FRM

PART I

FULL LENGTH TEST - 1

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FRM Part I Full Length Test - 1

Question 1

Financial risk management:

A)
B)
C)
D)

seeks to eliminate all financial risks.

is the process of detecting, assessing, and managing financial risks.
only focuses on managing market-related financial risks.
is the process of reacting to financial losses in order to minimize losses.

Question 2

The risk of sustaining significant losses due to the inability to take or exit a position at a fair price is most
likely:
A)
B)
C)
D)

market risk.
operational risk.
liquidity risk.
credit event risk.

Question 3

The risk that a counterparty will fail to deliver its obligation is:
A)
B)
C)
D)

people risk.
delivery risk.
counterparty risk.
settlement risk.

Question 4

Jim Sheehan manages a diversified portfolio containing forty stocks. The portfolio beta is 1.05. Jim is
considering adding the stock of ABC Inc. to the portfolio, and would fund the purchase with cash already
in the portfolio. ABC Inc. has a beta of 1.20, and is currently not part of the portfolio. Which statement
about the resulting portfolio is TRUE?
A)
B)
C)
D)

Systematic risk would decrease, but the unsystematic risk would be unchanged.
Both systematic risk and unsystematic risk would be unchanged.
Systematic risk would increase, but the unsystematic risk would be unchanged.
Both systematic risk and unsystematic risk would both increase.

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Question 5

Mital Tienes investment portfolio currently consists of stocks in two companies, 40 percent in Drysdahl
Banking and the remaining amount in Clampett Oil. Performance measurement information for these two
stocks is given in the table below:
Stock

Expected Return Standard Deviation

Drysdahl Banking

10.50%

8.5%

Clampett Oil

16.55%

25.0%

The covariance between the two stocks is 0.001. Tiene is considering adding a third stock, Hilbilee
Investors. Hilbilee Investors correlation coefficient with the current portfolio is 0.38.
Which of the following statements is least accurate?
A)
B)
C)
D)

With Hilbilee added to the portfolio, the variance could be 0.026.

As Tiene diversifies, he will reduce the portfolio's unsystematic risk.
The standard deviation of returns for the current portfolio is 15.5%.
The expected return of Tiene's current portfolio is approximately 14.1%.

Question 6

An investor owns the following three-stock portfolio today.

Stock

Market Value

K
L
M

$4,500
$6,300
$3,700

Expected Annual
Return
14%
9%
12%

The expected portfolio value two years from now is closest to:
A)
B)
C)
D)

$16,150.
$14,960.
$17,870.
$17,975.

Question 7

In the presence of taxes, risk management activities can create value by:
A)
B)
C)
D)

shifting the realization of taxable income from years when it is high to years when it is low.
minimizing each years taxable income.
postponing taxes indefinitely.
shifting the realization of taxable income from years when it is low to years when it is high.

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Question 8

Which of the following strategies may increase firm value by decreasing the costs of bankruptcy and
financial distress?
I.
II.
III.
IV.

Reducing the potential costs of financial distress and bankruptcy.

Reducing the weighted average cost of capital.
Improving management incentives.
Reducing information asymmetries.
A)
B)
C)
D)

I and II only.
I only.
I and III only.
I, II, and IV only.

Question 9

Which of the following measures used to evaluate the performance of a portfolio manager is (are) NOT
subject to the assumptions of the capital asset pricing model (CAPM)?
A)
B)
C)
D)

Jensen's alpha.
Treynor measure.
Jensen's alpha and the Treynor measure.
Sharpe measure.

Question 10

The following performance data for an actively managed portfolio and the S&P 500 Index is reported:

Return
Standard deviation
Beta

Actively Managed Portfolio

50%
18%
1.1

S&P 500
20%
15%
1.0

Risk-free rate = 6%.

Part 1)
Determine the Sharpe measure, Treynor measure, and Jensen's alpha for the actively managed portfolio.
A)
B)
C)
D)

Sharpe measure = 1.04; Treynor measure = 0.14; Alpha = 0.04.

Sharpe measure = 1.05; Treynor measure = 0.17; Alpha = 0.04.
Sharpe measure = 2.44; Treynor measure = 0.40; Alpha = 0.29.
Sharpe measure = 1.06; Treynor measure = 0.12; Alpha = 0.02.
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Part 2)
Based on the results from determining the Sharpe measure, Treynor measure, and Jensen's alpha for the
actively managed portfolio, does the portfolio manager outperform or underperform the S&P 500 index?
A) Sharpe measure underperform; Treynor measure outperform; Alpha outperform
B) Sharpe measure outperform; Treynor measure underperform; Alpha underperform.
C) Sharpe measure outperform; Treynor measure outperform; Alpha outperform.
D) Sharpe measure underperform; Treynor measure underperform; Alpha underperform.

Question 11

Which of the following are examples of model risk illustrated in the Long-Term Capital Management
case?
I. Poor management oversight.
II. Financial reporting standards.
III. Ignoring autocorrelation of economic shocks.
IV. Underestimating correlations among asset classes during economic crises.
A)
B)
C)
D)

II, III, and IV only.

III and IV only.
I, II, III, and IV.
I only.

Question 12

Metallgesellschaft could have addressed the cash flow crisis created by their stack-and-roll hedge
strategy by:
I. Buying puts.
II. Selling puts.
III. Selling calls.
IV. Requiring periodic cash settlements from customers.
A)
B)
C)
D)

I only.
I and IV only.
IV only.
II and IV.

