FRM Practice Test

Question 1

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.

Accepted Answer

Law of One Price

Answer

The Law of One Price states that identical assets or commodities should trade at the same price in different markets, assuming no transaction costs or barriers to trade. If prices differ, an arbitrage opportunity would exist, allowing investors to profit by simultaneously buying in the cheaper market and selling in the more expensive one until prices converge. This principle underpins efficient market theories.

Question 2

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?

Accepted Answer

Single-factor model

Answer

A single-factor model is the most basic form of a factor model, explaining asset returns using only one macro factor to capture the major source of nondiversifiable (systematic) risk. This aligns with the description of keeping the number of components as low as feasible while still capturing the primary systematic risk. Examples include the Capital Asset Pricing Model (CAPM) which uses the market risk premium as its single factor.

Question 3

‘Equals the stock return's sensitivity to a l-u nit change in the factor.'
Which of the following best describes the situation?

Accepted Answer

Factor beta

Answer

Arbitrage is the practice of simultaneously buying an asset in a market where its price is lower and selling it in another market where its price is higher. This action allows an investor to profit from the price differential without taking on significant risk. The described scenario perfectly matches the definition of arbitrage.

Question 4

Which of the following is the least likely to be a multifactor model's input?

Accepted Answer

The mean-variance efficient market portfolio.

Answer

In factor models, a stock's total return is decomposed into components explained by common macro factors (systematic risk) and a residual component. The firm-specific return, also known as idiosyncratic risk, represents the portion of the stock's return that is unique to that particular company and cannot be explained by the broad market or macro factors.

Question 5

‘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?

Accepted Answer

Arbitrage

Answer

According to the Basel Committee on Banking Supervision (BCBS), risk data aggregation involves defining, gathering, and processing risk data according to a bank's risk reporting requirements. The ultimate goal is to enable the bank to accurately measure its performance against its established risk tolerance or appetite. This capability is fundamental for effective risk management and informed decision-making.