Frm-Lo 2020

FRM
LEARNING
OBJECTIVES
PART II
Market Risk Measurement and Management
PART II EXAM WEIGHT | 20% (MR)
This area focuses on market risk measurement and management techniques. The broad knowledge points
covered in Market Risk Measurement and Management include the following:
• VaR and other risk measures
• Parametric and non-parametric methods of estimation
• VaR mapping
• Backtesting VaR
• Expected shortfall (ES) and other coherent risk measures
• Extreme Value Theory (EVT)
• Modeling dependence: correlations and copulas
• Term structure models of interest rates
• Volatility: smiles and term structures
• Fundamental Review of the Trading Book
The readings that you should focus on for this section and the specific learning objectives that should be achieved with
each reading are:
Kevin Dowd, Measuring Market Risk, 2nd Edition (West Sussex, UK: John Wiley & Sons, 2005).
Chapter 3. Estimating Market Risk Measures: An Introduction and Overview [MR–1]
After completing this reading you should be able to:
• Estimate VaR using a historical simulation approach.
• Estimate VaR using a parametric approach for both normal and lognormal return distributions.
• Estimate the expected shortfall given profit and loss (P/L) or return data.
• Define coherent risk measures.
• Estimate risk measures by estimating quantiles.
• Evaluate estimators of risk measures by estimating their standard errors.
• Interpret quantile-quantile (QQ) plots to identify the characteristics of a distribution.
Chapter 4. Non-parametric Approaches [MR–2]
• Apply the bootstrap historical simulation approach to estimate coherent risk measures.
• Describe historical simulation using non-parametric density estimation.
• Compare and contrast the age-weighted, the volatility-weighted, the correlation-weighted and the
filtered historical simulation approaches.
• Identify advantages and disadvantages of non-parametric estimation methods.
2020 FRM Learning Objectives Part II garp.org/frm 27
Chapter 7. Parametric Approaches (II): Extreme Value [MR-3]
• Explain the importance and challenges of extreme values in risk management.
• Describe extreme value theory (EVT) and its use in risk management.
• Describe the peaks-over-threshold (POT) approach.
• Compare and contrast generalized extreme value and POT.
• Evaluate the tradeoffs involved in setting the threshold level when applying the generalized Pareto
(GP) distribution.
• Explain the importance of multivariate EVT for risk management.
Philippe Jorion, Value at Risk: The New Benchmark for Managing Financial Risk, 3rd Edition (New York, NY:
McGraw-Hill, 2007).
Chapter 6. Backtesting VaR [MR–4]
• Define backtesting and exceptions and explain the importance of backtesting VaR models.
• Explain the significant difficulties in backtesting a VaR model.
• Verify a model based on exceptions or failure rates.

• Define and identify Type I and Type II errors.
• Explain the need to consider conditional coverage in the backtesting framework.
• Describe the Basel rules for backtesting.
Chapter 11. VaR Mapping [MR–5]
• Explain the principles underlying VaR mapping and describe the mapping process.
• Explain how the mapping process captures general and specific risks.
• Differentiate among the three methods of mapping portfolios of fixed income securities.
• Summarize how to map a fixed income portfolio into positions of standard instruments.
• Describe how mapping of risk factors can support stress testing.
• Explain how VaR can be used as a performance benchmark.
• Describe the method of mapping forwards, forward rate agreements, interest rate swaps and options.
“Messages from the academic literature on risk measurement for the trading book,” Basel Committee on
Banking Supervision, Working Paper, No. 19, Jan 2011. [MR–6]
• Explain the following lessons on VaR implementation: time horizon over which VaR is estimated, the
recognition of time varying volatility in VaR risk factors and VaR backtesting.
• Describe exogenous and endogenous liquidity risk and explain how they might be integrated into
VaR models.
• Compare VaR, expected shortfall and other relevant risk measures.
• Compare unified and compartmentalized risk measurement.
• Compare the results of research on “top-down” and “bottom-up” risk aggregation methods.
• Describe the relationship between leverage, market value of asset and VaR within an active balance sheet
management framework.
Gunter Meissner, Correlation Risk Modeling and Management, 2nd Edition (Risk Books, 2019).
Chapter 1. Correlation Basics: Definitions, Applications, and Terminology [MR–7]
• Describe financial correlation risk and the areas in which it appears in finance.
• Explain how correlation contributed to the global financial crisis of 2007-2009.
• Describe the structure, uses and payoffs of a correlation swap.
• Estimate the impact of different correlations between assets in the trading book on the VaR capital charge.
• Explain the role of correlation risk in market risk and credit risk.
• Relate correlation risk to systemic and concentration risk.
Chapter 2. Empirical Properties of Correlation: How Do Correlations Behave in the Real World? [MR–8]
• Describe how equity correlations and correlation volatilities behave throughout various economic states.
• Calculate a mean reversion rate using standard regression and calculate the corresponding autocorrelation.
• Identify the best-fit distribution for equity, bond and default correlations.
Chapter 5. Financial Correlation Modeling—Bottom-Up Approaches (pages 126-134 only) [MR–9]
• Explain the purpose of copula functions and the translation of the copula equation.
• Describe the Gaussian copula and explain how to use it to derive the joint probability of default of two assets.
• Summarize the process of finding the default time of an asset correlated to all other assets in a portfolio
using the Gaussian copula.
Bruce Tuckman and Angel Serrat, Fixed Income Securities: Tools for Today’s Markets, 3rd Edition (Hoboken,
NJ: John Wiley & Sons, 2011).
Chapter 6. Empirical Approaches to Risk Metrics and Hedging [MR–10]
• Explain the drawbacks to using a DV01-neutral hedge for a bond position.
• Describe a regression hedge and explain how it can improve a standard DV01-neutral hedge.
• Calculate the regression hedge adjustment factor, beta.
• Calculate the face value of an offsetting position needed to carry out a regression hedge.
• Calculate the face value of multiple offsetting swap positions needed to carry out a two-variable
regression hedge.
• Compare and contrast level and change regressions.
• Describe principal component analysis and explain how it is applied to constructing a hedging portfolio.
Chapter 7. The Science of Term Structure Models [MR–11]
• Calculate the expected discounted value of a zero-coupon security using a binomial tree.
• Construct and apply an arbitrage argument to price a call option on a zero-coupon security using
replicating portfolios.
• Define risk-neutral pricing and apply it to option pricing.
• Distinguish between true and risk-neutral probabilities and apply this difference to interest rate drift.
• Explain how the principles of arbitrage pricing of derivatives on fixed income securities can be extended
over multiple periods.
• Define option-adjusted spread (OAS) and apply it to security pricing.
• Describe the rationale behind the use of recombining trees in option pricing.
• Calculate the value of a constant maturity Treasury swap, given an interest rate tree and the risk-
neutral probabilities.
• Evaluate the advantages and disadvantages of reducing the size of the time steps on the pricing of
derivatives on fixed-income securities.