Question 13

Which of the following increases the cost of rolling a long hedge (i.e., using long futures contracts to
hedge a pre-existing short position)?
I. A market shift from normal backwardation to contango.
II. A market shift from contango to normal backwardation.
III. Futures prices rising above the spot price.
IV. Futures prices falling below the spot price.
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A)
B)
C)
D)

I and IV.
II and III.
I and III.
II and IV.

Question 14

Will Lambert, FRM, is a financial risk analyst for Offshore Investments. He is preparing a purchase
recommendation on Burch Corporation. According to the GARP Code of Conduct, which of the following
statements about disclosure of conflicts is most correct? Lambert would have to disclose that:
A)
B)
C)
D)

his wife owns 2,000 shares of Burch Corporation.

Offshore is an OTC market maker for Burch Corporations stock.
he has a material beneficial ownership of Burch Corporation through a family trust.
All of these choices require disclosure.

Question 15

Charmaine Townsend, FRM, has been managing a growth portfolio for her clients using a screening
process that identifies companies that have high earnings growth rates. Townsend has decided that,
because of a volatile economy, she is going to adopt a value strategy using a screening process that
identifies companies that have low price-earnings multiples. Townsend will violate the GARP Code of
Conduct if she makes this change in her investment process without:
A) notifying her supervisor before she makes the change.
B) promptly notifying her clients of the change.
C) getting written permission from her clients in advance of the change.
getting prompt written acknowledgment of the change from her clients within a reasonable
D)
time after the change was made.

Question 16

Greg Barns, FRM, and Jill Tillman, FRM, wish to test the specification of their econometric model. Barns
suggests adding another independent variable and examining the statistics of its parameters and the
effects on the other parameters. Tillman suggests rerunning the regression using logarithms of the data
instead of the original data. Which, if either, falls under the heading of testing the specification of an
econometric model?
A)
B)
C)
D)

Neither the suggestion of Barns nor that of Tillman.

Both the suggestion of Barns and that of Tillman.
The suggestion of Barns but not the suggestion of Tillman.
The suggestion of Tillman but not the suggestion of Barns.

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Question 17

A two-sided but very thick coin is expected to land on its edge twice out of every 100 flips. And the
probability of face up (heads) and the probability of face down (tails) are equal. When the coin is flipped,
the prize is $1 for heads, $2 for tails, and $50 when the coin lands on its edge. What is the expected
value of the prize on a single coin toss?
A)
B)
C)
D)

$17.67.
$1.50.
$26.50.
$2.47.

Question 18

Rafael Garza, CFA, is considering the purchase of ABC stock for a clients portfolio. His analysis includes
calculating the covariance between the returns of ABC stock and the equity market index. Which of the
following statements regarding Garzas analysis is most accurate?
The covariance of two variables is an easier measure to interpret than the correlation
coefficient.
B) A covariance of +1 indicates a perfect positive covariance between the two variables.
The actual value of the covariance is not very meaningful because the measurement is very
C)
sensitive to the scale of the two variables.
D) The covariance measures the strength of the linear relationship between two variables.
A)

Question 19

The distribution of annual returns for a bond portfolio is approximately normal with an expected value of
$120 million and a standard deviation of $20 million. Which of the following is closest to the probability
that the value of the portfolio one year from today will be between $110 million and $170 million?
A)
B)
C)
D)

74%.
58%.
42%.
66%.

Question 20

A bottler of iced tea wishes to ensure that an average of 16 ounces of tea is in each bottle. In order to
analyze the accuracy of the bottling process, a random sample of 150 bottles is taken. Using a tdistributed test statistic of -1.09 and a 5% level of significance, the bottler should:
A) reject the null hypothesis and conclude that bottles contain an average 16 ounces of tea.
reject the null hypothesis and conclude that bottles do not contain an average of 16 ounces of
B)
tea.
C) not reject the null hypothesis and conclude that bottles contain an average 16 ounces of tea.
not reject the null hypothesis and conclude that bottles do not contain an average of 16
D)
ounces of tea.

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Question 21

An analyst has determined that the probability that the S&P 500 index will increase on any given day is
0.60 and the probability that it will decrease is 0.40. The expected value and variance of the number of up
days in a 5-day period are closest to:
A)
B)
C)
D)

3.0 and 1.1.

2.0 and 0.5.
3.0 and 1.2.
2.0 and 2.1.

Question 22

The capital asset pricing model is given by: Ri =Rf + Beta ( Rm -Rf) where Rm = expected return on the
market, Rf = risk-free market and Ri = expected return on a specific firm. The dependent variable in this
model is:
A)
B)
C)
D)

Rf.
R m.
Ri .
Rm - Rf.

Question 23

Linear regression is based on a number of assumptions. Which of the following is least likely an
assumption of linear regression?
A)
B)
C)
D)

There is at least some correlation between the error terms from one observation to the next.
Values of the independent variable are not correlated with the error term.
A linear relationship exists between the dependent and independent variables.
The variance of the error terms each period remains the same.

