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FRM Part II Exam

Mock Questions - FRM Part II - Mock Exam #1

Offered by AnalystPrep

Last Updated: Mar 13, 2023

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Q.1 You are assigned to calculate the daily VaR for the stock of Fooda Inc. You are provided with the
following data for the ten worst returns of the stock during the last 100 days: -1.2% -0.7% -3.2%
-2.6% -2.4% -2.0% -1.9% -1.7% -1.5% -1.5% Which of the following is closest to the monthly
VaR for Fooda Inc. using a confidence level of 95%? (Assume there are 20 trading days in a month.)

A. -7.6%

B. -3.2%

C. -1.2%

D.-1.4%

Q.2 An analyst has gathered the following information about a portfolio which has normally
distributed geometric returns:

Mean 12%
Standard deviation 32%
Portfolio value 85 million

What is the 95% lognormal VaR for this portfolio?

A. $33.40 million

B. $27.20 million

C. $56.61 million

D.$28.39 million

Q.3 Since it was founded ten years ago, Bright Technologies pays no dividends to shareholders and is
financed with 100% equity. Recently, management decided to have the firm leveraged and issued a
zero-coupon bond with a principal amount of $100 million maturing in exactly three years. If the
value of the firm at maturity is $80 million, determine the values of the different components of the
firm’s capital structure at the maturity date of the bond.

A. Value of equity = $0; value of debt = $80 million

B. Value of equity = $20 million; value of debt = $80

C. Value of equity = $180 million; value of debt = $100 million

D.Value of equity = $20 million; value of debt = $0

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Q.4 A pension fund subscribes for a bond issued by Bright Technologies Limited. To protect itself
against borrower default, the pension fund enters into a 1-year CDS with AC&C bank. According to
the contract, the pension fund will receive 80% of the face value of the bond from AC&C bank in the
immediate aftermath of a default by Bright Technologies. In return, the fund pledges to pay AC&C
bank the CDS spread – a percentage of the face value – once at the end of the year. AC&C analysts
have estimated the risk-neutral default probability for Bright Technologies at 5% per year. T he rate
of return on risk-free government bonds is 2%. Determine an estimate for the CDS spread, given
that defaults can only occur half-way through the year and that the accrued premium is payable
immediately after a default event.

A. 500 bps

B. 440 bps

C. 518 bps

D.414 bps

Q.5 A portfolio consists of two assets – A and B.

Value Return 99% 1 day VaR Correlation

A 5 million 5% 0.58 million
B 10 million 6% 1.86 million 0.7

T he portfolio manager decides to rebalance the portfolio so that both the assets are equally
weighted. If there is no change in the volatility of the two assets, what will be the effect of this
rebalancing on the portfolio VaR?

A. 0.40 million

B. 0.17 million

C. 0.87 million

D.0.20 million

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Q.6 Which of these is an example of a dynamic financial correlation?

A. Value at Risk

B. Correlation copulas for CDOs

C. Pairs trading

D.Binomial default correlation model

Q.7 A hedge fund has the following credit risk exposures to AB&B, an A-rated corporation:

Contract Contract value (USD)

A 44, 000, 000
B 88, 000, 000
C 35, 200, 000
D 3, 300, 000
E 20, 000, 000

T he fund is looking into ways of reducing counterparty credit risk. Which of the following credit risk
mitigation techniques would be most appropriate?

A. Implementing a netting framework

B. Increasing collateral

C. Use of credit triggers

D.Sell credit default swaps

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Q.8 An investment bank has significant exposure to credit risk. T he bank has traditionally used
netting schemes to control risk exposures. Currently, the bank has 7 netting agreements – all on
equity trading positions. T hese positions have an average correlation of 0.32. T he bank’s CRO
believes there’s still room for improvement with regard to the diversification benefit of netting,
specifically by judiciously choosing exposures with a favorable correlation coefficient. In this
regard, the following trade combinations have been put forward:

T rade Combination Number of Positions Average Correlation

KAB 6 0.22
UGX 9 0.18
POT 14 −0.05
EFG 17 −0.06
CDM 18 0.12

Determine the trade combinations that would optimize the expected netting benefit.

A. UGX

B. CDM

C. EFG

D.POT

Q.9 Given the following data about a variable S:

St 50
St−1 30
Mean reversion rate 0.4

Calculate the long-run mean value for the variable.

A. 60

B. 80

C. 100

D.75

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Q.10 A model gives a VaR value of $5 million for a portfolio at a 99% confidence interval. A one-year
backtest conducted at the 95% confidence level reveals that losses exceeded $5 million on 8
occasions. T he model is accepted as accurate. Assuming 252 days in a year, which of these
statements is most likely true?