• Evaluate the appropriateness of the Black-Scholes-Merton model when valuing derivatives on fixed
income securities.
Chapter 8. The Evolution of Short Rates and the Shape of the Term Structure [MR–12]
• Explain the role of interest rate expectations in determining the shape of the term structure.
• Apply a risk-neutral interest rate tree to assess the effect of volatility on the shape of the term structure.
• Estimate the convexity effect using Jensen’s inequality.
• Evaluate the impact of changes in maturity, yield and volatility on the convexity of a security.
• Calculate the price and return of a zero-coupon bond incorporating a risk premium.
Chapter 9. The Art of Term Structure Models: Drift [MR–13]
• Construct and describe the effectiveness of a short-term interest rate tree assuming normally distributed
rates, both with and without drift.
• Calculate the short-term rate change and standard deviation of the rate change using a model with
normally distributed rates and no drift.
• Describe methods for addressing the possibility of negative short-term rates in term structure models.
• Construct a short-term rate tree under the Ho-Lee Model with time-dependent drift.
• Describe uses and benefits of the arbitrage-free models and assess the issue of fitting models to
market prices.
• Describe the process of constructing a simple and recombining tree for a short-term rate under the
Vasicek Model with mean reversion.
• Calculate the Vasicek Model rate change, standard deviation of the rate change, expected rate in T years
and half-life.
• Describe the effectiveness of the Vasicek Model.
Chapter 10. The Art of Term Structure Models: Volatility and Distribution [MR–14]
• Describe the short-term rate process under a model with time-dependent volatility.
• Calculate the short-term rate change and determine the behavior of the standard deviation of the rate
change using a model with time dependent volatility.
• Assess the efficacy of time-dependent volatility models.
• Describe the short-term rate process under the Cox-Ingersoll-Ross (CIR) and lognormal models.
• Calculate the short-term rate change and describe the basis point volatility using the CIR and
lognormal models.
• Describe lognormal models with deterministic drift and mean reversion.
John C. Hull, Options, Futures, and Other Derivatives, 10th Edition (New York, NY: Pearson, 2017).
Chapter 20. Volatility Smiles [MR–15]
• Define volatility smile and volatility skew.
• Explain the implications of put-call parity on the implied volatility of call and put options.
• Compare the shape of the volatility smile (or skew) to the shape of the implied distribution of the
underlying asset price and to the pricing of options on the underlying asset.
• Describe characteristics of foreign exchange rate distributions and their implications on option prices and
implied volatility.
• Describe the volatility smile for equity options and foreign currency options and provide possible
explanations for its shape.
• Describe alternative ways of characterizing the volatility smile.
• Describe volatility term structures and volatility surfaces and how they may be used to price options.
• Explain the impact of the volatility smile on the calculation of "the Greeks”.
• Explain the impact of a single asset price jump on a volatility smile.
Chapter 18. Fundamental Review of the Trading Book [MR-16]
• Describe the changes to the Basel framework for calculating market risk capital under the Fundamental
Review of the Trading Book (FRTB) and the motivations for these changes.
• Compare the various liquidity horizons proposed by the FRTB for different asset classes and explain how
a bank can calculate its expected shortfall using the various horizons.
• Explain the FRTB revisions to Basel regulations in the following areas:
- Classification of positions in the trading book compared to the banking book
- Backtesting, profit and loss attribution, credit risk and securitizations
Credit Risk Measurement and Management
PART II EXAM WEIGHT | 20% (CR)
This area focuses on a candidate’s understanding of credit risk management, with some focus given to
structured finance and credit products such as collateralized debt obligations and credit derivatives. The
broad areas of knowledge covered in readings related to Credit Risk Measurement and Management include
the following:
• Credit analysis
• Default risk: quantitative methodologies
• Expected and unexpected loss
• Credit VaR
• Counterparty risk
• Credit derivatives
• Structured finance and securitization
each reading are:
Jonathan Golin and Philippe Delhaise, The Bank Credit Analysis Handbook, 2nd Edition (Hoboken, NJ: John
Wiley & Sons, 2013).
Chapter 1. The Credit Decision [CR–1]
• Define credit risk and explain how it arises using examples.
• Explain the components of credit risk evaluation.
• Describe, compare and contrast various credit risk mitigants and their role in credit analysis.
• Compare and contrast quantitative and qualitative techniques of credit risk evaluation.
• Compare the credit analysis of consumers, corporations, financial institutions and sovereigns.
• Describe quantitative measurements and factors of credit risk, including probability of default, loss given
default, exposure at default, expected loss and time horizon.
• Compare bank failure and bank insolvency.
Chapter 2. The Credit Analyst [CR–2]
• Describe the quantitative, qualitative and research skills a banking credit analyst is expected to have.
• Assess the quality of various sources of information used by a credit analyst.
• Explain the CAMEL system used for evaluating the financial condition of a bank.
Gerhard Schroeck, Risk Management and Value Creation in Financial Institutions (New York, NY: John Wiley
& Sons, 2002).
Chapter 5. Capital Structure in Banks (pages 170-186 only) [CR-3]
• Evaluate a bank’s economic capital relative to its level of credit risk.
• Identify and describe important factors used to calculate economic capital for credit risk: probability of
default, exposure and loss rate.
• Define and calculate expected loss (EL).
• Define and calculate unexpected loss (UL).
• Estimate the variance of default probability assuming a binomial distribution.
• Calculate UL for a portfolio and the UL contribution of each asset.
• Describe how economic capital is derived.
• Explain how the credit loss distribution is modeled.
• Describe challenges to quantifying credit risk.
Giacomo De Laurentis, Renato Maino and Luca Molteni, Developing, Validating and Using Internal Ratings:
Methodologies and Case Studies (West Sussex, UK: John Wiley & Sons, 2010).
Chapter 3. Rating Assignment Methodologies [CR–4]
• Explain the key features of a good rating system.
• Describe the experts-based approaches, statistical-based models and numerical approaches to
predicting default.
• Describe a rating migration matrix and calculate the probability of default, cumulative probability of
default, marginal probability of default and annualized default rate.
• Describe rating agencies’ assignment methodologies for issue and issuer ratings.
• Describe the relationship between borrower rating and probability of default.
• Compare agencies’ ratings to internal experts-based rating systems.
• Distinguish between the structural approaches and the reduced-form approaches to predicting default.
• Apply the Merton model to calculate default probability and the distance to default and describe the
limitations of using the Merton model.
• Describe linear discriminant analysis (LDA), define the Z-score and its usage and apply LDA to classify a
sample of firms by credit quality.
• Describe the application of a logistic regression model to estimate default probability.
• Define and interpret cluster analysis and principal component analysis.
• Describe the use of a cash flow simulation model in assigning rating and default probability and explain
the limitations of the model.
• Describe the application of heuristic approaches, numeric approaches and artificial neural networks in
modeling default risk and define their strengths and weaknesses.
• Describe the role and management of qualitative information in assessing probability of default.
René Stulz, Risk Management & Derivatives (Florence, KY: Thomson South-Western, 2002).
Chapter 18. Credit Risks and Credit Derivatives [CR–5]
• Using the Merton model, calculate the value of a firm’s debt and equity and the volatility of firm value.
• Explain the relationship between credit spreads, time to maturity and interest rates and calculate
credit spread.
• Explain the differences between valuing senior and subordinated debt using a contingent claim approach.
• Explain, from a contingent claim perspective, the impact of stochastic interest rates on the valuation of
risky bonds, equity and the risk of default.
• Compare and contrast different approaches to credit risk modeling, such as those related to the Merton
model, CreditRisk+, CreditMetrics and the KMV model.
• Assess the credit risks of derivatives.
• Describe a credit derivative, credit default swap and total return swap.
• Explain how to account for credit risk exposure in valuing a swap.
Allan Malz, Financial Risk Management: Models, History, and Institutions (Hoboken, NJ: John Wiley &
Sons, 2011).
Chapter 7. Spread Risk and Default Intensity Models [CR–6]
• Compare the different ways of representing credit spreads.
• Compute one credit spread given others when possible.
• Define and compute the Spread ‘01.
• Explain how default risk for a single company can be modeled as a Bernoulli trial.
• Explain the relationship between exponential and Poisson distributions.
• Define the hazard rate and use it to define probability functions for default time and conditional
default probabilities.
• Calculate the unconditional default probability and the conditional default probability given the hazard rate.
• Distinguish between cumulative and marginal default probabilities.
• Calculate risk-neutral default rates from spreads.
• Describe advantages of using the CDS market to estimate hazard rates.
• Explain how a CDS spread can be used to derive a hazard rate curve.
• Explain how the default distribution is affected by the sloping of the spread curve.
• Define spread risk and its measurement using the mark-to-market and spread volatility.
Chapter 8. Portfolio Credit Risk (Sections 8.1, 8.2, 8.3 only) [CR–7]
• Define and calculate default correlation for credit portfolios.
• Identify drawbacks in using the correlation-based credit portfolio framework.
• Assess the impact of correlation on a credit portfolio and its Credit VaR.
• Describe the use of a single factor model to measure portfolio credit risk, including the impact
of correlation.
• Define and calculate Credit VaR.
• Describe how Credit VaR can be calculated using a simulation of joint defaults.
• Assess the effect of granularity on Credit VaR.
Chapter 9. Structured Credit Risk [CR–8]
• Describe common types of structured products.
• Describe tranching and the distribution of credit losses in a securitization.
• Describe a waterfall structure in a securitization.
• Identify the key participants in the securitization process and describe conflicts of interest that can arise
in the process.
• Compute and evaluate one or two iterations of interim cashflows in a three-tiered securitization structure.
• Describe a simulation approach to calculating credit losses for different tranches in a securitization.
• Explain how the default probabilities and default correlations affect the credit risk in a securitization.
• Explain how default sensitivities for tranches are measured.
• Describe risk factors that impact structured products.
• Define implied correlation and describe how it can be measured.
• Identify the motivations for using structured credit products.
Jon Gregory, The xVA Challenge: Counterparty Credit Risk, Funding, Collateral, and Capital, 3rd Edition
(West Sussex, UK: John Wiley & Sons, 2015).
Chapter 4. Counterparty Risk [CR–9]
• Describe counterparty risk and differentiate it from lending risk.
• Describe transactions that carry counterparty risk and explain how counterparty risk can arise in
each transaction.
• Identify and describe institutions that take on significant counterparty risk.
• Describe credit exposure, credit migration, recovery, mark-to-market, replacement cost, default
probability, loss given default and the recovery rate.
• Describe credit value adjustment (CVA) and compare the use of CVA and credit limits in evaluating and
mitigating counterparty risk.
• Identify and describe the different ways institutions can quantify, manage and mitigate counterparty risk.
• Identify and explain the costs of an OTC derivative.
• Explain the components of the xVA term.
Chapter 5. Netting, Close-out and Related Aspects [CR–10]
• Explain the purpose of an ISDA master agreement.
• Summarize netting and close-out procedures (including multilateral netting), explain their advantages
and disadvantages and describe how they fit into the framework of the ISDA master agreement.
• Describe the effectiveness of netting in reducing credit exposure under various scenarios.
• Describe the mechanics of termination provisions and trade compressions and explain their advantages
and disadvantages.
• Identify and describe termination events and discuss their potential effects on parties to a transaction.
Chapter 6. Collateral [CR–11]
• Describe the rationale for collateral management.
• Describe the terms of a collateral and features of a credit support annex (CSA) within the ISDA Master
Agreement including threshold, initial margin, minimum transfer amount and rounding, haircuts, credit
quality and credit support amount.
• Describe the role of a valuation agent.
• Describe the mechanics of collateral and the types of collateral that are typically used.
• Explain the process for the reconciliation of collateral disputes.
• Explain the features of a collateralization agreement.
• Differentiate between a two-way and one-way CSA agreement and describe how collateral parameters
can be linked to credit quality.
• Explain aspects of collateral including funding, rehypothecation and segregation.
• Explain how market risk, operational risk and liquidity risk (including funding liquidity risk) can arise
through collateralization.
Chapter 7. Credit Exposure and Funding [CR–12]
• Describe and calculate the following metrics for credit exposure: expected mark-to-market, expected
exposure, potential future exposure, expected positive exposure and negative exposure, effective
exposure and maximum exposure.
• Compare the characterization of credit exposure to VaR methods and describe additional considerations
used in the determination of credit exposure.
• Identify factors that affect the calculation of the credit exposure profile and summarize the impact of
collateral on exposure.
• Identify typical credit exposure profiles for various derivative contracts and combination profiles.
• Explain how payment frequencies and exercise dates affect the exposure profile of various securities.
• Explain the impact of netting on exposure, the benefit of correlation, and calculate the netting factor.
• Explain the impact of collateralization on exposure and assess the risk associated with the remargining
period, threshold and minimum transfer amount.
• Assess the impact of collateral on counterparty risk and funding, with and without segregation
or rehypothecation.
Chapter 9. Counterparty Risk Intermediation [CR–13]
• Identify counterparty risk intermediaries including central counterparties (CCPs), derivative product
companies (DPCs), special purpose vehicles (SPVs) and monoline insurance companies (monolines) and
describe their roles.
• Describe the risk management process of a CCP and explain the loss waterfall structure of a CCP.
• Compare bilateral and centrally cleared over-the-counter (OTC) derivative markets.
• Assess the capital requirements for a qualifying CCP and discuss the advantages and disadvantages
of CCPs.
• Discuss the impact of central clearing on credit value adjustment (CVA), funding value adjustment (FVA),
capital value adjustment (KVA) and margin value adjustment (MVA).
Chapter 14. Credit and Debt Value Adjustments [CR–14]
• Explain the motivation for and the challenges of pricing counterparty risk.
• Describe credit value adjustment (CVA).
• Calculate CVA and the CVA spread with no wrong-way risk, netting, or collateralization.
• Evaluate the impact of changes in the credit spread and recovery rate assumptions on CVA.
• Explain how netting can be incorporated into the CVA calculation.
• Define and calculate incremental CVA and marginal CVA and explain how to convert CVA into a
running spread.
• Explain the impact of incorporating collateralization into the CVA calculation.
• Describe debt value adjustment (DVA) and bilateral CVA (BCVA).
• Calculate BCVA and BCVA spread.
Chapter 17. Wrong-way Risk [CR–15]
• Describe wrong-way risk and contrast it with right-way risk.
• Identify examples of wrong-way risk and examples of right-way risk.

