FRM Practice Test
Identical assets sold in separate areas should be priced the same in each location, according to which of the following? Assume CH Inc.'s common stock is traded on both the New York Stock Exchange and the New York Stock Exchange.
Εξήγηση:
According to the Law of One Price. identical assets selling in different locations should
be priced identically in the different locations. For example, assume the common stock of
CH Inc. is listed on both the NYSE and NASDAQ.
A factor model's number of components should be kept as low as feasible while still capturing the major
sources of nondiversifiable (or systematic) risk. The model's most basic form just has one macro factor:
Which of the models below best fits the given description?
Εξήγηση:
The number of factors to include in a factor model should be as small as possible, yet still
capture the priced sources of nondiversifiable (or systematic) risk. The simplest version of
the model consists ofjust one macro factor: the single-factor model.
‘Equals the stock return's sensitivity to a l-u nit change in the factor.' Which of the following best describes the situation?
Εξήγηση:
The factor beta, equals the sensitivity of the stock return to a i-unit change in the factor.
Which of the following is the least likely to be a multifactor model's input?
Εξήγηση:
The mean—variance efficient market portfolio is essential to the capital asset pricing
model, but is not required in multifactor models.
‘The act of purchasing an asset in a lower-cost market while simultaneously selling it in a higher-cost market.' Which of the following best describes the above?
Εξήγηση:
The action of buying an asset in the cheaper market and simultaneously selling that
asset in the more expensive market is called arbitrage.
‘The part of a stock's return that aren't explained by macro factors.'
Which of the following best describes the above?
Εξήγηση:
The firm-specific return, is the portion ofthe stock's return that is unexplained by macro
factors lie, the F terms in the equation).
What does risk data aggregation mean, according to the Basel Committee on Banking Supervision?
Εξήγηση:
According to the Basel Committee on Banking Supervision, risk data aggregation means
“defining, gathering and processing risk data according to the bank's risk reporting
requirements to enable the bank to measure its performance against its risk tolerance/
appetite."
Many banks were unable to promptly and accurately detect risk concentrations across business lines and at the bank group level during the global financial crisis that began in 2007, due in part to which of the following?
Εξήγηση:
During the global financial crisis that began in 2007, many banks were unable to quickly
and accurately identify concentrations of risk across business lines and at the bank group
level due, in part, to an inability to aggregate risk exposures and report bank-wide risks
effectively.
When constructing a single-factor security market line, which of the following assumptions is not made?
Εξήγηση:
The derivation ofthe single—factor security market line does not rely on the assumption
that a mean-variance efficient market portfolio exists. This is in contrast with the capital
asset pricing model, which relies on the existence of the mean—variance efficient market
portfolio.
In stress/crisis conditions, systems should be in place to produce aggregated risk data promptly
for all essential hazards.
The following are only a few examples of critical risks:
I. Credit exposures to major corporate borrowers as a whole.
II. Credit risk exposures from counterparties, including derivatives.
III. Trading exposures, positions, and operational restrictions.
IV. Market concentrations by area and sector.
Εξήγηση:
Systems should be in place to produce aggregated risk data quickly in stress/crisis
situations for all critical risks. Critical risks include, but are not limited to:
— Aggregated credit exposures to large corporate borrowers.
— Counterparty credit risk exposures, including derivatives.
—Trading exposures, positions, and operating limits.
— Market concentrations by region and sector.
— Liquidity risk indicators.
—Time-critical operational risk indicators.
Which of the following is the least likely criteria for an arbitrage opportunity? Which of the following is a result of the arbitrage situation?
Εξήγηση:
An arbitrage situation exists if a risk-free, zero net investment can be created that
produces a positive profit. The arbitrage return need not exceed the risk-free rate.
To ensure the accuracy of risk reports, which of the following should the bank do?
I. Perform data reasonableness tests.
II. Identify the procedures for generating risk reports.
III. Produce error reports that discover, report, and explain data flaws and problems.
IV. Include descriptions of mathematical and logical linkages that should be confirmed in the data.
Εξήγηση:
To ensure the accuracy of risk reports the bank should:
- Create reasonableness checks 0 f the data.
- Define the processes used to create risk reports.
- Create error reports that identify, report, and explain weaknesses or errors in the
data.
- Include descriptions of mathematical and logical relationships in the data that
should be verified.
Assume that two risk factors (risk factors 1 and 2) have factor betas of 0.40 and 0.50, respectively, in Portfolio P. Assume a portfolio manager wants to eliminate all exposure to the two risk variables without selling the portfolio. Which of the following approaches is most likely to provide the intended outcome?
Εξήγηση:
A factor portfolio is a well—diversified portfolio that has a factor beta equal to one for a
single risk factor, and factor betas equal to zero on the remaining factors. By shorting the
hedge portfolio, the investor will offset the factor risks ofthe original portfolio. In this case,
the 0.40 and 0.50 exposures to the two risk factors are offset by the short position in the
hedge portfolio that also has 0.40 and 0.50 exposures to the two risk factors.
Supervisors should be satisfied that the bank's risk reporting is adequate in terms of coverage,
analysis, and cross-institutional comparability.
Which of the following information should be included in a risk report, but not limited to?
1. Market risk.
II. Credit risk.
III. Capital adequacy.
IV. Results of stress tests.
Εξήγηση:
Bank supervisors should be satisfied that the bank's risk reporting is sufficient in terms of
coverage, analysis, and comparability across institutions. A risk report should include, but
not be limited to, information regarding:
— Credit risk.
— Market risk.
— Liquidity risk.
— Operational risk.
