FRM Advanced Topics 4

Question 1

In an asset-backed security, 'overcollateralization' enhances credit quality by:

Accepted Answer

Pledging collateral whose value exceeds the issued notes

Answer

Overcollateralization means the collateral pool exceeds the principal of the issued securities, providing a loss cushion.

Question 2

The EWMA (exponentially weighted moving average) volatility model differs from a simple equally-weighted estimate by:

Accepted Answer

Assigning greater weight to more recent returns

Answer

EWMA places exponentially declining weights on past returns, emphasizing recent data over older observations.

Question 3

A GARCH(1,1) model adds which feature compared to EWMA?

Accepted Answer

A long-run mean variance to which volatility reverts

Answer

GARCH(1,1) includes a weighted long-run average variance term, giving it mean reversion that EWMA lacks.

Question 4

Stress testing differs from VaR primarily because stress testing:

Accepted Answer

Examines specific extreme scenarios rather than probability-based loss estimates

Answer

Stress testing evaluates portfolio impact under defined extreme or hypothetical scenarios rather than statistical quantiles.

Question 5

Liquidity-adjusted VaR (LVaR) incorporates which additional element relative to standard VaR?

Accepted Answer

The cost of unwinding positions over a liquidation horizon

Answer

LVaR adds the bid-ask spread and time needed to liquidate positions, capturing market liquidity risk.

FRM Practice Test