Question 24

In the multivariable regression model: Y = B0 + B1 Xli + B2 X2i + i, the formula for the standard errors
2
of the estimated coefficients includes the variance of i, which is represented by: . Since the term is:

A)

not known with certainty, the expression is replaced with:

B)
2

not known with certainty, the expression is replaced with:

.
C) not known with certainty, the standard errors of the coefficients cannot be estimated.
D) known with certainty, the standard errors of the coefficients are known with certainty.

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Question 25

You estimate the following GARCH model:

2

= 0.04 + 0.30

2
t-1

+ 0.50

n-1

If the most recent volatility estimate and error term are 0.15 and 0.02, respectively, the long-run average
volatility is closest to:
A)
B)
C)
D)

0.16.
0.20.
0.23.
0.04.

Question 26

A $2 million balanced portfolio is comprised of 40 percent stocks and 60 percent intermediate bonds. For
the next year, the expected return on the stock component is 9 percent and the expected return on the
bond component is 6 percent. The standard deviation of the stock component is 18 percent and the
standard deviation of the bond component is 8 percent. What is the annual VAR for the portfolio at a 1
percent probability level if the correlation between the stock and the bond component is 0.25?
A)
B)
C)
D)

$126,768.
$149,500.
$303,360.
$152,250.

Question 27

We can transform a simulated distribution of two independent random variables, 1 and 2, into two
random variables with a correlation coefficient of by defining the two outcomes as:
A)
B)
C)
D)

1/2

1 = 1 and 2 = 1 + (1- ) 2.
2 1/2
1 = 1 and 2 = 1 + (1- ) 2.
1 = 1 and 2 = 1 + 2.
1/2
1 = 1 and 2 = 1 + (1- ) 2.

Question 28

Which of the following statements regarding orders in exchange markets is least accurate?
A)
B)
C)
D)

In a short sale, a trader borrows stock and sells it.

A stop buy order is an order to purchase a stock if the price falls to the stop price.
A limit sell order is an order to sell at a price greater than the limit price.
A stop buy order can be combined with a short sale to limit losses.

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Question 29

When a futures trader receives a margin call what must he or she do to bring the position up to the initial
margin? The futures trader must:
A)
B)
C)
D)

deposit maintenance margin.

deposit variation margin.
deposit the daily settlement value.
sell stock to cover the margin call.

Question 30

Prior to contract expiration the short in a futures contract can avoid futures exposure by:
A)
B)
C)
D)

using an exchange-for-physicals.
paying a cash settlement amount.
entering into a reversing trade.
delivering the asset at the current spot price.

Question 31

A portfolio manager has a $15 million mid-cap portfolio that has a beta of 1.3 relative to the S&P 400.
S&P 500 futures are trading at 1,150 and have a multiplier of 250. The most significant risk this manager
faces in attempting to hedge his position is:
A)
B)
C)
D)

correlation risk resulting from a rollover of positions between the S&P 400 and S&P 500.
basis risk resulting from a cross-hedge.
volatility risk arising from unstable correlation predictions.
improper profit forecasts of the underlying position.

Question 32

A portfolio manager would like to use S&P 500 stock index futures to help increase his exposure to
movements in the stock market over the next three months. The current S&P500 futures contracts are
trading at 1,205 with a multiplier of $250, and the portfolio manager would like to increase the portfolio
beta from 0.92 to 1.05. If the value of the asset portfolio is $15 million, the position taken for stock index
futures would be closest to which of the following?
A)
B)
C)
D)

Sell 6 contracts.
Purchase 6 contracts.
Sell 50 contracts.
Purchase 50 contracts.

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Question 33

Which of the following factors is (are) often considered to be a problem with hedged positions?
I. Uncertainty with roll-over of the hedging instrument.
II. Perfect correlation between the asset and the hedging instrument.
III. Certainty with the date of the underlying assets purchase or sale.
IV. Imperfect correlation between the hedged asset and the hedging instrument.
A)
B)
C)
D)

I only.
I and IV only.
I and II only.
II and III only.

Question 34

A bond has an effective duration of 7.5 and a convexity of 104.0. If yields rise by 82 bps, the price of the
bond will:
A)
B)
C)
D)

increase by 6.50%.
increase by 6.15%.
decrease by 6.15%.
decrease by 5.80%.

Question 35

An investor has entered into a forward rate agreement (FRA) where she has contracted to pay a fixed
rate of 5 percent on $5,000,000 based on the quarterly rate in three months. If interest rates are
compounded quarterly, and the floating rate is 2 percent in three months, what is the payoff at the end of
the sixth month? The investor will:
A)
B)
C)
D)

receive a payment of $37,500.

make a payment of $75,000.
receive a payment of $75,000.
make a payment of $37,500.

Question 36

A bank has $100 million in assets with modified duration of 8.5, and $90 million of liabilities with modified
duration of 6.5. Accounting only for duration effects, a 50 basis point parallel downward shift would impact
the banks equity position by an amount closest to a:
A)
B)
C)
D)

$10 million increase in equity.

$1.325 million increase in equity.
$100 million decrease in equity.
$90 million increase in equity.

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Question 37

At the inception of a one-year forward contract on a stock index, the value of the index was $1,100, the
interest rate was 2.6 percent, and the continuous dividend was 1.2 percent. Six months later, the value of
the index is $1,125. Which of the following statements is TRUE? The value of the:
A)
B)
C)
D)

long position is -$17.17.

short position is -$17.17.
long position is $25.00.
short position is -$22.19.

