a (0, 0.3), (0.3, 0.65), and (065, 1.0). The random number that is generated (0.59) takes o 2 ale of 20 because itis inthe second interval (03,065) (See Book 2 Topic 18) or the sandadined approach, CBI muse apply diferent beta fore to specifi business lines, The amounts ae multiplied bythe average annual gros income over the past Bear perio. The bes factors for rel banking, commercial banking, and investment banking are 129%, 15%, and 189%, spectively Aveage annual gos sevenues for rel banking (380 + 344+ 326) /3 «350 milion Average annual gos revenues for commercial banking (712 + 645 + 599) (3 = 652 milion Average anual gros revenues for invesment banking (646 +777 +687) 3-770 milion (Operational rk expt requirement (0.12(350) +0.15(652) + 0.18(770) = 2784 milion (Sec Book 4, Topie 54) According tothe ashvand-carry formala, he Furs price shouldbe Lorodoour-to1nas «1,014.43, Hence thefts is overvalued, indicating it shouldbe sold and the ast be purchased fora ridefre profi of $1,020 ~ $1,014.43 ~ $5.57 (See Bock 3, Topic 27) ‘An effective ik appetite satement canbe revised, taking into account hat he ‘organization's gals and therefor, risks) may change over time, (See Book I, Topi 5) ‘Daa Rapin oe