• Discuss the impact of collateral on wrong-way risk.
• Discuss the impact of wrong-way risk on central counterparties.
Stress Testing: Approaches, Methods, and Applications, Edited by Akhtar Siddique and Iftekhar Hasan
(London, UK: Risk Books, 2013).
Chapter 4. The Evolution of Stress Testing Counterparty Exposures [CR–16]
• Differentiate among current exposure, peak exposure, expected exposure and expected
positive exposure.
• Explain the treatment of counterparty credit risk (CCR) both as a credit risk and as a market risk and
describe its implications for trading activities and risk management for a financial institution.
• Describe a stress test that can be performed on a loan portfolio and on a derivative portfolio.
• Calculate the stressed expected loss, the stress loss for the loan portfolio and the stress loss on a
derivative portfolio.
• Describe a stress test that can be performed on CVA.
• Calculate the stressed CVA and the stress loss on CVA.
• Calculate the DVA and explain how stressing DVA enters into aggregating stress tests of CCR.
• Describe the common pitfalls in stress testing CCR.
Michel Crouhy, Dan Galai and Robert Mark, The Essentials of Risk Management, 2nd Edition (New York, NY:
McGraw-Hill, 2014).
Chapter 9. Credit Scoring and Retail Credit Risk Management [CR–17]
• Analyze the credit risks and other risks generated by retail banking.
• Explain the differences between retail credit risk and corporate credit risk.
• Discuss the “dark side” of retail credit risk and the measures that attempt to address the problem.
• Define and describe credit risk scoring model types, key variables and applications.
• Discuss the key variables in a mortgage credit assessment and describe the use of cutoff scores, default
rates and loss rates in a credit scoring model.
• Discuss the measurement and monitoring of a scorecard performance including the use of cumulative
accuracy profile (CAP) and the accuracy ratio (AR) techniques.
• Describe the customer relationship cycle and discuss the trade-off between creditworthiness
and profitability.
• Discuss the benefits of risk-based pricing of financial services.
Chapter 12. The Credit Transfer Markets — and Their Implications [CR–18]

• Discuss the flaws in the securitization of subprime mortgages prior to the financial crisis of 2007.
• Identify and explain the different techniques used to mitigate credit risk and describe how some of these
techniques are changing the bank credit function.
• Describe the originate-to-distribute model of credit risk transfer and discuss the two ways of managing a
bank credit portfolio.
• Describe the different types and structures of credit derivatives including credit default swaps (CDS), first-
to-default puts, total return swaps (TRS), asset-backed credit-linked notes (CLN) and their applications.
Moorad Choudhry, Structured Credit Products: Credit Derivatives & Synthetic Securitisation, 2nd Edition
(New York, NY: John Wiley & Sons, 2010).
Chapter 12. An Introduction to Securitisation [CR–19]
• Define securitization, describe the securitization process and explain the role of participants in the process.
• Explain the terms over-collateralization, first-loss piece, equity piece and cash waterfall within the
securitization process.
• Analyze the differences in the mechanics of issuing securitized products using a trust versus a special
purpose vehicle (SPV) and distinguish between the three main SPV structures: amortizing, revolving and
master trust.
• Explain the reasons for and the benefits of undertaking securitization.
• Describe and assess the various types of credit enhancements.
• Explain the various performance analysis tools for securitized structures and identify the asset classes
they are most applicable to.
• Define and calculate the delinquency ratio, default ratio, monthly payment rate (MPR), debt service
coverage ratio (DSCR), the weighted average coupon (WAC), the weighted average maturity (WAM) and
the weighted average life (WAL) for relevant securitized structures.
• Explain the prepayment forecasting methodologies and calculate the constant prepayment rate (CPR)
and the Public Securities Association (PSA) rate.
Adam Ashcraft and Til Schuermann, “Understanding the Securitization of Subprime Mortgage Credit,”
Federal Reserve Bank of New York Staff Reports, No. 318 (March 2008). [CR–20]
• Explain the subprime mortgage credit securitization process in the United States.
• Identify and describe key frictions in subprime mortgage securitization and assess the relative
contribution of each factor to the subprime mortgage problems.
• Compare predatory lending and borrowing.
Operational Risk and Resiliency
PART II EXAM WEIGHT | 20% (ORR)
This area focuses on methods to measure and manage operational risk as well as methods to manage risk
across an organization, including risk governance, stress testing and regulatory compliance. The broad
knowledge points covered in Operational Risk and Resiliency include the following:
• Principles for sound operational risk management
• Risk appetite frameworks and enterprise risk management (ERM)
• Risk culture and conduct
• Analyzing and reporting operational loss data
• Model risk and model validation
• Risk-adjusted return on capital (RAROC)
• Economic capital frameworks and capital planning
• Stress testing banks
• Third-party outsourcing risk
• Risks related to money laundering and financing of terrorism
• Regulation and the Basel Accords
• Cyber risk and cyber resilience
• Operational resilience
each reading are:
“Principles for the Sound Management of Operational Risk,” (Basel Committee on Banking Supervision
Publication, June 2011). [ORR–1]
• Describe the three “lines of defense” in the Basel model for operational risk governance.
• Summarize the fundamental principles of operational risk management as suggested by the
Basel Committee.
• Explain guidelines for strong governance of operational risk and evaluate the role of the board of
directors and senior management in implementing an effective operational risk framework.
• Describe tools and processes that can be used to identify and assess operational risk.
• Describe features of an effective control environment and identify specific controls that should be in
place to address operational risk.
• Explain the Basel Committee’s suggestions for managing technology risk and outsourcing risk.
Brian Nocco and René Stulz, “Enterprise Risk Management: Theory and Practice,” Journal of Applied
Corporate Finance 18, No. 4 (2006): 8–20. [ORR–2]
• Define enterprise risk management (ERM) and explain how implementing ERM practices and policies can
create shareholder value, both at the macro and the micro level.
• Explain how a company can determine its optimal amount of risk through the use of credit rating targets.
• Describe the development and implementation of an ERM system, as well as challenges to the
implementation of an ERM system.
• Describe the role of and issues with correlation in risk aggregation and describe typical properties of a
firm’s market risk, credit risk and operational risk distributions.
• Distinguish between regulatory and economic capital and explain the use of economic capital in the
corporate decision making process.
James Lam, Enterprise Risk Management: From Incentives to Controls, 2nd Edition (Hoboken, NJ: John
Chapter 4. What is ERM? [ORR-3]