Question 38

The S&P 500 index is trading at 1015. The S&P 500 pays an expected dividend yield of 2 percent and the
current risk-free rate is 4.1 percent. The value of a 3-month futures contract on the S&P 500 is closest to:
A)
B)
C)
D)

979.86.
1,350.59.
997.68.
1,020.34.

Question 39

At the inception of a six-month forward contract on a stock index, the value of the index was $1,150, the
interest rate was 4.4 percent, and the continuous dividend was 1.8 percent. Three months later, the value
of the index is $1,075. Which of the following statements is TRUE? The value of the:
A)
B)
C)
D)

long position is $82.41.

long position is $47.56.
short position is $47.56.
long position is -$82.41.

Question 40

Suppose a bonds quoted price is 105 7/32 and the accrued interest is $23.54. If the bond has a par value
of $1,000, what is the bonds flat price?
A)
B)
C)
D)

$1,000.00.
$1,023.54.
$1,075.73.
$1,052.19.

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Question 41

A 5% coupon bond with semi-annual coupon payments on a coupon payment date when the coupon has
not been paid yet and the bond has a $1,000 par value. What is the accrued interest of the bond and
what is the bond's full price?
Accrued Interest Full Price
A) $25

$1,000

B) $25

$1,025

C) $50

$1,050

D) $50

$1,000

Question 42

Peter Stone is considering buying a $100 face value, semi-annual coupon bond with a quoted price of
105.19. His colleague points out that the bond is trading ex-coupon. Which of the following choices best
represents what Stone will pay for the bond?
A)
B)
C)
D)

$105.19 plus accrued interest.

$105.19 minus accrued interest.
$105.19 minus the coupon payment.
$105.19.

Question 43

A bank entered into a 4-year tenor plain vanilla swap three years ago. The agreements of the swap are to
pay 6.5 percent annually, based on annual compounding with a 30/360 day-count convention, fixed rate
on a $50 million notional, and receive 1-year London Interbank Offered Rate (LIBOR). The continuously
compounded LIBOR for 1-year obligations is currently 5.75 percent. The 1-year LIBOR at the beginning
of the period was 6.25 percent. The value of the swap is closest to:
A)
B)
C)
D)

$110,000.
$110,000.
$800,522.
$257,020.

Question 44

A firm has entered into a $22.5 MM plain vanilla interest rate swap in which it pays fixed at 4.2 percent
and receives LIBOR. At inception, what is the firms credit exposure on this swap if LIBOR is 3.2 percent?
A)
B)
C)
D)

$225,000.
$11.25 MM.
$22.5 MM.
$0.

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Question 45

A financial institution has entered into a plain vanilla currency swap with one of its customers. The period
left on the swap is 3 years, with the institution paying 5 percent on USD20 million and receiving 2.5
percent on JPY1,500 million annually. The current exchange rate is JPY120/USD, and the flat term
structure in both countries generates a 3 percent rate in the U.S. and a 0.75 percent rate in Japan. The
current value of this swap to the institution is closest to:
A)
B)
C)
D)

USD7.95 million.
USD7.95 million.
USD6.875 million.
USD6.875 million.

Question 46

Referring to put-call parity, which one of the following alternatives would allow you to create a synthetic
riskless pure-discount bond?
A)
B)
C)
D)

Buy a European put option; sell the same stock; sell a European call option.
Buy a European put option; buy the same stock; sell a European call option.
Sell a European put option; buy the same stock; buy a European call option.
Sell a European put option; sell the same stock; buy a European call option.

Question 47

Consider a call option on a stock currently priced at $50 with a strike price of $55. Which of the following
CANNOT be the price of the call option?
A) $10.
B) $15.
C) $55.
D) $50.
Question 48

Rachel Barlow is a recent graduate of Columbia University with a Bachelors degree in finance. She has
accepted a position at a large investment bank, but first must complete an intensive training program to
gain experience in several of the investment banks areas of operations. Currently, she is spending three
months at her firm's Derivatives Trading desk. One of the traders, Jason Coleman, CFA, is acting as her
mentor, and will be giving her various assignments over the three month period.
One of the first projects he asks her to do is to compare different option trading strategies. Coleman
would like Barlow to pay particular attention to strategy costs and their potential payoffs. Barlow is not
very comfortable with option models, and knows she needs to be able to fully understand the most basic
concepts in order to move on. She decides that she must first investigate how to properly price European
and American style equity options. Coleman has given her software that provides a variety of analytical
information using three valuation approaches: the Black-Scholes model, the Binomial model, and Monte
Carlo simulation. Barlow has decided to begin her analysis using a variety of different scenarios to
evaluate option behavior. The data she will be using in her scenarios is provided in Exhibits 1 and 2. Note
that all of the rates and yields are on a continuous compounding basis.

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Exhibit 1
Stock Price (S)
Strike Price (X)
Interest Rate (r)
Dividend Yield (q)
Time to Maturity
(years)
Volatility (Std. Dev.)

$100
$100
7%
0%
0.5
20%

Exhibit 2
Stock Price (S)
Strike Price (X)
Interest Rate (r)
Dividend Yield (q)
Time to Maturity
(years)
Volatility (Std. Dev.)
Value of European
Call

$110
$100
7%
0%
0.5
20%
$14.8445

Barlow notices that the stock in Exhibit 1 does not pay dividends. If the stock begins to pay a dividend,
how will the price of a call option on that stock be affected?
A)
B)
C)
D)

Decrease.
Increase.
Be unchanged.
Increase or decrease.