A. A T ype I error has occurred

B. A T ype II error has occurred

C. Both T ype I and T ype II errors have occurred

D.T he model has been accepted correctly

Q.11 A risk manager has gathered monthly correlation data from the most popular stocks in the S&P
500 over the past 3 years. T he goal is to estimate the long-run mean correlation of these stocks and
the mean reversion rate. Analysis of historical data suggests that the long-run mean correlation of
S&P 500 stocks is 30%. T he manager assembles the following and the regression model: Y = 0.20 −
0.80X In May 2021, all S&P 500 stocks had an average monthly correlation of 40%. Assuming the
mean reversion rate estimated in the regression analysis, the expected correlation for June 2021 is:

A. 20%

B. 40%

C. 30%

D.32%

Q.12 Which of these correctly describes the effects of maturity and volatility on convexity?

A. Convexity increases with maturity but decreases with volatility

B. Convexity increases with both maturity and volatility

C. Convexity decreases with maturity but increases with volatility

D.Convexity decreases with both maturity and volatility

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Q.13 Using a term structure model with no drift and normally distributed rates assume that short
term interest rates are 5%, annual volatility is 75 bps and after one month the realization of dw (a
normally distributed random variable with mean 0 and standard deviation √dt has an expected value of
0) is 0.2. What is the new spot rate?

A. 5.15%

B. 4.85%

C. 3.50%

D.6.50%

Q.14 Given the following information, calculate the new short term rate for an interval of one month

Current short term rate (r_0) 2.45%

Drift (λ) 0.24%
Volatility of rate change(σ) 80 bps per year
Realization of random variable (dw) over a period of one month 0.3

A. 2.50%

B. 2.93%

C. 2.71%

D.2.19%

Q.15 A foreign currency is valued at $1.80. T he foreign currency has a European call option with a
market price of $0.135, strike price of $1.70, and exactly one year to maturity. In the US, the risk-
free interest rate is 5% per annum and 8% per annum in the foreign country. Assuming no arbitrage,
determine the price of a European put option with a strike price of $1.70 and 1-year to maturity for
the foreign currency. (T ip: Let the yield on the underlying stock be equal to the foreign risk-free
rate.)

A. $0.254

B. $0.153

C. $2.5608

D.$0.0905

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Q.16 Given the information below, use the Cox Ingersoll Ross model to find the short-term rate after
one month.

Current short term rate 5%

Long run value of the short term rate 7.5%
Speed of mean revision adjustment 0.05
Volatility of rate change (σ) 0.8%
Random variable dw 0.3

A. 5.06%

B. 5.11%

C. 5.04%

D.5.21%

Q.17 A portfolio consists of two bonds – A and B. T he credit VaR is defined as the maximum loss due
to defaults at a confidence level of 99% over a one-year horizon. T he probability of joint default of A
and B is 1.45%, with 25% default correlation. Further details of the bonds are given in the table
below:

Bond Value Default probability Recovery rate

A £1, 000, 000 4% 70%
B £800,000 6% 60%

Determine the expected credit loss for the portfolio.

A. £12,000

B. £7,800

C. £31,200

D.£20,000

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Q.18 Which of the following statements about credit risk models is least accurate?

A. Credit risk+ models use a Poisson or Poisson-like distribution to describe default

B. Credit risk+ models offer an actuarial approach to measuring credit risk that treats the
bankruptcy and recovery process as exogenous

C. KMV models are an extension of Merton’s option pricing model and adopt equity price
volatility as a proxy for asset price volatility

D.KMV models present a structural avenue for measuring credit risk that’s largely based on
credit migration

Q.19 A bond with a face value of 500 matures in 12 years. Using the Merton model, the bond is
calculated to be worth 250. T he risk free rate is 4%. Determine the bond’s spread.

A. 1178 bps

B. 22 bps

C. 2 bps

D.178 bps

Q.20 A portfolio manager has gathered the following data about OilStok and Carbon Energy. He is
considering adding one of these two stocks to his existing portfolio.

Expected Annual Value Correlation

Return Volatility ($millions) with portfolio
Existing portfolio 8% 18% $500
OilStok 6% 22% $100 0.6
Carbon Energy 7% 23% $100 0.5

T he manager will only add a stock to the portfolio if the VaR of the resultant portfolio does not
exceed a daily VaR limit of $15 at 99% confidence level. Given the information above, which stock
should the manager add to the portfolio?

A. OilStok

B. Carbon Energy

C. Any of the two stocks

D.Neither OliStock nor Carbon Energy

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Q.21 Michael Roy, a risk analyst at a large multinational bank, is backtesting the VaR model of the
bank. T he model being tested is a daily, 98% VaR model. If the backtest is conducted for one year at
the 95% confidence level, and assuming 252 days in a year, what is the number of daily losses that
will lead Roy to conclude that the model is not calibrated correctly?