- Results 0 f stress tests.
— Capital adequacy.
— Regulatory capital.
- Liquidity projections.
— Capital projections.
— Risk concentrations.
- Funding plans.
What can factor portfolios do to protect against numerous risk factors?
Εξήγηση:
Factor portfolios can be used to hedge multiple risk factors by combining the original
portfolio with offsetting positions in the factor portfolios.
A portfolio manager employs a 2—factor APT model to calculate expected returns for
To compute expected returns for Portfolio P, a portfolio manager uses a 2-factor APT model. Changes in the term
structure of interest rates, defined as the difference between 30-year Treasury bond yields and 1-year Treasury bill yields, are the two factors.
Assume you have the following information:
Risk-free rate = 4%
GDP factor beta = 2.00
Term structure factor beta = 0.50
GDP risk premium = 6%
Term structure risk premium = 5%
Which of the following predicted returns for Portfolio P is correct using the 2-factor APT model?
Εξήγηση:
Record level consistency is consistency between one set of data values and another set
within the same record. Temporal level consistency is consistency between one set of
data values and another set within the same record at different points in time.
Republic Bank's risk management officer is Kate Williams. She's laying the groundwork for successful risk data aggregation governance standards. The bank has a history of being lax when it comes to risk management procedures, and Williams has been hired to change that. Which one of the following claims about governance concepts is incorrect?
Εξήγηση:
Governance principles for risk data aggregation relate to overall bank processes and the
roles of senior management and the board in supporting risk data aggregation and
reporting. Data sources relate to the accuracy and integrity of the data, not governance.
In addition, the bank should strive to have a single source for risk data, not multiple
sources.
Which of the following practices should be used for data aggregation and risk reporting?
I. Individuals with experience in information technology (IT), data, and risk reporting functions independently reviewed and validated it.
II. Detailed documentation.
III. Unaffected by the structure of the bank. Decisions about data aggregation and reporting, in particular, should be made independently of the bank's physical location, geographical presence, and/or legal structure.
IV. Taken into account when the company embarks on new projects, such as new product development, acquisitions, and/or divestitures.
Εξήγηση:
Data aggregation and risk reporting practices should be:
Independently reviewed and validated by individuals with expertise in information
technology (IT) and data and risk reporting functions.
Fully documented.
Unaffected by the bank’s structure. Specifically, decisions regarding data aggregation
and reporting should be independent of the bank's physical location or geographical
presence and/or legal organization.
Considered when the firm undergoes new initiatives, including new product
development, acquisitions, and/or divestitures.
In aggregated risk data, a bank should provide data characteristics (metadata) and naming conventions for legal entities, counterparties, customers, and account data. The Basel Committee on Banking Supervision recommends this in the principle of:
Εξήγηση:
Principle 2, data architecture and infrastructure, requires that risk data aggregation and
reporting practices should be a part of the bank's planning processes and subject to
business impact analysis. Banks should establish integrated data classifications and
architecture across the banking group. Multiple data models may be used as long as
there are robust automated reconciliation measures in place. In addition, data
architecture should include information on data characteristics (metadata) and naming
conventions for legal entities, counterparties, customers, and account data.
The estimated return on the Chrome Fund is 12%. The excess return on the Nickel Fund is estimated to be 8%. Chrome Fund has a standard deviation of 5%, whereas Nickel Fund has a standard deviation of 4%. 2 percent is the risk-free rate. A sensible investor should, based on the Sharpe ratio:
Εξήγηση:
Excess return for Chrome is 12% — 2% = 10%.
Chromes Sharpe ratio is 10% / 5% = 2.0.
Excess return for Nickel is given as 8%. Nickel’s Sharpe ratio is 8% / 4% = 2.0
An investor should be indifferent between these two funds because they provide the
same expected excess return per unit of risk.
Yoki Hamanaka, Sumitomo's chief copper trader, attempted to monopolize the copper market in a classic market manipulation approach over a decade ago. Poor internal controls resulted in such a lack of oversight of his trading activity. Which of the following series of transactions was he allowed to engage in as a result of that lack of monitoring, resulting in a $2.6 billion trading loss for Sumitomo?
Εξήγηση:
Hamanaka established a dominant long position in futures contracts and simultaneously
purchased large quantities of physical copper. As well, to help finance his long copper
positions, he even sold put options on copper. In essence, here was a “triple long" strategy
that would only pay off if the price of copper or copper futures increased. At the same
time, there was a huge risk of losses should the prices fall. Unfortunately, there was a
continuation of plummeting copper prices after other copper traders began selling their
copper holdings in anticipation of Sumitomo doing the same. The end result was total
losses of $2.6 billion for Sumitomo.
Which of the following best describes the term "risk metrics"?
Εξήγηση:
Risk metrics aid the management process by providing managers a target to achieve
(e.g., a particular VaR level).
What happens if risk managers aren't certain of all of the company's risks?
Εξήγηση:
Some risks may not be known explicitly, but they can still be accounted for. In this case,
risk management can still be successful. Also, not knowing the risks themselves but
understanding the results of the risk (i.e., the distribution of returns) can be adequate for
successful risk management.
Which of the following statements best describes the term "risk-free asset"?
Εξήγηση:
A risk-free asset is a security that has a return known ahead oftime, so the variance of the
return is zero.
The market portfolio, or M, is the universally agreed upon optimal risky portfolio. Which of the following best describes the term "market portfolio M"?
Εξήγηση:
This universally agreed upon optimal risky portfolio is called the market portfolio, M, and
it is defined as the portfolio of all marketable assets weighted in proportion to their
relative market values.