Question 49

Dennis Austin works for OReilly Capital Management and manages endowments and trusts for large
clients. The fund invests most of its portfolio in S&P 500 stocks, keeping some cash to facilitate
purchases and withdrawals. The funds performance has been quite volatile, losing over 20 percent last
year but reporting gains ranging from 5 percent to 35 percent over the previous five years. OReillys
clients have many needs, goals, and objectives, and Austin is called upon to design investment strategies
for their clients. Austin is convinced that the best way to deliver performance is to, whenever possible,
combine the funds stock portfolio with option positions on equity.
Part 1)
Given the following scenario:
Performance to Date: Up 3%
Client Objective: Stay positive
Austin's scenario: Low stock price volatility between now and end of year.
Which is the best option strategy to meet the client's objective?
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A)
B)
C)
D)

Bull call.
Protective put.
Long butterfly.
2:1 Ratio Spread.

Part 2)
Given the following scenario:
Performance to Date: Up 16%
Client Objective: Earn at least 15%
Austin's scenario: Good chance of large gains or large losses between now and end of year.
Which is the best option strategy to meet the client's objective?
A) Long straddle.
B) Short straddle.
C) Long butterfly.
D) Condor.
Part 3)
Given the following scenario:
Performance to Date: Up 16%
Client Objective: Earn at least 15%
Austin's scenario: Good chance of large losses between now and end of year.
Which is the best option strategy to meet the client's objective?
A) Long call options.
B) Short call options.
C) Long put options.
D) Short put options.

Question 50

Which of the following is least likely one of the conditions that must be met for a trade to be considered an
arbitrage?
A)
B)
C)
D)

There is no risk.
There are no commissions.
There is a guaranteed profit.
There is no initial investment.

Question 51

The process that ensures that two securities positions with identical future payoffs, regardless of future
events, will have the same price is called:
A)
B)
C)
D)

exchange parity.
arbitrage.
the law of one price.
payoff parity.

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Question 52

Which of the following relationships between arbitrage and market efficiency is least accurate?
A) Investors acting on arbitrage opportunities help keep markets efficient.
B) Momentary deviations from market efficiency can create an arbitrage opportunity.
The concept of rationally priced financial instruments preventing arbitrage opportunities is the
C)
basis behind the no-arbitrage principle.
Market efficiency refers to the low cost of trading derivatives because of the lower expense to
D)
traders.

Question 53

If the October 2005 spot price for natural gas is 5.171, the annual risk-free rate of interest is 5 percent,
and the November forward price is 5.253. What is the natural gas implied storage cost for the month of
October?
A)
B)
C)
D)

0.043.
0.060.
0.057.
0.075.

Question 54

A hedge fund specializing in commodity related derivatives is considering a crush spread position using
soybean and soybean oil futures contracts. Using the information in the table below, determine which of
the following statements is correct.
< >>

Soybeans

Soybean Oil

Spot Price

$5.83/bushel $0.27/pound

Storage Cost*

0.63/bushel 0.03/pound

Convenience Yield*

6%

6%

Interest rate*

11%

11%

Time to expiration
3 months
6 months
*Continuously compounded annual rates
The hedge fund should establish a long position in the soybean futures contract for no more
than $7.01 and a short position in the soybean oil contract for no less than $0.28.
The hedge fund should establish a long position in the soybean futures contract for no more
B)
than $6.91 and a short position in the soybean oil contract for no less than $0.29.
The hedge fund should establish a short position in the soybean futures contract for no less
C)
than $7.01 and a long position in the soybean oil contract for no less than $0.28.
The hedge fund should establish a long position in the soybean futures contract for no more
D)
than $7.01 and a long position in the soybean oil contract for no more than $0.29.
A)

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Question 55

Suppose the owner of a commodity decides to lend out the commodity. If the commodity has a
continuously compounded convenience yield of c, proportional to the value of the commodity, which of
the following best represents the lowest forward price?
A)
B)
C)
D)
Question 56

A European bank exchanges euros for USD, lends them at the U.S. risk-free rate, and simultaneously
enters into a forward contract to sell the loan proceeds for euros at loan maturity. If the net effect of these
transactions is to earn the risk-free euro rate, it is an example of:
A)
B)
C)
D)

arbitrage.
interest rate parity.
spot-forward equality.
the law of one price.

Question 57

Assume that the current spot exchange rate between the U.S. dollar and the euro is $1.2500 per . In the
U.S., the 3-year nominal continuously compounded risk-free interest rate is 5%. In Europe, the 3-year
nominal continuously compounded risk-free interest rate is 6.5%. The 3-year forward exchange rate is
closest to:
A)
B)
C)
D)

$1.213.
$1.288.
$1.195.
$1.308.

Question 58

A multiyear restructuring agreement (MYRA) for a $100 million loan with a sovereign has the following
features: maturity extended from two to five years; principal amortization for four years at 25 percent per
year; grace period of one year; up-front fee of 1.25 percent; loan rate of 6 percent; and bank discount rate
of 6.75 percent. If the original loan had a value equal to its par, the concessionality attached to this MYRA
is closest to:
A) $52,570,000.
B) $98,924,000.
C) $997,000.
D) $47,430,000.