A. 8

B. 9

C. 10

D.5

Q.22 Richard Cooke, FRM, works at a mid-sized hedge fund based in Singapore. He intends to
establish the credit risks of several recently executed trading positions. It’s the hedge fund’s policy
to wholesomely invest in corporate debt. T he fund also utilizes both relative value and long-only
trades using bonds and credit default swaps. One recent, high-profile trade involved a BBB+ rated long
bond with a value of SGD 20 billion. T he fund also imposes a 5-year withdrawal restriction on all new
clients, including the BBB+ rated bond holders. Cooke is currently assessing the liquidity impacts of
various default scenarios. According to his estimates, the BBB+ rated bond has a marginal probability
of default of 3% in year 1, 6% in year 2, 11% in year 3, 18% in year 4, and 28% in year 5. Determine
the probability that the bond makes coupon payments for 5 years and then defaults at the end of year
5.

A. 14.6%

B. 18.6%

C. 48%

D.13.40%

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Q.23 Which of the following statements regarding frictions in the securitization of subprime
mortgages is correct?

A. One way to eliminate the risk of foreclosure entails the use of escrow accounts for
insurance and tax payments.

B. Credit rating agencies are usually remunerated by investors as a reward for their rating
services of mortgage-backed securities, creating a potential conflict of interest.

C. T he originator of a security will typically have more borrower information than the
arranger, and may therefore be incentivized to collude with the borrower and submit loan
applications laden with falsified information.

D.T he arranger will typically have more borrower information than the originator with
regard to the securitized assets.

Q.24 T he buyer of a correlation swap with three assets and a maturity of one year pays a fixed rate
of 2.5%. T he notional amount of the swap is $1 million. If the realized pairwise correlations of the
daily log returns for the three assets are ρ2,1 = 0.2, ρ3,1 = 0.4 and ρ3,2 = 0.3, what is the realized
correlation?

A. 0.30

B. 0.20

C. 0.45

D.0.16

Q.25 Which of these statements is NOT accurate?

A. Exogenous liquidity risks represent the risk associated with market-specific average
transaction costs

B. Endogenous liquidity is particularly relevant for complex trading positions

C. Endogenous liquidity risk can be addressed by calculating liquidity adjusted VaR (LVaR)

D.Endogenous liquidity risk is related to transaction size and occurs when orders are large
enough to affect prices

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Q.26 Bank of Baroda often enters into swap contracts with Bank of Panamba – a major provider of
swaps. In the last few months, Bank of Panamba was downgraded from a rating of A to a rating of A-,
while Bank of Baroda was downgraded from a rating of BB+ to a rating of BB. Following these
changes, the credit spread for Bank of Panamba has increased from 38bps to 128 bps, while the
credit spread for Bank of Baroda has increased from 118 bps to 228 bps. Which of the following
actions will most likely be taken by the counterparties with respect to their credit value adjustment?

A. Bank of Panamba requests an increase in the CVA charge it receives

B. Bank of Baroda requests a reduction in the CVA charge it pays

C. CVA is no longer as important a factor, and therefore the counterparties will most likely
migrate to other risk mitigation measures

D.Status quo remains because although the credit qualities of both institutions have migrated,
the overall change is not sufficient to warrant an amendment of the existing CVA
arrangement

Q.27 A risk analyst has performed an extensive analysis of a firm and come up with a hazard rate of
0.15 per year. What is the conditional 1-year default probability for year 2 given that the firm
survived in year 1?

A. 12.30%

B. 16.04%

C. 14.19%

D.13.93%

Q.28 Under the IRB approach, banks are allowed to use their internal rating systems conditional on
approval by their supervisors. If a bank was to use the foundation IRB approach, then it would have
to use:

A. Its internal estimates of PD

B. Its internal estimates of exposure-at-default (EAD) and the loss-given-default (LGD)

C. Predetermined estimates of exposure-at-default (EAD) and the loss-given-default (LGD)

based on the size of the bank.

D.All of the above.

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Q.29 A new bank is to be established in New York City. According to the Basel Committee, three of
the following are principles that should be considered in the operation of the new bank. Which one is
does NOT fit with the Basel’s principle?

A. T he board of directors should establish, approve and periodically review the framework

B. T he board of directors should take a strong lead in establishing a powerful risk

management culture

C. T he bank should develop, implement and maintain a framework that is fully integrated into
the bank’s overall risks management processes

D.T he bank should establish the number of customer loans that best fits its risk profile

Q.30 A derivative trader in France sells a European-type call option on AB&B stock with a time to
expiry of 11 months, an underlying asset price of EUR 45, a strike price of EUR 37, and implied
annual volatility of 23%. Given that the annual risk-free rate is 2.5%, determine the trader’s
counterparty credit exposure from this transaction:

A. EUR 22.50

B. EUR 35.00

C. EUR 7.45

D.EUR 0.00

Q.31 An investment firm has sold default protection on the most senior tranche of a collateralized
debt obligation. Suppose the default correlation between assets held in the CDO increases sharply,
but everything else remains unchanged. How will the firm’s position be affected?

