FRM FRM Market Risk 3

Question 1

What is basis risk in the context of hedging?

Accepted Answer

The risk that the hedge instrument does not perfectly offset the exposure being hedged

Answer

The risk of a sudden change in the risk-free rate

Answer

The risk that the underlying asset price moves against the hedger

Answer

The risk of counterparty default on a derivatives contract

Question 2

Under a normal distribution assumption, approximately what percentage of daily returns fall outside 2 standard deviations?

Accepted Answer

5%

Answer

1%

Answer

10%

Answer

32%

Question 3

What is the key difference between systematic risk and idiosyncratic risk?

Accepted Answer

Systematic risk affects the entire market and cannot be diversified away, while idiosyncratic risk is firm-specific and can be diversified

Answer

Systematic risk can be eliminated through hedging while idiosyncratic risk cannot

Answer

Systematic risk is measured by VaR while idiosyncratic risk is measured by ES

Answer

Systematic risk relates to credit events while idiosyncratic risk relates to market movements

Question 4

Which model is commonly used to estimate time-varying volatility by weighting recent observations more heavily?

Accepted Answer

EWMA (Exponentially Weighted Moving Average)

Answer

Historical Simulation

Answer

Black-Scholes

Answer

CAPM

Question 5

What does a correlation of -1 between two assets imply for portfolio risk?

Accepted Answer

The assets move in perfectly opposite directions, allowing complete risk elimination when combined in the right proportions

Answer

The portfolio risk equals the sum of individual asset risks

Answer

The assets are unrelated so diversification provides no benefit

Answer

The portfolio variance is the average of individual variances

Question 6

In the context of options, what does 'delta hedging' involve?

Accepted Answer

Continuously rebalancing a position in the underlying asset to offset changes in option value

Answer

Purchasing options to hedge an existing equity portfolio

Answer

Using options of different strikes to neutralize gamma exposure

Answer

Selling options to collect premium and reduce delta