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Question 59

Which of the following statements about the early retirement of debt is least accurate?
A) Noncallable bonds generally cannot be retired for any reason prior to maturity.
Sinking fund provisions require the issuer to systematically retire the issue over its life rather
B)
than at maturity.
Non-refundable bonds prohibit a company from calling an issue financed by the proceeds of a
C)
lower cost refunding bond issue.
When bonds are redeemed under sinking fund provisions, the call price is known as the
D)
"regular redemption price."
Question 60

Which of the following is most accurate about a bond with a deferred call provision?
A)
B)
C)
D)

It could be called at any time during the initial call period, but not later.
It could be redeemed at any time prior to maturity.
Principal repayment can be deferred until it reaches maturity.
It could not be called right after the date of issue.

Question 61

Which of the following statements regarding callable bonds is most accurate? Callable bonds:
A) are likely to be called when interest rates have increased.
B) that have a deferred call feature allow the bondholder to defer the call for up to 5 years.
may not be called at par value--there must be at least a slight call premium to compensate the
C)
holder for losing the bond.
typically require that the issuer pay a premium above par to call the issue, and the amount of
D)
this premium usually declines as the bond approaches maturity.

Question 62

Which of the following is most accurate in relation to P-STRIPS and shorter term C-STRIPS?
A)
B)
C)
D)

P-STRIPS: Trade at fair value; C-STRIPS: Trade cheap.

P-STRIPS: Trade at fair value; C-STRIPS: Trade rich.
P-STRIPS: Trade rich; C-STRIPS: Trade at fair value.
P-STRIPS: Trade rich; C-STRIPS: Trade rich.

2010 Finstructor. All Rights Reserved

Question 63

If the one-year spot rate is 7 percent and the one-year forward rate is 7.4 percent, what is the two-year
spot rate?
A)
B)
C)
D)

7.12 %.
7.20%.
7.27%.
7.40%.

Question 64

An investor holds a 20-year, semi-annual 8.00 percent coupon Treasury bond issued at par. Market
interest rates are currently at 6.50 percent. The bond is noncallable. A coupon payment is due this week.
Which of the following choices best represents the type of risk the investor faces?
A)
B)
C)
D)

Prepayment risk.
Reinvestment risk.
Liquidity risk.
Credit risk.

Question 65

A 10-year, 11 percent annual coupon bond with $100 par value currently yields 9 percent. What is the
duration of the bond given a 50 basis point change in yield?
A)
B)
C)
D)

4.80
6.19
6.95
7.27

years.
years.
years.
years.

Question 66

A stock is priced at 38 and the periodic risk-free rate of interest is 6 percent. What is the value of a twoperiod European put option with a strike price of 35 on a share of stock using a binomial model with an up
factor of 1.15 and a risk-neutral probability of 68 percent?
A)
B)
C)
D)

$2.58.
$0.57.
$0.64.
$2.90.

2010 Finstructor. All Rights Reserved

Question 67

Using the Black-Scholes model compute the value of a European put option using the following inputs:

Underlying stock price: $90

Exercise price: $90
Risk-free interest rate: 5%
Volatility: 20%
Dividend yield: 0%
Time to expiration: one year

The Black-Scholes put option price is closest to:

A)
B)
C)
D)

$4.11.
$5.89.
$6.12.
$5.01.

Question 68

Which of the following is FALSE?

I.
II.
III.
IV.

The delta of forwards and futures is 1.

Gamma is largest when options are at-the-money.
Two problems using stop-loss trading on naked options are transaction costs and stock price
uncertainty.
For a delta-neutral portfolio, although opposite in sign, theta can serve as a proxy for gamma.
A)
B)
C)
D)

II only.
I only.
I and III only.
II and IV only.

Question 69

Which of the following is NOT a criteria of a coherent risk measure?

I. homogeneity larger positions bring larger risk.
II. monotonicity greater future return will have less risk.
III. subadditivity the risk of the sum is more than or equal to the sum of the risks.
IV. risk-free condition risk-free assets should have less risk.
A) III and IV.
B) I and II.
C) I and III.
D) II and III.

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Question 70

Which of the following statements regarding the structured Monte Carlo approach is CORRECT?
I.
II.
III.

The general equation assumes the underlying asset has normally distributed returns with a mean
of and a standard deviation of .
The structured Monte Carlo (SMC) approach can address multiple assets with multiple risk
exposures by generating correlated scenarios based on a statistical distribution.
In some cases where it does not produce an accurate forecast of future volatility, increasing the
number of simulations can improve the forecast.
A)
B)
C)
D)

I and III.
II and III.
I, II and III.
I and II.

Question 71

An analyst at Burns Holdings, Inc. is considering using simulation analysis to calculate the VAR of the
firms assets. The analyst has read the following comments from a colleague about the structured Monte
Carlo (SMC) approach. Which of the statements regarding the SMC approach are true?
I.
II.
III.
IV.
V.