A. It will neither lose nor gain value because correlation does not affect default losses

B. It will lose significant value, since the probability of exercising the protection increases

C. It will either increase or decrease depending on market conditions

D.It will gain significant value because the probability of exercising the protection falls

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Q.32 Ben Gilford, a credit analyst at X&Y Bank, gathers the following information about a bond:

Face value $100

Years to maturity 10
Risk-free rate 2.5%

Gilford uses the Merton model to calculate the value of the bond as $72. What is the credit spread
for the bond?

A. 92 bps

B. 64 bps

C. 79 bps

D.57 bps

Q.33 Angela Myer, FRM, works at Pinebridge Bank. She was recently reviewing the bank’s firewalls
and safety measures erected to guard against cyber-based data theft. T he exercise also entailed an in-
depth outlook into governance processes in the bank. Ms Myer is most likely part of the bank’s:

A. Senior management

B. Risk management department

C. Board of directors

D.Internal audit team

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Q.34 T he following information has been extracted from the P&L of a European bank over a 3-year
period:

Year (ended) 20X6 20X7 20X8 20X9

Interest, leases and dividends €950 million €1.3 billion €1.8 billion €1.6 billion
Services €1.6 billion €2.2 billion €2.6 billion €1.8 billion
Financial (Net Profit/Loss on €500 million €1.1 billion €1.3 billion €1.5 billion
the trading book)

Using the Standardized Measurement Approach, the bank’s Business Indicator (BI) for the year ended
31 Dec 20X9 is closest to:

A. €4 billion

B. €5 billion

C. €3.2 billion

D.€500 million

Q.35 An investment firm is contemplating taking positions in various tranches of a collateralized debt
obligation. T he chief CDO analyst at the firm predicts that the default probability will increase
significantly and that default correlation will decrease. On this basis, the analyst will most likely
recommend the:

A. Purchase of the senior tranche and sale of the equity tranche

B. Purchase of the equity tranche and sale of the senior tranche

C. Purchase of the senior tranche and purchase of the equity tranche

D.Sale of the senior tranche and sale of the equity tranche

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Q.36 A Spanish bank has the following derivative positions with a local company:

Position Price (USD)

Long currency swaps 33 million
Short credit default swaps -22 million
Long interest rate swaps 8 million
Short swaptions -17 million

In the event that the counterparty (company) defaults, what would be the loss to the financial
institution if netting is used compared to the loss without netting?

A.

Loss if netting is used (USD) Loss without netting (USD)

A 2 million 2 million
B 2 million 41 million
C 41 million 2 million
D 29 million 41 million

B.

Loss if netting is used (USD) Loss without netting (USD)

A 2 million 2 million
B 2 million 41 million
C 41 million 2 million
D 29 million 41 million

C.

Loss if netting is used (USD) Loss without netting (USD)

A 2 million 2 million
B 2 million 41 million
C 41 million 2 million
D 29 million 41 million

D.

Loss if netting is used (USD) Loss without netting (USD)

A 2 million 2 million
B 2 million 41 million
C 41 million 2 million
D 29 million 41 million

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Q.37 Richard Brooke works as a financial analyst at Daytime Investments where he has accumulated
over seventeen years of experience. He was recently tasked with scenario analysis of the FX
trading department to establish the maximum losses that could be incurred under various
circumstances. His analysis repeatedly projects losses of above $10 million on three different
occasions, but he believes this can not be possible since he has never experienced such big losses,
borrowing from his 17 years of experience. Brooke’s belief most likely forms part of:

A. Context bias

B. Overconfidence bias

C. Availability bias

D.Inexpert bias

Q.38 A bank majors in four business lines whose corresponding multipliers and gross income (in
millions) for three years are given in the table below:

Business Line Multiplier Annual Gross Income

Year 1 Year 2 Year 3
Retail Banking 13% 6 18 8
Asset Management 14% 8 10 18
T rading and Sales 19% 9 −48 28
Corporate Finance 18% 42 25 20

Based on the Basel II accord, what is the value of the required capital for operational risk under
standardized approach?

A. 11.83

B. 11.17

C. 12.48

D.7.59

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Q.39 Consider the following scenarios;

I. An individual shows up in a banking hall to present a check purportedly written by a

customer for an amount that’s substantially more than the customer’s account balance.
When the bank attempts to reach out to the customer via a phone call in an attempt to
recover the funds, the call is disconnected and the bank is unable to recover the funds
II. A financial analyst captures a corporate bond’s financial information incorrectly in the
proprietary credit risk model
III. On a day of adverse market movement, a bank’s computer network system crumbles under
heavy traffic. As a result, only intermittent pricing information is relayed to the bank’s
trading desk. T his leads to huge losses as traders are unable to adjust their positions in
response to real time price falls
IV. A bank, acting as a trustee for a loan portfolio, receives less than the projected funds due to
delayed repayment of certain loans

Which of the above scenarios present operational risk loss events?