• Describe Enterprise Risk Management (ERM) and compare and contrast differing definitions of ERM.
• Compare the benefits and costs of ERM and describe the motivations for a firm to adopt an
ERM initiative.
• Describe the role and responsibilities of a chief risk officer (CRO) and assess how the CRO should interact
with other senior management.
• Describe the key components of an ERM program.
“Implementing Robust Risk Appetite Frameworks to Strengthen Financial Institutions,” Institute of
International Finance, June 2011. [ORR-4]
• Describe best practices for the implementation and communication of a risk appetite framework (RAF)
at a firm.
• Explain the relationship between a firm’s RAF and its risk culture and between the RAF and a firm’s
strategy and business planning process.
• Explain key challenges to the implementation of an RAF and describe ways that a firm can overcome
each challenge.
• Assess the role of stress testing within an RAF and describe challenges in aggregating firm-wide
risk exposures.
• Explain lessons learned in the implementation of a RAF through the presented case studies.
“Banking Conduct and Culture: A Permanent Mindset Change,” G30 Working Group, 2018. (Introduction
through Lessons Learned only) [ORR-5]
• Describe challenges faced by banks with respect to conduct and culture and explain motivations for
banks to improve their conduct and culture.
• Explain methods by which a bank can improve its corporate culture and assess progress made by banks
in this area.
• Explain how a bank can structure performance incentives and make staff development decisions to
encourage a strong corporate culture.
• Summarize expectations by different national regulators for banks’ conduct and culture.
• Describe best practices and lessons learned in managing a bank’s corporate culture.
Alessandro Carretta, Franco Fiordelisi and Paola Schwizer, Risk Culture in Banking (Palgrave Macmillan, 2017).
Chapter 2: Risk Culture [ORR-6]
• Compare risk culture and corporate culture and explain how they interact.
• Explain factors that influence a firm’s corporate culture and its risk culture.
• Describe methods by which corporate culture and risk culture can be measured.
• Describe characteristics of a strong risk culture and challenges to the implementation of an effective
risk culture.
• Assess the relationship between risk culture and business performance.
Marcelo G. Cruz, Gareth W. Peters and Pavel V. Shevchenko, Fundamental Aspects of Operational Risk and
Insurance Analytics: A Handbook of Operational Risk (Hoboken, NJ: John Wiley & Sons, 2015).
Chapter 2: OpRisk Data and Governance [OR–7]
• Describe the seven Basel II event risk categories and identify examples of operational risk events in
each category.
• Summarize the process of collecting and reporting internal operational loss data, including the selection
of thresholds, the timeframe for recoveries and reporting expected operational losses.
• Explain the use of a risk control self-assessment (RCSA) and key risk indicators (KRIs) in identifying,
controlling and assessing operational risk exposures.
• Describe and assess the use of scenario analysis in managing operational risk and identify biases and
challenges that can arise when using scenario analysis.
• Compare the typical operational risk profiles of firms in different financial sectors.
• Explain the role of operational risk governance and explain how a firm’s organizational structure can
impact risk governance.
“Supervisory Guidance on Model Risk Management,” Federal Deposit Insurance Corporation,
June 7, 2017. [ORR-8]
• Describe model risk and explain how model risk can arise in the implementation of a model.
• Describe elements of an effective process to manage model risk.
• Explain best practices for the development and implementation of a model.
• Describe elements of a strong model validation process and challenges to an effective validation process.
Anthony Tarantino and Deborah Cernauskas, Risk Management in Finance: Six Sigma and Other Next
Generation Techniques (Hoboken, NJ: John Wiley & Sons, 2009).
Chapter 3. Information Risk and Data Quality Management [ORR–9]
• Identify the most common issues that result in data errors.
• Explain how a firm can set expectations for its data quality and describe some key dimensions of data
quality used in this process.
• Describe the operational data governance process, including the use of scorecards in managing
information risk.
Giacomo De Laurentis, Renato Maino, Luca Molteni, Developing, Validating and Using Internal Ratings
(Hoboken, NJ: John Wiley & Sons, 2010).
Chapter 5. Validating Rating Models [ORR–10]
• Explain the process of model validation and describe best practices for the roles of internal organizational
units in the validation process.
• Compare qualitative and quantitative processes to validate internal ratings and describe elements of
each process.
• Describe challenges related to data quality and explain steps that can be taken to validate a model’s
data quality.
• Explain how to validate the calibration and the discriminatory power of a rating model.
Sons, 2011).
Chapter 11. Assessing the Quality of Risk Measures [OR–11]
• Describe ways that errors can be introduced into models.
• Explain how model risk and variability can arise through the implementation of VaR models and the
mapping of risk factors to portfolio positions.
• Identify reasons for the failure of the long-equity tranche, short-mezzanine credit trade in 2005 and
describe how such modeling errors could have been avoided.
• Explain major defects in model assumptions that led to the underestimation of systematic risk for
residential mortgage backed securities (RMBS) during the 2007-2009 financial downturn.
Michel Crouhy, Dan Galai and Robert Mark, The Essentials of Risk Management, 2nd Edition (New York, NY:
McGraw-Hill, 2014).
Chapter 17. Risk Capital Attribution and Risk-Adjusted Performance Measurement [ORR–12]
• Define, compare and contrast risk capital, economic capital and regulatory capital, and explain methods
and motivations for using economic capital approaches to allocate risk capital.
• Describe the RAROC (risk-adjusted return on capital) methodology and its use in capital budgeting.
• Compute and interpret the RAROC for a project, loan, or loan portfolio and use RAROC to compare
business unit performance.
• Explain challenges that arise when using RAROC for performance measurement, including choosing a
time horizon, measuring default probability and choosing a confidence level.
• Calculate the hurdle rate and apply this rate in making business decisions using RAROC.
• Compute the adjusted RAROC for a project to determine its viability.
• Explain challenges in modeling diversification benefits, including aggregating a firm’s risk capital and
allocating economic capital to different business lines.
• Explain best practices in implementing an approach that uses RAROC to allocate economic capital.
“Range of practices and issues in economic capital frameworks,” (Basel Committee on Banking Supervision
Publication, March 2009). [ORR–13]
• Within the economic capital implementation framework describe the challenges that appear in:
- Defining and calculating risk measures
- Risk aggregation
- Validation of models
- Dependency modeling in credit risk
- Evaluating counterparty credit risk
- Assessing interest rate risk in the banking book
• Describe the BIS recommendations that supervisors should consider to make effective use of internal risk
measures, such as economic capital, that are not designed for regulatory purposes.
• Explain benefits and impacts of using an economic capital framework within the following areas:
- Credit portfolio management
- Risk based pricing
- Customer profitability analysis
- Management incentives
• Describe best practices and assess key concerns for the governance of an economic capital framework.
“Capital Planning at Large Bank Holding Companies: Supervisory Expectations and Range of Current
Practice,” Board of Governors of the Federal Reserve System, August 2013. [ORR–14]
• Describe the Federal Reserve’s Capital Plan Rule and explain the seven principles of an effective capital
adequacy process for bank holding companies (BHCs) subject to the Capital Plan Rule.
• Describe practices that can result in a strong and effective capital adequacy process for a BHC in the
following areas:
- Risk identification
- Internal controls, including model review and validation
- Corporate governance
- Capital policy, including setting of goals and targets and contingency planning
- Stress testing and stress scenario design
- Estimating losses, revenues and expenses, including quantitative and qualitative methodologies
- Assessing the impact of capital adequacy, including risk-weighted asset (RWA) and balance
sheet projections
“Stress Testing Banks,” Til Schuermann, International Journal of Forecasting 30, no. 3, (2014):
717–728 [ORR–15]
• Describe the historical evolution of the stress testing process and compare methodologies of historical
European Banking Association (EBA), Comprehensive Capital Analysis and Review (CCAR) and
Supervisory Capital Assessment Program (SCAP) stress tests.
• Explain challenges in designing stress test scenarios, including the problem of coherence in modeling
risk factors.
• Explain challenges in modeling a bank’s revenues, losses and its balance sheet over a stress test
horizon period.
“Guidance on Managing Outsourcing Risk,” Board of Governors of the Federal Reserve System, December
2013. [ORR-16]
• Explain how risks can arise through outsourcing activities to third-party service providers and describe
elements of an effective program to manage outsourcing risk.
• Explain how financial institutions should perform due diligence on third-party service providers.
• Describe topics and provisions that should be addressed in a contract with a third-party service provider.
Mark Carey “Management of Risks Associated with Money Laundering and Financing of Terrorism,” GARP
Risk Institute, February 2019. [ORR-17]
• Explain best practices recommended for the assessment, management, mitigation and monitoring of
money laundering and financial terrorism (ML/FT) risks.
John C. Hull, Risk Management and Financial Institutions, 5th Edition (Hoboken, NJ: John Wiley &
Sons, 2018).
Chapter 17. Regulation of the OTC Derivatives Market [ORR–18]
• Summarize the clearing process in OTC derivative markets.
• Describe changes to the regulation of OTC derivatives which took place after the 2007-2009 financial
crisis and explain the impact of these changes.
Mark Carey, “Capital Regulation Before the Global Financial Crisis,” GARP Risk Institute,
April 2019. [ORR-19]
• Explain the motivations for introducing the Basel regulations, including key risk exposures addressed and
explain the reasons for revisions to Basel regulations over time.
• Explain the calculation of risk-weighted assets and the capital requirement per the original Basel I guidelines.
• Describe measures introduced in the 1995 and 1996 amendments, including guidelines for netting of
credit exposures and methods to calculate market risk capital for assets in the trading book.
• Describe changes to the Basel regulations made as part of Basel II, including the three pillars.
• Compare the standardized IRB approach, the Foundation Internal Ratings-Based (IRB) approach and the
advanced IRB approach for the calculation of credit risk capital under Basel II.
• Compare the basic indicator approach, the standardized approach and the Advanced Measurement
Approach for the calculation of operational risk capital under Basel II.
• Summarize elements of the Solvency II capital framework for insurance companies.
Mark Carey, “Solvency, Liquidity and Other Regulation After the Global Financial Crisis,” GARP Risk
Institute, April 2019. [ORR-20]
• Describe and calculate the stressed VaR introduced in Basel 2.5 and calculate the market risk
capital charge.
• Explain the process of calculating the incremental risk capital charge for positions held in a bank’s
trading book.
• Describe the comprehensive risk (CR) capital charge for portfolios of positions that are sensitive to
correlations between default risks.
• Define in the context of Basel III and calculate where appropriate:
- Tier 1 capital and its components
- Tier 2 capital and its components
- Required Tier 1 equity capital, total Tier 1 capital and total capital
• Describe the motivations for and calculate the capital conservation buffer and the countercyclical buffer,
including special rules for globally systemically important banks (G-SIBs).
• Describe and calculate ratios intended to improve the management of liquidity risk, including the
required leverage ratio, the liquidity coverage ratio and the net stable funding ratio.
• Describe the mechanics of contingent convertible bonds (CoCos) and explain the motivations for banks
to issue them.
• Explain motivations for “gold plating” of regulations and provide examples of legislative and regulatory
reforms that were introduced after the 2007-2009 financial crisis.
“High-level summary of Basel III reforms,” (Basel Committee on Banking Supervision Publication,
December 2017). [ORR-21]
• Explain the motivations for revising the Basel III framework and the goals and impacts of the December
2017 reforms to the Basel III framework.
• Summarize the December 2017 revisions to the Basel III framework in the following areas:
- The standardized approach to credit risk
- The internal ratings-based (IRB) approaches for credit risk
- The CVA risk framework
- The operational risk framework
- The leverage ratio framework
• Describe the revised output floor introduced as part of the Basel III reforms and approaches to be used
when calculating the output floor.
“Basel III: Finalising post-crisis reforms,” (Basel Committee on Banking Supervision Publication, December
2017): 128-136. [ORR-22]
• Explain the elements of the new standardized approach to measure operational risk capital, including the
business indicator, internal loss multiplier and loss component and calculate the operational risk capital
requirement for a bank using this approach.
• Compare the Standardized Measurement Approach (SMA) to earlier methods of calculating operational
risk capital, including the Advanced Measurement Approaches (AMA).
• Describe general and specific criteria recommended by the Basel Committee for the identification,
collection and treatment of operational loss data.
Andrew Coburn, Eireann Leverett, and Gordon Woo, Solving Cyber Risk: Protecting Your Company and
Society (Hoboken, NJ: Wiley, 2019).
Chapter 8: The Cyber-Resilient Organization [ORR-23]
• Describe elements of an effective cyber-resilience framework and explain ways that an organization can
become more cyber-resilient.
• Explain resilient security approaches that can be used to increase a firm’s cyber resilience and describe
challenges to their implementation.
• Explain methods that can be used to assess the financial impact of a potential cyber attack and explain
ways to increase a firm’s financial resilience.
“Cyber-resilience: Range of practices,” (Basel Committee on Banking Supervision Publication, December
2018). [ORR-24]
• Define cyber-resilience and compare recent regulatory initiatives in the area of cyber-resilience.
• Describe current practices by banks and supervisors in the governance of a cyber risk management
framework, including roles and responsibilities.
• Explain methods for supervising cyber-resilience, testing and incident response approaches and
cybersecurity and resilience metrics.
• Explain and assess current practices for the sharing of cybersecurity information between different types
of institutions.
• Describe practices for the governance of risks of interconnected third-party service providers.
“Building the UK financial sector’s operational resilience,” (Bank of England, July 2018). (Exclude Section
3, Include only Annex 1) [ORR-25]
• Describe operational resilience and describe threats and challenges to the operational resilience of a
financial institution.
• Explain recommended principles, including tools and metrics, for maintaining strong operational
resilience at financial institutions.
• Describe potential consequences of business disruptions, including potential systemic risk impacts.
• Define impact tolerance; explain best practices and potential benefits for establishing the impact
tolerance for a firm or a business process.
“Striving for Operational Resilience: The Questions Boards and Senior Management Should Ask,” Oliver
Wyman, 2019. [ORR-26]
• Compare operational resilience to traditional business continuity and disaster recovery approaches.
• Describe elements of an effective operational resilience framework and its potential benefits.
Liquidity and Treasury Risk Measurement
and Management
PART II EXAM WEIGHT | 15% (LTR)
This area focuses on methods to measure and manage liquidity and treasury risk. The broad knowledge
points covered in the Liquidity and Treasury Risk Management section include the following:
• Liquidity risk principles and metrics
• Liquidity portfolio management
• Cash-flow modeling, liquidity stress testing and reporting
• Contingency funding plan
• Funding models
• Funds transfer pricing
• Cross-currency funding
• Balance sheet management
• Asset liquidity
each reading are:
John C. Hull, Risk Management and Financial Institutions, 5th Edition (Hoboken, NJ: John Wiley &
Sons, 2018).
Chapter 24. Liquidity Risk [LTR–1]
• Explain and calculate liquidity trading risk via cost of liquidation and liquidity-adjusted VaR (LVaR).
• Identify liquidity funding risk, funding sources and lessons learned from real cases: Northern Rock,
Ashanti Goldfields and Metallgesellschaft.
• Evaluate Basel III liquidity risk ratios and BIS principles for sound liquidity risk management.
• Explain liquidity black holes and identify the causes of positive feedback trading.