An advantage to the SMC approach is that inaccurate future volatility forecast can be improved
by running more simulations.
SMC approach cannot predict extreme values from correlation breakdowns if the underlying
covariance matrix relies on normal market volatility.
A disadvantage of the SMC approach is that it can only be used to estimate VAR for portfolios
with long only positions.
SMC estimates the underlying asset prices and returns through the following stochastic process:
+z
st+1,i = ste
An advantage to the SMC approach is that multiple risk factors can be incorporated into VAR
estimate by incorporating correlation estimates.
A)
B)
C)
D)

I, III, and V.
II, IV, and V.
I, II, III, and V.
II and IV.

Question 72

One of the basic requirements of a risk control process that a risk and control self-assessment program
(RCSA) fails in is the:
A)
B)
C)
D)

expert opinion of managers.

identification of expected losses.
ongoing assessment of the effectiveness of risk management activities.
independent verification of risk identification and measurement.

2010 Finstructor. All Rights Reserved

Question 73

Which of the following is FALSE regarding the use of scorecard data?

A)
B)
C)
D)

It is forward looking rather than backward looking.

It is more subjective because it relies upon the judgment of business line managers.
It more accurately captures the future benefits of risk management activities.
It usually results in higher capital charges than the use of historical data.

Question 74

From an operational risk perspective, the risks that are unlikely to jeopardize the future of the firm are:
A) low-frequency, high-severity risks.
B) high-frequency, low-severity risks.
C) risks related to business practices.
D) risks related to internal fraud.
Question 75

Which of the following statements highlights an issue with conducting stress tests?
I.
II.
III.

Identifying key input variables.

Predicting regime shifts or structural changes.
Predicting how a change in one variable will impact others during a financial crisis.
A)
B)
C)
D)

II and III.
I, II and III.
I and III.
I and II.

Question 76

Which of the following statements is (are) CORRECT regarding stress testing methodologies?
I.
II.

III.
IV.

Prior to the recent crisis, stress testing methodology was based on an underlying assumption that
risk is generated by unknown and non-stochastic processes.
The process of reverse testing involves a scenario of known outcome, identification of likely
events producing the outcome and evaluation of effectiveness of risk mitigating strategies to deal
with the risk outcome.
Basis risk is the difference in the prices (or interest rates) between the cash market and the
futures market.
Contingent risk arises due to contractual agreements only.
A)
B)
C)
D)

I only.
II only.
III only.
I, II and III.

2010 Finstructor. All Rights Reserved

Question 77

According to Moody's credit rating scheme, a rating below investment grade is:
A)
B)
C)
D)

Ba.
Aaa.
Aa.
Baa.

Question 78

Under the Moodys bond rating system, the threshold for non-investment grade debt is reached when a
bonds rating falls from:
A)
B)
C)
D)

Baa to Ba.
A to Baa.
Ba to B.
Caa to D.

Question 79

Which of the following statements is (are) CORRECT? Country risk:

I.
II.
III.
IV.

is defined as the likelihood of delayed, reduced, or omitted payment of interest and principal
attributable to conditions of the country of the borrower.
is the broadest measure of credit risk.
is contagious.
does not include sovereign risk.

A)
B)
C)
D)

I only.
I, II and III.
I and II.
I, II, III and IV.

Question 80

Country F has a debt service ratio (DSR) of 4. Its exports total $17 billion, and its principal repayments
are $3 billion. The value of its interest payments is closest to:
A)
B)
C)
D)

$2.3 billion.
$65.0 billion.
$4.0 billion.
$11.0 billion.

2010 Finstructor. All Rights Reserved

Question 81

Bank X has contractually agreed to a $20,000,000 credit facility with Bank Y. Y will immediately access
40% of the commitment. Bank X has no experience with Bank Y and conservatively estimates drawdown
in default to be 75%. Calculate the adjusted exposure for Bank X.
A)
B)
C)
D)

$12,000,000.
$8,000,000.
$15,000,000.
$17,000,000.

Question 82

Smallville Savings Bank (SSB) has a loan portfolio totaling $20,000,000 in commitments. Currently 60%
is outstanding. The bank has assessed an average internal credit rating equivalent to 2% default
probability over the next year. Drawdown upon default is assumed to be 75%. The bank has additionally
estimated a recovery rate of 60%. The standard deviation of EDF and LGD is 5% and 25%, respectively.
The unexpected loss for SSB falls within which of the following ranges?
A)
B)
C)
D)

Greater than $750,000.

$250,001 to $500,000.
Less than $250,000.
$500,001 to $750,000.

Question 83

Country R has a debt service ratio (DSR) of 0.78. If its annual interest payments are $11 billion, and its
principal repayments are $119 billion, the income from its exports is closest to:
A)
B)
C)
D)

$1.67 billion.
$167 billion.
$84 billion.
$109 billion.

Question 84

An analyst runs a regression of portfolio returns on three independent variables. These independent
variables are price-to-sales (P/S), price-to-cash flow (P/CF), and price-to-book (P/B). The analyst
discovers that the p-values for each independent variable are relatively high. However, the F-test has a
very small p-value. The analyst is puzzled and tries to figure out how the F-test can be statistically
significant when the individual independent variables are not significant. What violation of regression
analysis has occurred?
A)
B)
C)
D)

serial correlation.
multicollinearity.
conditional heteroskedasticity.
unconditional heteroskedasticity.

2010 Finstructor. All Rights Reserved

Question 85

Which of the following is the best approximation of the gamma of an option if its delta is equal to 0.6 when
the price of the underlying security is 100 and 0.7 when the price of the underlying security is 110?
A)
B)
C)
D)

0.00.
0.10.
1.00.
0.01.

Question 86

Consider a study of 100 university endowment funds that was conducted to determine if the funds annual
risk-adjusted returns could be explained by the size of the fund and the percentage of fund assets that
are managed to an indexing strategy. The equation used to model this relationship is:
ARARi = b0 + b1Sizei + b2Indexi + ei
Where:
ARARi

= the average annual risk-adjusted percent returns for the fund i over the 19982002 time period.

Sizei

= the natural logarithm of the average assets under management for fund i.

Indexi

= the percentage of assets in fund i that were managed to an indexing strategy.

The table below contains a portion of the regression results from the study.
Partial Results from Regression ARAR on Size and Extent of Indexing
Coefficients

Standard Error

t-Statistic

Intercept

???

0.55

5.2

Size

0.6

0.18

???

Index

1.1

???

2.1

Part 1)
Which of the following is the most accurate interpretation of the slope coefficient for size? ARAR:
will change by 0.6% when the natural logarithm of assets under management changes by 1.0,
holding index constant.
will change by 1.0% when the natural logarithm of assets under management changes by 0.6,
B)
holding index constant.
and index will change by 1.1% when the natural logarithm of assets under management
C)
changes by 1.0.
will change by 1.1% when the natural logarithm of assets under management changes by 1.0
D)
and index changes by 0.6.

A)

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Part 2)
Which of the following is the estimated standard error of the regression coefficient for index?
A) 0.52.
B) 1.91.
C) 2.31.
D) 1.00.
Part 3)
Which of the following is the t-statistic for size?
A) 3.33.
B) 0.30.
C) 0.12.
D) 0.70.
Part 4)
Which of the following is the estimated intercept for the regression?
A) 0.11.
B) 9.45.
C) 4.65.
D) 2.86.
Part 5)
Which of the following statements is most accurate regarding the significance of the regression
parameters at a 5% level of significance?
The parameter estimates for the intercept are significantly different than zero. The slope
A)
coefficients for index and size are not significant.
All of the parameter estimates are significantly different than zero at the 5% level of
B)
significance.
The parameter estimates for the intercept and the independent variable size are significantly
C)
different than zero. The coefficient for index is not significant.
None of the regression parameters are significantly different than zero at the 5% level of
D)
significance.

Question 87

Of the Sharpe, Treynor, and Jensens Alpha measures, when measuring the risk/return performance of
actively managed portfolios, which is the most appropriate to use?

A)
B)
C)
D)

Jensen's Alpha.
Treynor measure.
Sharpe ratio.
All three measures are equally appropriate.

Question 88

For the investments shown in the table below, what are the mean, median, and mode of the returns?

2010 Finstructor. All Rights Reserved

Investment

Return (%)

12

14

13

12
Median

Mean

Mode

A) 12.00%

12%

12%

B) 11.20%

12%

12%

C) 10.71%

9%

13%

D) 10.71%

12%

12%

Question 89

As part of a regression analysis, an analyst finds that: Y b1 X = -1.8 and b1 = 3.2. Based upon these
results, for every unit increase in the independent variable, on average the dependent variable increases
by:
A) 1.4.
B) 1.8.
C) 5.0.
D) 3.2.
Question 90

The current price of Razor Manufacturing is $20. In each of the next two years you expect the stock price
to either move up 20 percent or down 20 percent. The probability of an upward move is 0.65 and the
probability of a downward move is 0.35. The risk-free rate is 5 percent. The value of a 2-year American
put option with strike price of $24 is closest to:
A) $4.00.
B) $3.22.
C) $3.85.
D) $3.65.

Question 91

Using both RiskMetrics and historical standard deviation, calculate the K-value that equates the most
recent weight between the two models. Assume is 0.98.
A)
B)
C)
D)

K = 30.
K = 51.
K = 50.
K = 98.

2010 Finstructor. All Rights Reserved

Question 92

Consider a 145-day put option at 30 on a stock selling at 27 with an annualized standard deviation of 0.30
when the continuously compounded risk-free rate is 4 percent. The value of the put option is closest to:
[round d1 and d2 rather than interpolate for N(.)].
-r (T)

PT = [Xe

(1 - N(d2))] - [ST (1 - N(d1))]

where:
2

d1 = [ln(St / X) + [r + /2](T) ] / (T-t)

d2 = d1 - (T)

Cumulative Standard Normal Probability:

0.06
0.3
0.5
0.4

0.07

0.08

0.09

0.6406
0.7123
0.6772

0.6443
0.7157
0.6808

0.6480
0.7190
0.6844

0.6517
0.7224
0.6879

A)
B)
C)
D)

$3.32.
$3.97.
$4.07.
$3.64.

Question 93

Bank A has extended a commitment of $10,000,000 and assessed a probability of default of 5%. The loss
given default based on historical data is estimated to be 30%. Bank B has extended a $5,000,000
commitment to a company with a lower credit quality. A default rate of 10% and loss given default of 20%
is estimated. For Bank A to have a lower expected loss than Bank B, which of the following is TRUE? The
recovery rate of:
A)
B)
C)
D)

Bank Bs loan will decrease to 90%.

Bank Bs loan will increase to 80%.
Bank As loan will decrease to 80%.
Bank As loan will increase to 90%.

2010 Finstructor. All Rights Reserved

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