A. I, II, and III

B. I, II, and IV

C. II, III and IV

D.All of the above

Q.40 T he Credit Bank of India (CBI) recently sought to revamp its risk management processes. To
this end, the bank has introduced a new decision-making framework on all matters to do with
economic capital. Going forward, the bank will assess risks (I) within and (II) across the different
autonomous business units, taking into account the correlations between various risks. In this
regard, which of the following statements is most likely true?

A. Total credit VaR will be less than or equal to the sum of individual loan credit VaRs.

B. Total credit VaR will be greater than or equal to the sum of individual loan credit VaRs.

C. T he bank’s assessment of correlations between risks within a business unit is irrelevant

because correlations are only relevant between business units

D.T here is zero correlation between broad risk types such as credit, market, and operational
risk

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Q.41 Assume that the following information on revenue has been provided by Jacque’s & Josh Bank
(in USD million). From the data, how much operational risk capital should be held by the bank under
Basel II by applying the Standardized Approach? T he multipliers for corporate finance and retail
banking are 17.99% and 12.11%, respectively.

Year one Year two Year three

Corporate finance 11.9 19.3 29.7
Retail banking −26.2 29.4 −31.7

A. USD 2.845 million

B. USD 4.268 million

C. USD 3.527 million

D.USD 4.119 million

Q.42 Family Bank has entered a $100 million interest rate swap with a corporation. T he swap has a
remaining maturity of five years. T he current value of the swap is $4.5 million. T he table below
gives add-on factors as a percentage of principal for derivatives.

T ime remaining to maturity Interest rate Equity

< 1 year 0.0 6.0
1 to 5 years 0.5 8.0
> 5 years 1.5 10.0

Based on the table above, the equivalent risk-weighted asset (RWA) under Basel I is closest to:

A. $5,000,000

B. $1,125,000

C. $3,500,000

D.$2,500,000

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Q.43 Joe Hart, a market analyst at Smart Investment Bank, has been tasked with the development of
early warning signals to help the bank to monitor potential liquidity stress events. At the preliminary
stage, Mr. Hart has researched on a set of background guidelines as follows:

I. All EWIs must be updated every two months to detect potentially threatening events
II. T heir bank should conduct a variety of short-term and protracted bank-specific and market-
wide liquidity stress tests using conservative and regularly reviewed assumptions
III. T he bank should establish a robust escalation policy so that critical decisions and
transactions are handled at an appropriate level of management.

As a risk analyst, which of the above proposals would you disagree with?

A. I

B. II

C. III

D.None of the above

Q.44 A company has bought the following assets:

1 million shares of company A, which are bid $95, offer $96

10 million ounces of a commodity, which is bid $50.5, offer $51.5

10 million shares of company Y, which are bid $49.25, offer 50.5

what is the cost of liquidation in a normal market?

A. $5.25million

B. $8.75 million

C. $10.25 million

D.$11.75 million

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Q.45 Equity bank’s senior management intends to create a capital buffer enough to enable the bank
to absorb unexpected losses corresponding to a bank-wide VaR at the 1% level. T he bank measures
bank-wide VaR by summing up individual VaRs for market risk, operational risk, and credit risk. T here
is a risk that the bank has too little capital because:

A. Addition of VaRs is quantitatively meaningless

B. VaR should only be used to measure operational and credit risks, not market risk

C. It ignores risks that are not market, operational, or credit risks

D.All of the above

Q.46 ABC Bank is planning to create and adopt a risk appetite and tolerance statement. Which of the
following is the most appropriate body to approve and review this risk appetite and tolerance
statement?

A. Share holders

B. T he internal audit

C. T he board of directors

D.Senior management

Q.47 T rademark Bank uses insurance as a risk mitigation technique. Its risk management team points
out that risk transfer to an insurance company as a risk mitigation strategy could create a new risk to
the organization. Which one?

A. Market risk

B. Reputation risk

C. Counterparty risk

D.Forex exchange risk

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Q.48 Suppose you have a portfolio consisting of four distinct assets. T he risk contribution of each is
as follows:

Asset Contribution
US large cap 6.3%
US small cap 6.6%
US government bonds 1.9%
Non-US bonds 2.1%

Which of the following would not be a valid explanation for the relatively high risk contribution
values for US equities?

A. High volatilities of US equities

B. High expected returns of US equities

C. High weights on US equities

D.High correlation of US equities with other assets in the portfolio

Q.49 Quincy Maxwell, FRM, assumes that the joint distribution of returns is multivariate normal. He
goes ahead to calculate the following risk measures for a two-asset portfolio – Assets A and B.

Asset Position Individual Marginal VaR

contribution VaR VaR contribution
A GBP 1, 000 GBP 89.6 0.0779 GBP 77.9
B GBP 1, 000 GBP 179.2 0.175 GBP 175.0
Total GBP 2, 000 GBP 268.8 GBP 252.9

ρip σi
Let βip = Where ρip denotes the correlation between the return of asset i and the portfolio
σp
return, σi is the volatility of the return of asset i, and σp is the volatility of the portfolio return. T he
values of βA and βB are, respectively,

A. 0.5796 and 1.3021

B. 1.7388 and 1.9531

C. 0.1558 and 0.35

D.0.6161 and 1.3839

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Q.50 Which of the following statements about economic and regulatory capital are valid?

I. Regulatory capital is always greater than economic capital for an individual bank
II. Economic capital provides protection against the various risks inherent in the business of
corporation, hence safeguarding its stability and soundness
III. Economic capital ensures that an institution can absorb unexpected losses up to a level of
confidence in line with the dictates of important stakeholders
IV. T he level of confidence used in the calculation of economic capital is determined by trial and
error

A. (II), (III), and (IV)

B. (I), (II), and (III)

C. (II) and (III)

D.All of the above

Q.51 Bob Woolmer is a fund manager at Fortune Investment. He is analyzing shares of Bell Aviation
which currently have a bid price of $32.45 and an ask price of $32.90. T he sample standard deviation
of this bid-ask spread is 0.004. Given this information, determine the expected transactions cost and
99% spread risk factor for a transaction involving Bell Aviation.

A. T ransactions Cost: $0.759; Spread Risk Factor: 0.0232

B. T ransactions Cost: $0.759; Spread Risk Factor: 0.0139

C. T ransactions Cost: $0.379; Spread Risk Factor: 0.0116

D.T ransactions Cost: $0.377; Spread Risk Factor: 0.0115

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Q.52 Your Chief Risk Officer asks you to come up with a list of early warning signs for liquidity
problems for your bank. Which of the following are early warning indicators of a potential liquidity
problem?

I. Narrowing credit default swap spreads

II. Increasing redemptions of CDs prior to maturity
III. Growing concentrations in liabilities
IV. An increase of the weighted average maturity of liabilities
V. Request for additional collateral by counterparties

A. (I) and (II)

B. (II), (III), and (V)

C. (II), (III), (IV), and (V)

D.All of the above

Q.53 You are given the following information:

Country Economic growth Inflation Volatility

X High Low Low
Y Low High High

Which of the following is the best investment avenue for investors in country Y?

A. High-yield bonds

B. Government bonds

C. Investment-grade corporate and local municipal bonds

D.Stocks

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Q.54 T he FIR Fund provides a large positive alpha. T he fund can take leveraged long and short
positions in stocks. Given that the market went up over the same period, which of the following
statements is correct?

A. If the fund has net negative beta, all of the alpha must come from the market

B. If the fund has net positive beta, part of the alpha comes from the market

C. If the fund has net positive beta, all of the alpha must come from the market

D.If the firm has net negative beta, part of the alpha must come from the market

Q.55 John Carter has a well-balanced portfolio of securities. Which of the following categories of
stocks would most likely help him mitigate the effects of bad market performance? Stocks with:

A. a low β

B. β =1

C. β =0

D.A high β

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Q.56 Hedge Q is a database of hedge fund returns, constructed as follows. T he first year of the
database is 2002. All funds in existence as of 31 December 2002 are included in that year,
preconditioned on their willingness to report verified returns. Database managers decide to expand it
even further. T hey ask for return data for years before 2002. Subsequently, a funds inclusion in the
database is premised only on their willingness to report verified returns. What’s more, if a fund stops
reporting returns in totality, its returns are deleted from the system. And although the rules require
submission of verified returns on a monthly basis, funds that submit returns at quarterly intervals
are also included in the system. Which of the following five statements are correct?

I. T he database suffers from infrequent trading bias

II. T he database suffers from backfilling bias
III. T he database suffers from an error-in-variables bias
IV. T he database suffers from survivorship bias
V. T he equally weighted annual return average of fund returns will overestimate the
performance one would expect from a hedge fund

A. I, II, and IV

B. III and V

C. I, II, IV, and V

D.All of the above

Q.57 An investor wants to purchase a $1,500 par-value treasury note that has a 10% coupon rate and
is expected to mature in 4 years. If the current price of the T reasury note is $1,200, calculate the
yield to maturity of the note.

A. 15.22%

B. 16.38%

C. 16.59%

D.17.34%

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Q.58 Which of the given options is the most accurate reason why banks choose to use pooled
average costs approach to LT P?

A. It is a more straightforward method

B. It is simple, thus makes it easier for banks to understand and comply with the LT P
process.

C. T he average cost of funds approach is vulnerable to transitional changes in banks’ real

market cost of funding, therefore, minimizing net interest income deviation across all
businesses.

D.All of the above

Q.59 T he stretch to which banks invest in one currency and fund in another via F.X. swaps is known
as:

A. Cross currency funding

B. Funding gap

C. Carry trading

D.Hedging

Q.60 T he racial makeup of the U.S. state of Maine is 94% white, 2% black, with other minority
communities making up the difference. A model developed to help a Maine-based bank make lending
decisions has been found to favor whites while turning down similarly situated black applicants. T his
is an example of:

A. overt discrimination

B. disparate treatment discrimination

C. disparate impact discrimination

D.both disparate treatment and the disparate impact discrimination

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Q.61 T he adoption of e-money in the banking sector could lead to several plausible scenarios. T he
most plausible scenario is that e-money and b-money will coexist. For example, providers might
recycle client funds back to banks as certificates of deposit or other forms of short-term funding.
However, banks would not be too keen to propagate or nurture this kind of relationship with e-
money providers because:

A. in the long-term, E-money providers would only fund large banks, leaving smaller banks at
a permanent risk of funding strains and a greater risk of funding volatility.

B. it would result in automatic loss of deposit funding from customers.

C. it would be illegal to accept wholesale funding from a few large players.

D.it would increase funding costs and destabilize retail funding.

Q.62 Excel Investment Firm recently hired an active manager for its pension fund. Her benchmark
is the Russel 2000 growth index. Which of the following statistics are most suitable to evaluating the
manager’s performance and risk?

A. VaR and information ratio

B. T racking error and sharpe ratio

C. T racking error and information ratio

D.VaR and sharpe ratio

Q.63 A financial manager wishes to estimate the liquidity-adjusted VaR using the constant spread
approach. She gathers the following data:

0.49
μ = 0, σ = , spread = 0.02, α = 0.95
√490

Based on these data, which of the following statements is true?

A. T he constant spread liquidity adjustment raises the VaR by almost 30%

B. T he constant spread liquidity adjustment reduces the VaR by 28%

C. A small spread cannot translate into a large liquidity adjustment to the VaR

D.T he constant spread liquidity adjustment raises the VaR by 50%

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Q.64 Capital Bank, based in Ireland, is a dealer bank. T he bank has several revenue-generating
segments, including investment banking, deposit taking, and corporate lending. T he CRO is wary of
liquidity problems that could be triggered by a run arising from unprecedented poor performance or
some other external shock. Which of the following steps could the bank take to mitigate the risk of
loss of liquidity from a run by short-term creditors?

A. Setting up a buffer stock of cash or securities

B. Establishing emergency lines of credit

C. Streamlining the maturities of its liabilities to cap the maximum number of liabilities that
must be settled with a given period of time.

D.All of the above

Q.65 Richard Cryer, FRM, is a fund manager in New York. During a workshop with junior managers,
he made the following comments:

I. T he correct way to compare transactions costs incurred on the annual rate of gain from
alpha and the annual rate of loss from active risk is to amortize the transactions costs where
the rate of amortization depends on the anticipated holding period.
II. T he annualized transactions cost is given by round trip cost divided by the holding period in
years.

A. Only I is correct

B. Only II is correct

C. Both I and II are correct

D.Both I and II are incorrect

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Q.66 T he BC&C pension fund has 60%, or about $21 billion, invested in equities. T he fund measures
absolute risk with a 95%, one-year VaR, which gives $3.4545 billion, assuming a normal distribution
and volatility of 10% per annum. T he fund would like to allocate this risk to two of its experienced
equity managers, each with the same VaR budget. Determine what the VaR budget for each manager
should be, given that the correlation between them is 0.5.

A. $2.0 billion

B. $3.4545 billion

C. $2.4427 billion

D.$1.7273 billion

Q.67 T he use of an inaccurate model leads to valuation errors. What type of risk does valuation error
fall into?

A. Operation risk

B. Market risk

C. Both market and operation risk

D.None of the above

Q.68 Which of the following statements about the methodologies for calculating an operational risk
capital charge in Basel II is incorrect?

A. T he basic indicator approach does not reflect the operational risk in a firm since is uses
only income as a driver

B. T he standardized approach assumes that different business lines have different multipliers

C. Under no circumstances does Basel II allow a national regulator to permit a bank to use an
alternative standardized approach

D.Advanced measurement approaches allow an institution to adopt its own method of

assessment of operational risk

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Q.69 Which of the following statements regarding the various portfolio construction techniques is
correct?

A. Although screening ignores all information in alphas except the rankings, it limits
transaction costs through judicious choice of the buy, sell, and hold lists

B. T he stratification technique provides superior risk control by overweighting the

categories with lower risks and underweighting the categories with higher risks

C. T he linear programming approach characterizes stocks along dimensions of risk, and

requires that these dimensions distinctly and exclusively partition the stocks

D.Quadratic programming requires many more inputs than other portfolio construction
techniques and as a result minimizes both noise and the potential for poor calibration.

Q.70 T he following table presents selected financial information for a certain pension fund in India.
T he fund has major investments in government and corporate bonds.

Pension Liabilities
Amount (in ₹ million) 500 410
Expected Growth Per Year 8% 9%
Modified Duration 14 12
Annual Volatility of Growth 15% 8%

To establish whether the fund has sufficient surplus to meet its obligations to members, the fund’s
manager estimates the possible surplus values at the end of one year. T he fund manager further
assumes that annual returns on assets and annual growth of liabilities follow a joint normal
distribution, and their correlation coefficient stands at 0.7. Based on this information, the manager
can report that, with 95% confidence, the surplus value will be less than or equal to:

A. ₹150 million

B. ₹205 million

C. ₹182 million

D.₹187 million

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Q.71 Which of the following is most accurate about alpha?

A. Alpha is the average return of an asset in excess of the benchmark

B. Alpha is the return of an asset or a strategy in excess of the benchmark

C. Alpha is a measure of a portfolio manager's ability to generate excess returns relative to

the benchmark

D.None of the above

Q.72 A portfolio has an alpha of 0.4 and a standard deviation per month for the nonsystematic risk
equal to 3. What is the value of N at a 95% level of significance?

A. 4 months

B. 14 months

C. 108 months

D.216 months

Q.73 Among the natural disasters which have affected the United States over the years, Hurricane
Andrew, which hit Florida and Louisiana on August 24, 1992, was the most costly disaster in terms of
insurance payouts to those whose houses, vehicles, and businesses were damaged. Approximately
$15.5 billion worth of insurance claims were paid at the time. T he leading insurers responded by
charging higher premiums for coverage. T he insurers' actions are examples of:

A. Financial mitigants

B. Financial amplifiers

C. Stranded assets

D.Proactive actions

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Q.74 When communicating with customers, the FSMB principle requires that market participants
communicate in a clear, accurate, professional, and not misleading manner. Key themes when
communicating with customers include the following except:

A. Identifying conflicts of interest

B. Ensuring timely disclosures

C. Discussing product options

D.An objective overview of alternative products

Q.75 T he unceasing downward revisions coupled with high future uncertainty experienced during
mid-March led to sharp market movements. Which of the following best describes the stages by
which stress spread through the financial system as the pandemic unfolded?

A. T here was selling pressure on the assets held by funds on the commercial paper (CP) and
certificate of deposit (CD) of the money market with outflow from non-government MMF's
in the US and Europe.

B. Lack of liquidity was also a matter of concern for benchmark providers of fixed income in
corporate bond markets

C. T he longtime relationship in prices across different markets began to break down,

including in the US T reasuries markets.

D.All of the above

Q.76 Banks borrow short (i.e., take on customers deposits) and lend long (i.e., issue mortgages). T his
process is known as maturity transformation. During the 2007-2008 financial crisis, many banks fell
because they were unable to meet the demand of customers wishing to withdraw their deposits.
From an analyst’s perspective, this is most likely to represent:

A. Balance sheet risk

B. T ransactions liquidity risk

C. Systematic risk

D.Maturity transformation risk

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Q.77 Over the past year, ABC fund had a return of 22.4%, while its benchmark, the S&P 500 index,
had a return of 21.8%. Over this period, the fund’s volatility was 13.3% while the S&P index’s
volatility was 12.06% and the fund’s tracking error volatility (T EV) was 1.21%. Assume a risk-free
rate of 6%. What is the information ratio for the ABC fund, and for how many years must this
performance persist to be statistically significant at 95% confidence level?

A. 0.48 and approximately 17.5 years

B. 0.50 and approximately 15.37 years

C. 0.38 and approximately 1.5 years

D.2.50 and approximately 5 years

Q.78 In an FRM exam, a candidate highlights the following points regarding cyber threats faced by
financial institutions following the covid-19 crisis: I. Reliance on third-party vendors has increased
cyber attacks
II. Compared to other sectors, the financial sector has faced more cyber attacks since the COVID-19
pandemic.
III. Evidence suggests that COVID-19 presented new opportunities for attacks, but the same threat
actors, methods, and tools have been in use.
Which of the above statements is correct?

A. I only.

B. II only.

C. III only.

D.All of the above.

Q.79 Which of the following statements best differentiates supervised learning from unsupervised
learning? Supervised learning involves:

A. using labeled data to infer the patterns between the inputs and outputs.

B. using unlabeled data to infer the patterns between the inputs and outputs.

C. using existing data to train algorithms to establish patterns and then use that to make
predictions about new data.

D.using algorithms to identify patterns in a data set and then imitate decision-making, just like
humans.

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Q.80 Which of the following is not a challenge facing LIBOR as a benchmark reference rate?

A. T he methodology for calculating LIBOR is considered outdated

B. T he number of reported transactions on which LIBOR is based has been consistently

decreasing

C. LIBOR is subject to manipulation by individual banks

D.LIBOR is hugely unpopular in many parts of the world

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