Sons, 2011).
Chapter 12. Liquidity and Leverage [LTR–2]
• Differentiate between sources of liquidity risk and describe specific challenges faced by different types of
financial institutions in managing liquidity risk.
• Summarize the asset-liability management process at a fractional reserve bank, including the process of
liquidity transformation.
• Compare transactions used in the collateral market and explain risks that can arise through collateral
market transactions.
• Describe the relationship between leverage and a firm’s return profile (including the leverage effect) and
distinguish the impact of different types of transactions on a firm’s leverage and balance sheet.
• Distinguish methods to measure and manage funding liquidity risk and transactions liquidity risk.
• Calculate the expected transactions cost and the spread risk factor for a transaction and calculate the
liquidity adjustment to VaR for a position to be liquidated over a number of trading days.
• Discuss interactions between different types of liquidity risk and explain how liquidity risk events can
increase systemic risk.
Shyam Venkat, Stephen Baird, Liquidity Risk Management: A Practitioner's Perspective (Hoboken, NJ: John
Chapter 6. Early Warning Indicators [LTR–3]
• Evaluate the characteristics of sound Early Warning Indicators (EWI) measures.
• Identify EWI guidelines from banking regulators and supervisors (OCC, BCBS, Federal Reserve).
• Discuss the applications of EWIs in the context of the liquidity risk management process.
Peter Rose, Sylvia Hudgins, Bank Management & Financial Services, 9th Edition (New York, NY: McGraw-
Hill, 2013).
Chapter 10. The Investment Function in Financial-Services Management [LTR–4]
• Compare various money market and capital market instruments and discuss their advantages
and disadvantages.
• Identify and discuss various factors that affect the choice of investment securities by a bank.
• Apply investment maturity strategies and maturity management tools based on the yield curve
and duration.
Chapter 11. Liquidity and Reserves Management: Strategies and Policies [LTR–5]
• Calculate a bank’s net liquidity position and explain factors that affect the supply and demand of liquidity
at a bank.
• Compare strategies that a bank can use to meet demands for additional liquidity.
• Estimate a bank’s liquidity needs through three methods (sources and uses of funds, structure of funds
and liquidity indicators).
• Summarize the process taken by a US bank to calculate its legal reserves.
• Differentiate between factors that affect the choice among alternate sources of reserves.

