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# FRM Exam

## Sample Examination （15 representative questions from 2003 exam）

Q1. If you use Delta-VaR for a portfolio of options, which of the following
statements is always correct?
A: It can sometimes overstate the VaR.
Using delta-VaR for a portfolio that pursues a portfolio insurance strategy
with options will necessarily overstate the VaR over longer periods of time.
Hence, delta-VaR can overstate, but we can also find examples where it
understates.

## Q2. Assume we calculate a one-week VaR for a natural gas position by

rescaling the daily VaR using the square-root rule. Let us now assume
that we determine the true gas price process to be mean reverting and
recalculate the VaR. Which of the following statements are true?
A: The recalculated VaR will be less than the original VaR.
If the process is mean reverting then we can no longer scale volatility (and
associated VaR) up by the square root of time. Mean-reversion makes
extreme outcomes less likely since following large losses changes the
conditional mean of the distribution will be higher.

Q3. Of the following options, which one does not benefit from an increase
in the stock price when the current stock price is ＄100 and the
barrier has not yet been crossed:
A: A down and in call with in barrier at ＄90 and strike at ＄110.

Q4. The 1-year US dollar interest rate is 3% and 1-year Canadian dollar
interest rate is 4.5%. The current USD/CAD spot exchange rate is
1.5000. Calculate the 1-year forward rate.
A: 1.5218
1.5218=1.500*(1.045/1.03)

Q5. Suppose you have a position of ＄100 million in the instruments below.
Each one has a maturity of 10 years. Which instrument is most likely to
have a DV01 that exceeds the DV01 of a Treasury strip with 10-year
maturity?
A: Inverse floating rate securities.
Q6. Which of the following properties of ineffective hedges is not correct:
A: SEC disclosure requirements are such that firms have to disclose hedges that
turn out to be ineffective when the hedges mature.
SEC disclosure requirements say nothing about this.

## Q7. An unexpected change in taxation making it optimal for firms to

reduce divided payments and to replace them by share repurchases for
an amount equal to the reduction in dividend payments would:
A: Increase the value of a portfolio of calls on common stock.
This has no effect on leverage. It increases the share price, but decreases the
supply of shares over time. This makes calls more valuable.

## Q8.The latest proposal of the Basel Committee on Banking Supervision

(BCBS, Basel 2) for the new Basel Accord introduces the advanced
internal rating approach for credit risk. Banks will input their own:
A: EDF and LGD.

Q9.Assuming the time horizon for all transactions is the same, which of the
following transactions would have the least credit risk?
A: A forward sale of oil to a C rated company where the total purchase price is
guaranteed by a letter of credit from an AAA rated bank.
The trade with the least credit risk would be d as it is fully collateralized by a
AAA rated bank. Each of the other answers has a higher potential credit loss.

## Q10. A Credit Default Swap is an instrument that can be characterized

best as:
A: An option to sell defaulted securities at par value to a third party in
exchange for a serious of fixed cash flows.
A credit default swap is a standard type of credit derivative. It is an option to
sell defaulted securities to a third party at par value.

Q11. Quite a few models were developed in the last few years to measure
credit risk exposure. Which of the models below is based on an actuarial
approach?
A: CreditRisk﹢
Q12. A bank computes the distribution of its loan portfolio
marked-to-market value one year from now using the CreditMetrics
approach of computing values for rating transition outcomes using (a) a
rating agency transition matrix, (b)current forward curves, and (c)
correlations among rating transition outcomes derived from stock
returns of the obligors. In computing firm-wide risk using this
distribution of its loan portfolio, the bank is most likely to understate its
risk because it ignores:
A: Spread risk.
Rating drift is in the transition matrix; the term structure of interest rates is
not a risk; the negative correlation reduces risk.

Q13. When your firm started trading fixed income securities, it used the
Black-Scholes model to price European options on fixed income
securities. You have a long position in a five-year European option on a
coupon bond that has eight years to maturity. If you were to conclude
that you are using the wrong model and should use the HJM one-factor
model, which of the following statements would be correct:
A: The value of your position would fall because Black-Scholes fails to capture
pull-to-par effect.

## Q14. Each of the following companies experienced massive losses

associated with derivatives positions that made headlines. Which
company suffered losses for reasons that have nothing to do with
operational risk?
A: Metallgesellschaft.

Q15. Consider a stock with an initial price of ＄100. Its price one year
from now is given by S＝100*exp(r), where the rate of return r is
normally distributed with a mean of 0.1 and a standard deviation of 0.2.
With 95% confidence, after rounding, S will be between:
A: ＄74.68 and ＄163.56
In(S/100) = r-N(0.1, 0.22) thus 0.1-1.96*0.2<In(S/100)<0.1+1.96*0.2.
0.1-1.96*0.2 is -0.292, so that 100Exp[-0.292] is ﹩74.68. 0.1+1.96*0.2 is
0.492, yielding ﹩163.56.