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FRM Part 1 - SAMPLE QUESTIONS

Foundations Of Risk Management (FRM)

Q.1.

Three candidates from MidhaFin who are preparing for FRM are having a conversation regarding risk appetites and risk risk capacity. The first Candidate, Antonio says - “The risk appetite is set well below the firm's total risk bearing capacity, and above the amount of risk the firm is exposed to currently.” The second Candidate, Yash says - “The amount of risk the firm is exposed to currently is labeled as the firm's risk profile.” The third Candidate, Harpreet says - “Trigger points are designed to let the board know if risk taking looks unnaturally low or if there is a danger of breaching the agreed risk appetite.” Who is correct?

  •   Antonio only
  •   Antonio and Harpreet only
  •   All three are correct
  •   Yash only

A.1.

The Correct Answer is C.
Generally, the risk appetite is set well below the firm's total risk bearing capacity, and above the amount of risk the firm is exposed to currently (labeled as the firm's risk profile). Upper and lower trigger points are set for reporting purposes. These are designed to let the board know if risk taking looks unnaturally low or if there is a danger of breaching the agreed risk appetite. So all three are correct

Q.2.

Consider a portfolio consists of a risk-free asset with rf=4% and the market portfolio rf=4% with rf=4% and the market portfolio rf=4%and rf=4% and the market portfolio rf=4% with rf=4% and the market portfolio rf=4% . What is the expected return of the portfolio if Standard deviation of portfolio is equal to rf=4%?

  •   12%
  •   13%
  •   14%
  •   15%

A.2.

The Correct Answer is D.
Since the portfolio is a combination of risk-free asset and market portfolio, it will lie on the CML. So , equation of CML will be used.rf=4%

Q.3.

Consider two portfolios,rf=4% and rf=4%.
rf=4% .
There is only one factor which is the market factor.
rf=4% .
rf=4% also generates extra return given by rf=4% .
The risk-free rate and the expected return on the market should be

  •   2% and 10% respectively.
  •   2% and 8% respectively.
  •   3% and 10% respectively.
  •   3% and 8% respectively.

A.3.

The Correct Answer is A.
rf=4%
rf=4%rf=4%rf=4%rf=4%rf=4%Multiplying Equation 1 by 2 and multiplying equation 2 by 10, we get the following 2 equationsrf=4%rf=4%Now subtracting the first equation above from the second equation, we getrf=4%Substituting rf=4% in the first equation above, we getrf=4%

Q.4.

Lacking a liquid market for appropriate long-term futures contracts to hedge its price risk, MGRM implemented a dynamic hedging strategy, known as a rolling hedge, that used short-dated energy futures contracts. It can be profitable when spot price of assets is higher than futures price (this behaviour of prices is known as backwardation). The derivative position was adjusted monthly to reflect the changing amount of outstanding contracts to be hedged in order to preserve a one-to-one hedge. This type of strategy can result in losses when the opposite price relationship exists (a situation known as the market being in contango). MGRM was exposed to

  •   curve risk and strategic risk
  •   basis risk and strategic risk
  •   curve risk and basis risk
  •   basis risk and rolling risk

A.4.

The Correct Answer is C.
MGRM was exposed to curve risk (i.e., the risk of shifts in the price curve between backwardation and contango) and basis risk resulting from deviations between short-term prices and long-term prices.

Q.5.

Delinquencies on adjustable-rate subprime mortgages approached by August 2007 (roughly triple its level in mid-2005). By May 2008, this figure had risen to , leading to a massive number of ratings downgrades for subprime mortgage securitized products. There were several reasons for the increase in delinquencies after mid-2005. Which of the following is NOT one such reason?

  •   Many subprime mortgages included teaser rates for initial 2 or 3 years. This was not a problem if a borrower could refinance the mortgage before the reset date. But if the borrower could not refinance and if interest rates increased, the monthly mortgage costs could rise very quickly. Interest rates actually increased, with the rate on the three-month Treasury bill rising from less than 1.0% in April 2004 to over 4.0% in November 2005. Other mortgage features, such as interest-only teaser periods, made this issue even worse.
  •   The ability to refinance mortgages declined significantly when housing prices began to fall sharply in 2006. Furthermore, subprime mortgage balances quickly began to exceed the market value of the homes that collateralized the loans, increasing the incentive for borrowers to default.
  •   In a subprime mortgage transaction, the mortgage often overcollateralized. Income and payment histories are inconsistent, and debt-to-income ratios are typically high for subprime borrowers.
  •   Some borrowers were deliberately pushed into subprime mortgages even though they qualified for mortgages with better terms.

A.5.

The Correct Answer is C.
C is incorrect because – “In a subprime mortgage transaction, the inherent credit quality of the borrower is typically weak and the mortgage often undercollateralized. Income and payment histories are inconsistent, and debt-to-income ratios are typically high for subprime borrowers.”