Chapter 4. Intraday Liquidity Risk Management [LTR–6]
• Identify and explain the uses and sources of intraday liquidity.
• Discuss the governance structure of intraday liquidity risk management.
• Differentiate between methods for tracking intraday flows and monitoring risk levels.
Antonio Castagna, Francesco Fede, Measuring and Managing Liquidity Risk (United Kingdom, John Wiley &
Sons, 2013).
Chapter 6. Monitoring Liquidity [LTR–7]
• Distinguish between deterministic and stochastic cash flows and provide examples of each.
• Describe and provide examples of liquidity options and explain the impact of liquidity options on a bank’s
liquidity position and its liquidity management process.
• Define liquidity risk, funding cost risk, liquidity generation capacity, expected liquidity, cash flow at risk.
• Interpret the term structure of expected cash flows and cumulative cash flows.
• Discuss the impact of available asset transactions on cash flows and liquidity generation capacity.
Darrell Duffie, 2010. “The Failure Mechanics of Dealer Banks,” Journal of Economic Perspectives 24:1,
51-72. [LTR–8]
• Compare and contrast the major lines of business in which dealer banks operate and the risk factors they
face in each line of business.
• Identify situations that can cause a liquidity crisis at a dealer bank and explain responses that can
mitigate these risks.
• Assess policy measures that can alleviate firm-specific and systemic risks related to large dealer banks.
Chapter 3. Liquidity Stress Testing [LTR–9]
• Differentiate between various types of liquidity, including funding, operational, strategic, contingent and
restricted liquidity.
• Estimate contingent liquidity via the liquid asset buffer.
• Discuss liquidity stress test design issues such as scope, scenario development, assumptions, outputs,
governance and integration with other risk models.
Moorad Choudhry, The Principles of Banking (Singapore: John Wiley & Sons, 2012).
Chapter 14. Liquidity Risk Reporting and Stress Testing [LTR–10]
• Identify best practices for the reporting of a bank’s liquidity position.
• Compare and interpret different types of liquidity risk reports.
• Explain the process of reporting a liquidity stress test and interpret a liquidity stress test report.

c
Shyam Venkat, Stephen Baird, Liquidity Risk Management (Hoboken, NJ: John Wiley & Sons, 2016).
Chapter 7. Contingency Funding Planning [LTR–11]
• Discuss the relationship between contingency funding plan and liquidity stress testing.
• Evaluate the key design considerations of a sound contingency funding plan.
• Assess the key components of a contingency funding plan (governance and oversight, scenarios and
liquidity gap analysis, contingent actions, monitoring and escalation, data and reporting).
Hill, 2013).
Chapter 12. Managing and Pricing Deposit Services [LTR–12]
• Differentiate between the various transaction and non-transaction deposit types.
• Compare different methods used to determine the pricing of deposits and calculate the price of a deposit
account using cost-plus, marginal cost and conditional pricing formulas.
• Explain challenges faced by banks that offer deposit accounts, including deposit insurance, disclosures,
overdraft protection and basic (lifeline) banking.
Chapter 13. Managing Nondeposit Liabilities [LTR–13]

• Distinguish the various sources of non-deposit liabilities at a bank.
• Describe and calculate the available funds gap.
• Discuss factors affecting the choice of non-deposit funding sources.
• Calculate overall cost of funds using both the historical average cost approach and the pooled-
funds approach.
Bruce Tuckman and Angel Serrat, Fixed Income Securities: Tools for Today’s Markets, 3rd Edition (Hoboken,
NJ: John Wiley & Sons, 2011).
Chapter 12. Repurchase Agreements and Financing [LTR–14]
• Describe the mechanics of repurchase agreements (repos) and calculate the settlement for a
repo transaction.
• Discuss common motivations for entering into repos, including their use in cash management and
liquidity management.
• Discuss how counterparty risk and liquidity risk can arise through the use of repo transactions.
• Assess the role of repo transactions in the collapses of Lehman Brothers and Bear Stearns during the
(2007-2009) credit crisis.
• Compare the use of general and special collateral in repo transactions.
• Identify the characteristics of special spreads and explain the typical behavior of US Treasury special
spreads over an auction cycle.
• Calculate the financing advantage of a bond trading special when used in a repo transaction.

Joel Grant, 2011. “Liquidity Transfer Pricing: A Guide to Better Practice,” Occasional Paper, Financial
Stability Board, Bank for International Settlements. [LTR–15]
• Discuss the process of liquidity transfer pricing (LTP) and identify best practices for the governance and
implementation of an LTP process.
• Discuss challenges that may arise for banks during the implementation of LTP.
• Compare the various approaches to liquidity transfer pricing (zero cost, average cost, matched maturity
marginal cost).
• Describe the contingent liquidity risk pricing process and calculate the cost of contingent liquidity risk.
Patrick McGuire, Goetz von Peter, 2009. “The US Dollar Shortage in Global Banking and the International
Policy Response,” BIS Working Papers, Bank for International Settlements. [LTR-16]
• Identify the causes of the US Dollar shortage during the Great Financial Crisis.
• Evaluate the importance of assessing maturity/currency mismatch across the balance sheets of
consolidated entities.
• Discuss how central bank swap agreements overcame challenges commonly associated with international
lenders of last resort.
Claudio Borio, Robert McCauley, Patrick McGuire, Vladyslav Sushko, 2016. “Covered Interest Parity
Lost: Understanding the Cross-Currency Basis,” BIS Quarterly Review. [LTR–17]
• Differentiate between the mechanics of foreign exchange (FX) swaps and cross-currency swaps.
• Identify key factors that affect the cross-currency swap basis.
• Assess the causes of covered interest rate parity violations after the financial crisis of 2008.
Hill, 2013).
Chapter 7. Risk Management for Changing Interest Rates: Asset-Liability Management and Duration
Techniques [LTR–18]
• Discuss how asset-liability management strategies can help a bank hedge against interest rate risk.
• Describe interest-sensitive gap management and apply this strategy to maximize a bank’s net
interest margin.
• Describe duration gap management and apply this strategy to protect a bank’s net worth.
• Discuss the limitations of interest-sensitive gap management and duration gap management.

Andrew Ang, Asset Management: A Systematic Approach to Factor Investing (New York, NY: Oxford
University Press, 2014).
Chapter 13. Illiquid Assets [LTR–19]
• Evaluate the characteristics of illiquid markets.
• Examine the relationship between market imperfections and illiquidity.
• Assess the impact of biases on reported returns for illiquid assets.
• Explain the unsmoothing of returns and its properties.
• Compare illiquidity risk premiums across and within asset categories.
• Evaluate portfolio choice decisions on the inclusion of illiquid assets.

Risk Management and Investment Management
PART II EXAM WEIGHT | 15% (IM)
This area focuses on risk management techniques applied to the investment management process. The broad
knowledge points covered in Risk Management and Investment Management include the following:
• Factor theory
• Portfolio construction
• Portfolio risk measures
• Risk budgeting
• Risk monitoring and performance measurement
• Portfolio-based performance analysis
• Hedge funds
each reading are:
Andrew Ang, Asset Management: A Systematic Approach to Factor Investing (New York, NY: Oxford
University Press, 2014).
Chapter 6. Factor Theory [IM–1]
• Provide examples of factors that impact asset prices and explain the theory of factor risk premiums.
• Describe the capital asset pricing model (CAPM) including its assumptions and explain how factor risk is
addressed in the CAPM.
• Explain implications of using the CAPM to value assets, including equilibrium and optimal holdings,
exposure to factor risk, its treatment of diversification benefits and shortcomings of the CAPM.
• Describe multifactor models and compare and contrast multifactor models to the CAPM.
• Explain how stochastic discount factors are created and apply them in the valuation of assets.
• Describe efficient market theory and explain how markets can be inefficient.
Chapter 7. Factors [IM–2]

• Describe the process of value investing and explain reasons why a value premium may exist.
• Explain how different macroeconomic risk factors, including economic growth, inflation and volatility
affect risk premiums and asset returns.
• Assess methods of mitigating volatility risk in a portfolio and describe challenges that arise when
managing volatility risk.
• Explain how dynamic risk factors can be used in a multifactor model of asset returns, using the Fama-
French model as an example.
• Compare value and momentum investment strategies, including their risk and return profiles.
2020 FRM Learning Objectives Part II garp.org/frm 55r

Chapter 10. Alpha (and the Low-Risk Anomaly) [IM–3]
• Describe and evaluate the low-risk anomaly of asset returns.
• Define and calculate alpha, tracking error, the information ratio and the Sharpe ratio.
• Explain the impact of benchmark choice on alpha and describe characteristics of an effective benchmark
to measure alpha.
• Describe Grinold’s fundamental law of active management, including its assumptions and limitations and
calculate the information ratio using this law.
• Apply a factor regression to construct a benchmark with multiple factors, measure a portfolio’s sensitivity
to those factors and measure alpha against that benchmark.
• Explain how to measure time-varying factor exposures and their use in style analysis.
• Describe issues that arise when measuring alphas for nonlinear strategies.
• Compare the volatility anomaly and beta anomaly and analyze evidence of each anomaly.
• Describe potential explanations for the risk anomaly.
Richard Grinold and Ronald Kahn, Active Portfolio Management: A Quantitative Approach for Producing
Superior Returns and Controlling Risk, 2nd Edition (New York, NY: McGraw-Hill, 2000).
Chapter 14. Portfolio Construction [IM–4]
• Distinguish among the inputs to the portfolio construction process.
• Evaluate the methods and motivation for refining alphas in the implementation process.
• Describe neutralization and methods for refining alphas to be neutral.
• Describe the implications of transaction costs on portfolio construction.
• Assess the impact of practical issues in portfolio construction, such as determination of risk aversion,
incorporation of specific risk aversion and proper alpha coverage.
• Describe portfolio revisions and rebalancing and evaluate the tradeoffs between alpha, risk, transaction
costs and time horizon.
• Determine the optimal no-trade region for rebalancing with transaction costs.
• Evaluate the strengths and weaknesses of the following portfolio construction techniques: screens,
stratification, linear programming and quadratic programming.
• Describe dispersion, explain its causes and describe methods for controlling forms of dispersion.
Philippe Jorion, Value-at-Risk: The New Benchmark for Managing Financial Risk, 3rd Edition (New York,
NY: McGraw-Hill, 2007).
Chapter 7. Portfolio Risk: Analytical Methods [IM–5]
• Define, calculate and distinguish between the following portfolio VaR measures: individual VaR,
incremental VaR, marginal VaR, component VaR, undiversified portfolio VaR and diversified
portfolio VaR.
• Explain the role of correlation on portfolio risk.
• Describe the challenges associated with VaR measurement as portfolio size increases.
• Apply the concept of marginal VaR to guide decisions about portfolio VaR.
• Explain the risk-minimizing position and the risk and return-optimizing position of a portfolio.
• Explain the difference between risk management and portfolio management and describe how to use
marginal VaR in portfolio management.

Chapter 17. VaR and Risk Budgeting in Investment Management [IM–6]
• Define risk budgeting.
• Describe the impact of horizon, turnover and leverage on the risk management process in the investment
management industry.
• Describe the investment process of large investors such as pension funds.
• Describe the risk management challenges associated with investments in hedge funds.
• Distinguish among the following types of risk: absolute risk, relative risk, policy-mix risk, active
management risk, funding risk and sponsor risk.
• Apply VaR to check compliance, monitor risk budgets and reverse engineer sources of risk.
• Explain how VaR can be used in the investment process and the development of investment guidelines.
• Describe the risk budgeting process and calculate risk budgets across asset classes and active managers.
Robert Litterman and the Quantitative Resources Group, Modern Investment Management: An Equilibrium
Approach (Hoboken, NJ: John Wiley & Sons, 2003).
Chapter 17. Risk Monitoring and Performance Measurement [IM–7]
• Define, compare and contrast VaR and tracking error as risk measures.
• Describe risk planning, including its objectives, effects and the participants in its development.
• Describe risk budgeting and the role of quantitative methods in risk budgeting.
• Describe risk monitoring and its role in an internal control environment.
• Identify sources of risk consciousness within an organization.
• Describe the objectives and actions of a risk management unit in an investment management firm.
• Describe how risk monitoring can confirm that investment activities are consistent with expectations.
• Describe Liquidity Duration Statistic and how it can be used to measure liquidity.
• Describe the use of alpha, benchmark and peer group as inputs in performance measurement tools.
• Describe the objectives of performance measurement.
Zvi Bodie, Alex Kane, and Alan J. Marcus, Investments, 11th Edition (New York, NY: McGraw-Hill, 2017).
Chapter 24. Portfolio Performance Evaluation [IM–8]
• Differentiate between time-weighted and dollar-weighted returns of a portfolio and describe their
appropriate uses.
• Describe and distinguish between risk-adjusted performance measures, such as Sharpe’s measure,
Treynor’s measure, Jensen’s measure (Jensen’s alpha) and information ratio.
• Describe the uses for the Modigliani-squared and Treynor’s measure in comparing two portfolios and the
graphical representation of these measures.
• Determine the statistical significance of a performance measure using standard error and the t-statistic.
• Explain the difficulties in measuring the performance of hedge funds.
• Describe style analysis.
• Explain how changes in portfolio risk levels can affect the use of the Sharpe ratio to measure performance.
• Describe techniques to measure the market timing ability of fund managers with a regression and with a
call option model and compute return due to market timing.
• Describe style analysis.
• Describe and apply performance attribution procedures, including the asset allocation decision, sector
and security selection decision and the aggregate contribution.

if a
G. Constantinides, M. Harris and R. Stulz, eds., Handbook of the Economics of Finance, Volume 2B (Oxford,
UK: Elsevier, 2013).
Chapter 17. Hedge Funds [IM–9]
• Describe the characteristics of hedge funds and the hedge fund industry and compare hedge funds with
mutual funds.
• Explain biases that are commonly found in databases of hedge funds.
• Explain the evolution of the hedge fund industry and describe landmark events that precipitated major
changes in the development of the industry.
• Evaluate the role of investors in shaping the hedge fund industry.
• Explain the relationship between risk and alpha in hedge funds.
• Compare and contrast the different hedge fund strategies, describe their return characteristics and
describe the inherent risks of each strategy.
• Describe the historical portfolio construction and performance trend of hedge funds compared to
equity indices.
• Describe market events that resulted in a convergence of risk factors for different hedge fund strategies
and explain the impact of such a convergence on portfolio diversification strategies.
• Describe the problem of risk sharing asymmetry between principals and agents in the hedge
fund industry.
• Explain the impact of institutional investors on the hedge fund industry and assess reasons for the
growing concentration of assets under management (AUM) in the industry.
Kevin R. Mirabile, Hedge Fund Investing: A Practical Approach to Understanding Investor Motivation,
Manager Profits, and Fund Performance, 2nd Edition (Hoboken, NJ: Wiley Finance, 2016).
Chapter 12. Performing Due Diligence on Specific Managers and Funds [IM–10]
• Identify reasons for the failures of funds in the past.
• Explain elements of the due diligence process used to assess investment managers.
• Identify themes and questions investors can consider when evaluating a manager.
• Describe criteria that can be evaluated in assessing a fund’s risk management process.
• Explain how due diligence can be performed on a fund’s operational environment.
• Explain how a fund’s business model risk and its fraud risk can be assessed.
• Describe elements that can be included as part of a due diligence questionnaire.

Current Issues in Financial Markets
PART II EXAM WEIGHT | 10% (CI)
This area focuses on current issues that have a strong impact on financial markets. The broad knowledge
points covered in Current Issues in Financial Markets include the following:
• Blockchain
• Fintech revolution
• Artificial intelligence (AI), machine learning and “big data”
• Climate change and financial risk
• Reference rates
each reading are:
“The Impact of Blockchain Technology on Finance: A Catalyst for Change,” International Center for
Monetary and Banking Studies, 2018. (Section 1-Section 3 only) [CI-1]
• Describe the challenges blockchain technology faces in gaining widespread adoption in
economic applications.
• Explain and assess the questions to be considered prior to implementing a blockchain solution to any
economic activity.
• Explain the concept of cost of trust when speaking about legacy financial systems and
blockchain technology.
• Describe the current regulatory concerns surrounding crypto-finance and assess the steps taken by
regulators to address these issues.
“FinTech and market structure in financial services: Market developments and potential financial stability
implications,” Financial Stability Board, February 14, 2019. [CI-2]
• Differentiate between the potential changes to market structure (lending, payments, insurance, trading)
and financial stability risks resulting from financial innovation through traditional providers, Fintech
providers, Big Tech and third-party tech servicers.
• Discuss the impact and risks of technological developments in the areas of APIs, mobile banking and
cloud computing on payment systems along with the scope of the EU’s Payment Services Directive.
• Analyze the market structure impact and risks of China’s NPI’s online MMFs in the areas of same day
cash availability, deposit guarantee mechanisms and concentration risk along with the effort of Chinese
authorities to address these risks.

Stijn Claessens, Jon Frost, Grant Turner, and Feng Zhu, “Fintech credit markets around the world: size,
drivers and policy issues,” BIS Quarterly Review, September 23, 2018. [CI-3]
• Describe the difficulties involved in measuring the size of the global fintech credit market.
• Describe the factors that have driven the recent growth of the fintech credit market.
• Examine the potential benefits and risks inherent in the fintech credit market.
• Compare and evaluate how different jurisdictions have crafted policy and regulatory responses to the
fintech credit market.
“Sound Practices: Implications of fintech developments for banks and bank supervisors,” Bank for
International Settlements (BIS), February 2018. [CI-4]
• Differentiate between the five Basel fintech scenarios and the roles participants (incumbent banks, new
banks, Big Tech, fintech firms and service providers) perform and risks they are subject to in each.
• Discuss the Basel disintermediated bank scenario and its impact on incumbent banks’ present business
models. Identify areas of existing product and funding risks.
• Distinguish practical instances of Basel Committee’s Principles for sound management of operational risk
(PSMOR) as applied to fintech.
• Distinguish the implications for bank supervisors on regulatory frameworks as a result of fintech along
with existing licensing regimes and regulatory responses.
Tobias Adrian and Tommaso Mancini-Griffoli, “The Rise of Digital Money,” International Monetary Fund
(IMF), July 2019. [CI-5]
• Describe the characteristics of e-money that could propel a rapid global adoption of this type of money.
• Describe the risks faced by the banking sector as e-money adoption increases.
• Evaluate regulatory and policy actions that could be implemented in response to risks arising from
increased adoption of e-money.
Hal Varian, “Big Data: New Tricks for Econometrics,” Journal of Economic Perspectives (Spring 2014):
28(2), 3-28. [CI-6]
• Describe the issues unique to big datasets.
• Explain and assess different tools and techniques for manipulating and analyzing big data.
• Examine the areas for collaboration between econometrics and machine learning.
Bart van Liebergen, “Machine Learning: A Revolution in Risk Management and Compliance?” Institute of
International Finance, April 2017. [CI-7]
• Describe the process of machine learning and compare machine learning approaches.
• Describe the application of machine learning approaches within the financial services sector and the
types of problems to which they can be applied.
• Analyze the application of machine learning in three use cases:
- Credit risk and revenue modeling
- Fraud
- Surveillance of conduct and market abuse in trading

“Artificial intelligence and machine learning in financial services,” Financial Stability Board,
Nov. 1, 2017. [CI-8]
• Describe the drivers that have contributed to the growing use of FinTech and the supply and demand
factors that have spurred adoption of AI and machine learning in financial services.
• Describe the use of AI and machine learning in the following cases:
(i) customer-focused uses
(ii) operations-focused uses
(iii) trading and portfolio management in financial markets
(iv) uses for regulatory compliance
• Describe the possible effects and potential benefits and risks of AI and machine learning on financial
markets and how they may affect financial stability.
Hugues Chenet, “Climate Change and Financial Risk,” Social Science Research Network, June 25, 2019. [CI-9]
• Discuss the history of climate change related risks for the financial sector including the Paris Agreement
(2015) and distinguish the significance of Article 2.1 c as it pertains to the financial system.
• Distinguish the causes of potential mispricing of climate change risk and the impact of relevant
history and data, non-normal probability distributions, kurtoses, skew, “black swan” events, and risk
materialization time horizons on pricing as compared to traditional investment risk analysis.
• Discuss recent reporting and disclosure requirements under Article 173 of the French Energy Transition
Act and the impact of The European Commission Sustainable Finance Action Plan on the allocation of
capital towards sustainable investments and inclusion of climate and environmental factors in financial
institutions’ risk management policies.
Andreas Schrimpf and Vladyslav Sushko, “Beyond LIBOR: a primer on the new benchmark rates,” BIS
Quarterly Review, March 5, 2019. [CI-10]
• Describe the features comprising an ideal benchmark.
• Examine the issues that led to the replacement of LIBOR as the reference rate.
• Examine the risks inherent in basing risk-free rates (RFR’s) on transactions in the repo market.

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FRM

Market Risk Measurement and Management

PART II EXAM WEIGHT | 20% (MR)

covered in Market Risk Measurement and Management include the following:

• VaR and other risk measures

• Parametric and non-parametric methods of estimation

• Expected shortfall (ES) and other coherent risk measures

• Extreme Value Theory (EVT)

• Modeling dependence: correlations and copulas

• Term structure models of interest rates

• Volatility: smiles and term structures

• Fundamental Review of the Trading Book

each reading are:

Chapter 3. Estimating Market Risk Measures: An Introduction and Overview [MR–1]

After completing this reading you should be able to:

• Estimate VaR using a historical simulation approach.

• Define coherent risk measures.

• Estimate risk measures by estimating quantiles.

• Evaluate estimators of risk measures by estimating their standard errors.

• Interpret quantile-quantile (QQ) plots to identify the characteristics of a distribution.

Chapter 4. Non-parametric Approaches [MR–2]

After completing this reading you should be able to:

• Describe historical simulation using non-parametric density estimation.

filtered historical simulation approaches.

• Identify advantages and disadvantages of non-parametric estimation methods.

2020 FRM Learning Objectives Part II garp.org/frm 27

Chapter 7. Parametric Approaches (II): Extreme Value [MR-3]

After completing this reading you should be able to:

• Explain the importance and challenges of extreme values in risk management.

• Describe the peaks-over-threshold (POT) approach.

• Compare and contrast generalized extreme value and POT.

• Explain the importance of multivariate EVT for risk management.

Chapter 6. Backtesting VaR [MR–4]

After completing this reading you should be able to:

• Explain the significant difficulties in backtesting a VaR model.

• Verify a model based on exceptions or failure rates.

• Explain the need to consider conditional coverage in the backtesting framework.

• Describe the Basel rules for backtesting.

Chapter 11. VaR Mapping [MR–5]

After completing this reading you should be able to:

• Describe how mapping of risk factors can support stress testing.

• Explain how VaR can be used as a performance benchmark.

Banking Supervision, Working Paper, No. 19, Jan 2011. [MR–6]

After completing this reading you should be able to:

• Compare VaR, expected shortfall and other relevant risk measures.

• Compare unified and compartmentalized risk measurement.

2020 FRM Learning Objectives Part II garp.org/frm 28

Chapter 1. Correlation Basics: Definitions, Applications, and Terminology [MR–7]

After completing this reading you should be able to:

• Explain how correlation contributed to the global financial crisis of 2007-2009.

• Describe the structure, uses and payoffs of a correlation swap.

• Relate correlation risk to systemic and concentration risk.

After completing this reading you should be able to:

Chapter 5. Financial Correlation Modeling—Bottom-Up Approaches (pages 126-134 only) [MR–9]

After completing this reading you should be able to:

using the Gaussian copula.

NJ: John Wiley & Sons, 2011).

Chapter 6. Empirical Approaches to Risk Metrics and Hedging [MR–10]

After completing this reading you should be able to: