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2001 Financial Risk Manager Examination
2001 Financial Risk Manager Examination
2001 Financial Risk Manager Examination
Session I
Saturday, November 17, 2001
9:00 a.m. 11:30 a.m.
Marcelo Cruz
Antonio Duarte
Neels Erasmus
Dan Galai
Lisa Godar
Manos Hatzakis
Ken Kapner
George Montgomery
Gary Pickholz
Nick Reed
Jean-Paul St. Germain
Sorin Straja
Andrew Street
Fred Vacelet
And
Table of Contents
a. The calling back of a bond that has a borrower call option provision
2. Which of the following is the best-rated country according to the most important
ratings agencies:
a. Argentina
b. Brazil
c. Mexico
d. Peru
3. Suppose you are given the current value of firms assets as 200 million, the
current value of its liabilities as 160 million and the standard deviation of asset
values as 20 million. What would KMV calculate as the approximate distance
from default? (This question did not count when the exam was graded)
a. 1 standard deviation
b. 2 standard deviations
4. Assume two companies of a similar rating and credit risk profile, based in two
different countries. What is most likely to invalidate the comparison between
default swaps on these two companies?
a. Currency risk
c. Cultural differences
5. What is the approximate probability of exactly one default over the next year from
a portfolio of 20 BBB-rated obligors? (Assume the 1-year probability of default for
a BBB-rated counterparty to be 4% and obligor defaults to be independent from
one another) (This question did not count when the exam was graded)
a. 2%
b. 4%
c. 45%
d. 96%
6. Standard and Poors rating agency have compiled actual default rates using data
over the last twenty years, what are their approximate computed odds for the
default of a CCC rated bond over a five year period?
a. 1 in 100
b. 1 in 50
c. 1 in 10
d. 1 in 2
7. Choose the most complete answer that describes the type of events that cause a
bond to exit from the original population.
a. Default
8. Which of the following 10-year swaps has the highest potential credit exposure?
a. 0.084%
b. 0.84%
c. 0.009%
d. 1%
10. Consider two bonds, one AA rated and the other B rated. Which of the following
is true?
a. The marginal default rate of the B rated bond declines over a long time
period (say 10 years) compared with the AA rated bond
b. The marginal default rate of the B rated bond increases over a long time
period (say 10 years) compared with the AA rated bond
c. The marginal rates of default stay roughly the same over all time scales
d. The ratio of marginal default rate between the two bonds stays constant at
all times
11. A money market fund invests in Treasury bills. What is the principal risk that the
fund manager must hedge for?
b. Default risk
12. A pool of high yield bonds is placed in an SPV and three tranches (including the
equity tranche) of bonds are issued collateralized by the bonds to create a
Collateralized Bond Obligation (CBO). Which of the following is true?
a. At fair value the value of the issued bonds should be less than the
collateral
b. At fair value the total default probability, weighted by size of issue, of the
issued bonds should equal the default probability of the collateral pool
c. The equity tranche of the CBO has the least risk of default
d. The yield on the low risk tranche must be greater than the yield on the
collateral pool
a. $2,500,000
b. $25,000,000
c. $5,000,000
d. $25,000
14. To what sort of option on the counterpartys assets can the current exposure of a
credit-risky position better be compared?
a. A short call
b. A short put
d. A binary option
a. 80%
b. 82%
c. 85%
d. 99%
17. For a given bank, which framework is less likely to convince regulators of a good
credit risk exposure management system?
a. Mertons model
b. Raroc
c. KMV system
18. The US Government Bond Zero Curve give a 1-year semi-annual yield of 4%, on
the same basis a corporate security has a yield of 5%. What is the market
implied 1-year default probability of the corporate security? The recovery rate is
88.6%.
a. 0.974%
b. 1.000%
c. 9.000%
d. 0.184%
19. You work for a bank that lends to lots of different companies. Your boss asks you
to quantify the impact of diversifying credit risk across industries. Which
statement is true?
a. The dollar standard deviation of a loan portfolio goes down as the number
of loans in the portfolio goes up, as long as the loans are negatively
correlated with each other.
b. The dollar standard deviation of a loan portfolio goes down as the number
of loans in the portfolio goes up, as long as the loans are positively
correlated with each other.
c. The dollar standard deviation of a loan portfolio goes down as the number
of loans in the portfolio goes up, as long as the loans are independent of
each other.
b. Guarantee
21. The current exposure to credit risk of a financial obligation is best defined as:
22. The current mark to market value of a 5y Interest Rate Swap is positive $2m with
a counterparty whose S&P credit rating is BB, which of the following schematic
equations best describes the credit risk of this position over a one year horizon?
a. $2m x 5y x 1 = $10m
24. In the credit risk model of KMV which of the following best describes the basic
methodology?
25. The market trades a 1-year bond at 50bp credit spread, and a 3-year bond at
60bp. In the USD market conditions as of fall 2001 and with a recovery rate of
50%, what is the implicit probability of default before year 3?
a. 1%
b. 2%
c. 3%
d. 4%
26. If the incremental annual default probability of an obligor is 10% in year one and
20% in year two, what is the survival rate at the end of year two assuming a
recovery rate of zero?
a. 72%
b. 70%
c. 80%
d. 90%
28. What element is not directly part of the CAMEL approach to determining country
risk?
29. Which of the following models can least be used to price credit derivatives?
a. Madan-Unal
b. Heath-Jarrow-Morton
c. Duffie-Singleton
d. Jarrow-Turnbull
30. Moodys and Standard & Poors ratings at investment grade means that default
probability is less than:
a. 5%
b. 3%
c. 1%
d. 0.1%
31. What is the main issue in modeling a credit spreads stochastic process like that
of an equity?
a. Dividends
32. Which of the following input is NOT common to the most widely used portfolio
credit risk models:
a. Spread curves
b. Recovery rates
c. Default correlations
d. Credit exposures
c. FRA contract
34. Which of the following proposals was implemented in the New Basle Capital
Accord.
d. OECD countries
36. Which of the following most reflects the Basle Committee on Banking
Supervisions approach to calculating regulatory capital for operational risk?
37. Which of the following is least likely to be a principle use for the buyer of a credit
default swap?
b. Portfolio adjustments
38. A Bank subject to the Basel Accord makes a loan of $100m to a firm with a risk
weighting of 50%. What is the basic on balance credit risk charge?
a. $8m
b. $4m
c. $2m
d. $1m
39. The June 1999 Basle Committee on Banking Supervision issued proposals for
reform of its 1988 Capital Accord (the Basle II Proposals). These proposals
contained MAINLY:
a. I, III and VI
b. II, IV and V
c. I, IV and V
41. Which of the following qualitative standards must be met in an Internal Models
Approach?
42. Which of the following best describes the quantitative parameters of the Internal
Models Approach?
43. The value of the VaR calculated under the Internal Models Approach is subject to
a multiplicative factor. What is it?
a. 3
c. 4
d. 1
44. In the Internal Models Approach, an exception occurs when an actual P&L
results exceeds the VaR forecast. How many times may this occur before the
model falls into the penalty Red Zone? (This question did not count when
the exam was graded)
a. 4 times a year
b. 6 times a year
c. 9 times a year
d. 10 times a year
45. The Basel Accord computes the credit exposure of derivatives using both
replacement cost and an add-on to cover potential future exposure, which of
the following is the correct credit risk charge for a purchased 7 y OTC equity
index option of $50m notional with a current mark to market of $15m with no
netting and a counterparty weighting of 100%?
a. $1.6m
b. $1.2m
c. $150,000
d. $1m
d. Events that affect the cost basis directly and, in some cases, indirectly
a. Set compensation and incentives for the performance the bank wants,
according to the bank's risk appetite
b. Pay traders well enough for them not to need to behave unreasonably
48. Which of the following most reflect an operational risk faced by a bank
c. A power outage shuts down the trading floor indefinitely with no back-up
facility.
d. The rating agencies downgrade the sovereign debt of the bank sovereign
counterparty.
49. Which of the below is the term used within the insurance industry to refer to the
effect of a reduction in control of losses by an individual insured due to the
protection provided by insurance?
a. Control trap
b. Moral hazard
c. Adverse selection
d. Control hazard
50. The MAIN challenge of banks (as of fall 2001) in operational risk is to:
51. Which of the terms below refers to the situation where the various buyers of
insurance have different expected losses, however, the insurer (or the capital
market, as the seller of insurance) is unable to distinguish between the different
types of hedge buyer and is therefore unable to charge differentiated premiums?
a. Moral hazard
b. Average insurance
c. Adverse selection
d. Control hazard
a. Management
b. Operating divisions
c. External consultants
d. Regulators
53. The causes and effects of the operational events are very often confused. For
example, it is very common to see operational risk types as human or people
risk or even system risk, although these types of events are, in general, merely
the causes of the risk and not the effect, the latter being the monetary
consequence (or the impact in the P&L). Identify below a correct set of cause-
effect relationship in operational risk:
a. I only
b. II and IV
c. II and III
d. I and IV
b. Does not impact market risk measurement but has some impact in credit
risk measurement.
c. Does not impact credit risk measurement but has some impact in market
risk measurement.
c. Mean little more than an attitude: potential risks can be accepted, real
risks are to be eliminated.
57. Unlike credit risk, when the calculated expected credit losses might be covered
by general and/or specific provisions in the balance sheet, in operational risk,
due to its multidimensional nature, the treatment of expected losses is more
complex and restrictive. Recently, with the issuing of IAS37 by the International
Accounting Standards Board, the rules have become clearer as to what can (or
cannot) be subject to provisions. Which of the operational risk types below can
clearly be provisioned (given that a figure can be reasonably estimated)?
b. Legal risk
c. Systems risk
d. Interest expenses
58. What is the percentage of minimum regulatory capital that, according to the
Basel Committee on Banking Supervision September 2001 paper, would provide
a reasonable cushion and produce required capital amounts in line with the risks
faced by large, complex organizations?
a. 10%
b. 12%
c. 15%
d. 20%
59. The success of information technology projects is defined as a use of the project
in a banking production environment. The impact of failure includes
implementers loss of credibility, disruption to business and cost of software. How
can project risk be best assessed? Probability of success is:
a. More than half, impact of failure is limited, success brings a minor direct
return.
a. Kurtosis measures the nature of the spread of the values around the
mean. It represents the 4th moment of a distribution. A small kurtosis
indicates a sharp peak in the middle of a distribution. A population with
high kurtosis is usually called leptokurtic. The kurtosis plays an important
role in distinguishing those distributions that place additional probability on
larger values.
62. Which of the below are methods to estimate parameters of operational loss
distributions?
I. Moments
II. Probability-weighted moments
III. Maximum likelihood
IV. Econometric
a. I and III
b. I, II and III
c. IV
d. III and IV
63. What is likely to be the most appropriate policy to manage technology risk?
64. The operational VaR is generated through the aggregation of the following
general stochastic processes:
65. Testing the fitness of the operational loss distributions to the data is fundamental.
Which one of the below is NOT a goodness-of-fitness test?
a. Kolmogarov-Smirnov
b. Anderson-Darling
c. Macaulay
d. Cramer-Von Mises
Session II
Saturday, November 17, 2001
12:30 p.m. 3:00 p.m.
Table of Contents
Quantitative Analysis
66. Calculate the duration of a two-year bond paying a annual coupon of 6% with
yield to maturity of 8%. Assume par value of the bond to be $1,000:
a. 2.00 years
b. 1.94 years
c. 1.87 years
d. 1.76 years
a. -1,237,500 USD
b. -4,893,963 USD
c. -7,422,044 USD
d. -8,250,000 USD
68. EVT, Extreme Value Theory, helps quantify two key measures of risk.
b. The magnitude of VaR and the level of risk obtained from scenario
analysis
a. 6.00%
b. 5.91%
c. 5.76%
d. 5.63%
70. Consider the following 6x9 FRA. Assume the buyer of the FRA agrees to a
contract rate of 6.35% on a notional amount of 10 million USD. Calculate the
settlement amount of the seller if the settlement rate is 6.85%. Assume a 30/360
day count basis.
a. 12,500
b. 12,290
c. +12,500
d. +12,290
71. Calculate the Modified Duration of a bond with a Macauley duration of 13.083
years. Assume market interest rates are 11.5% and the coupon on the bond is
paid semi-annually.
a. 13.083
b. 12.732
c. 12.459
d. 12.371
a. Positively skewed
b. Negatively skewed
a. 5.19%
b. 5.12%
c. 5.07%
d. 4.98%
74. Options on the Nikkei 225 from Osaka Exchange are traded on a multiplier of
1000. Volatility of the index is expected to be less than 15%. The index is at
12,000.
76. A martingale is a:
b. Chaos-theory-related process.
JPY/USD at 9%
JPY/EUR at 11%
EUR/USD at 7%,
a. -58%
b. 62%
c. 34%
d. -34%
78. What is the Net Present Value of a yearly payment starting at 100 and increasing
2% yearly for 15 years when the discount rate is 4%? (rounded to the nearest
tenth)
a. 1,120
b. 1,260
c. 1,470
d. 1,620
79. A bank has sold USD 300,000 of call options on 100,000 equities. The equities
trade at 50, the option strike price is 49, the maturity is in 3 months, volatility is
20%, and the interest rate is 5%. How does it the bank delta hedge? (round to
the nearest thousand share)
a. Gamma-negative, delta-neutral
b. Gamma-positive, delta-positive
c. Gamma-negative, delta-positive
d. Gamma-positive, delta-neutral
November 17, 2001 II - 5 2001 GARP
Global Association of Risk Professionals 2001 Financial Risk Manager Exam
81. When pricing an FX option, what factor must be used, on top of the factors used
for Black-Scholes pricing? The:
82. The VaR of one asset is100; the VaR of another asset is 150. If their combined
VaR is 220, what is their correlation?
a. 0.92
b. 0.53
c. 0.53
d. 0.92
83. The volatility of an asset, over 1.5 years, is 35%. What is its 1-year volatility if it is
derived from the 1.5 year value?
a. 43%
b. 35%
c. 29%
d. 23%
84. If a counterparty defaults before maturity, which of the following situations will
cause a credit loss?
a. You are short EUR in a 1-year EUR/USD forward FX contract and the
EUR has appreciated.
b. You are short EUR in a 1-year EUR/USD forward FX contract and the
EUR has depreciated.
c. You sold a 1-year OTC EUR call option and the EUR has appreciated.
d. You sold a 1-year OTC EUR call option and the EUR has depreciated.
a. $11,952
b. $27,849
c. $60,000
d. $88,066
86. If two securities have the same volatility and a correlation equal to 0.5, their
minimum variance hedge ratio is:
a. 1:1
b. 2:1
c. 4:1
d. 16:1
87. You would expect the ratio of premiums for two at-the-money call options on the
same underlying equity with the same strike price, one expiring 12 months and
the other 1 month from now, to be close to:
a. 12
b. 6
c. 3.5
d. 2
88. A 3 month European call option on DEF stock with a strike price of $50 is trading
for $2.25. The risk free rate is 10%. The current stock price of DEF stock is $48.
Calculate the value of a corresponding put with the same strike and maturity.
a. $2.00
b. $2.25
c. $3.02
d. $3.57
November 17, 2001 II - 7 2001 GARP
Global Association of Risk Professionals 2001 Financial Risk Manager Exam
89. Estimate the forward rate of a 6-month EUR/USD foreign exchange rate
contract. USD LIBOR is 6% and EURIBOR is 4%. The current exchange rate is
0.8800 USD per EUR.
a. 0.9240
b. 0.9064
c. 0.8976
d. 0.8888
90. Which of the following is the riskiest form of speculation using options contracts?
91. Using the Black-Scholes model calculate the value of a European call option
given the following information:
Spot rate = 100
Strike price = 110
Risk- free rate = 10%
Time to expiry = 0.5 years
N(d1) = 0.457185
N(d2) = 0.374163
a. $10.90
b. $9.51
c. $6.57
d. $4.92
92. Under usually accepted rules of market behavior, the relationship between
parametric delta-normal VaR and historical VaR will tend to be:
93. Calculate the price of a 1-year forward contract on gold. Assume the storage cost
for gold is $5.00 per ounce with payment made at the end of the year. Spot gold
is $290 per ounce and the risk free rate is 5%.
a. $304.86
b. $309.87
c. $310.12
d. $313.17
94. An option trader constructs the following position: buys 1 call with a strike price at
X , buys 1 call with a strike price at X and sell 2 calls with a strike X . Where
X < X < X and X = *( X + X ). This strategy is referred to as a
a. Butterfly Spread
b. Bull Spread
c. Strap Spread
d. Strip Spread
95. The option-adjusted duration of a callable bond will be close to the duration of a
similar non-callable bond when the:
96. A company anticipates the purchase British pounds in 6 months. The standard
deviation of the change in British pounds over a 6-month period is calculated to
be 9%. The company chooses to hedge their exposure by buying future contracts
on EUR. The standard deviation of the change in the futures price over a 6-
month period is calculated to be 10% and the correlation coefficient between
British pounds and EUR is 0.70. Calculate the optimal hedge ratio.
a. 1.0
b. 0.90
c. 0.70
d. 0.63
November 17, 2001 II - 9 2001 GARP
Global Association of Risk Professionals 2001 Financial Risk Manager Exam
97. Which of the following is NOT a reason why corporates should hedge their
exposures? To:
98. What is the most typical underlying used for weather derivatives?
101. What is the scenario most used for stress-test of firm-wide positions?
102. A fund manager owns a 50 million USD growth portfolio that has a beta of 1.6
relative to the S&P 500. The S&P 500 Index is trading at 1190. Calculate the
number of futures contracts the fund manager needs to sell to hedge the
portfolio. (The multiplier of the S&P 500 is 250)
a. 105
b. 168
c. 269
d. 283
103. Suppose that at the maturity of futures contracts, the fund manager of the
previous question experiences a decline in value of his portfolio of 15%. The
market index is trading at 1078 and the risk free rate is 3%. Calculate the
effectiveness of the hedge.
b. Gain of 32K
c. Gain of 424K
d. Gain of 1500K
104. When the maturity of a plain coupon bond increases, its duration increases:
b. Up to a certain level
105. Assume that the current spot exchange rate is 0.8950 USD per 1 EUR. An
American bank pays 3.5 percent annual interest rate for a dollar deposit and a
European bank pays 2.75 percent annual interest rate for a EUR deposit. Both
rates are compounded annually. If the interest-rate parity theory holds true,
calculate the no arbitrage forward exchange rate for EUR/USD one year from
now:
a. 0.9015
b. 0.8990
c. 0.8975
d. 0.8950
106. Consider a non-dividend paying stock currently priced at $37. It is known with
certainty that over the next two 3-month periods, the price will either rise by 5%
or fall by 5%. The continuously compounded risk free rate is 7%. Calculate the
value of a six-month European call option with a strike price at $38.
a. $1.065
b. $1.234
c. $1.856
d. $2.710
a. Delta-negative, vega-negative
b. Delta-negative, vega-positive
c. Delta-neutral, vega-negative
d. Delta-neutral, vega-positive
a. Cubic splines
b. Step-wise interpolation
c. Log-linear interpolation
d. Linear interpolation
109. What instrument makes a convexity correction necessary for a yield curve?
a. Option-based instruments
b. FRAs
c. Futures
d. Swaps
110. Consider a European call option on a non-dividend paying stock. The current
market price is $100, the strike price is $102, the time to maturity is 9 months and
the risk free rate is 7.25%. Calculate the lower bound of the option price.
a. $3.40
b. $3.22
c. $2.75
d. $2.00
111. Consider the following bearish option strategy of buying one at-the-money put
with a strike price of $43 for $6, selling two puts with a strike price of $37 for $4
each and buying one put with a strike price of $32 for $1. If the stock price
plummets to $19 at expiration, calculate the net profit/loss per share of the
strategy.
d. Prior to exercise the value of the American call is always equal to the
European call.
114. Rank the following portfolios from least risky to most risky. Assume 252 trading
days a year and there are 5 trading days per week. (This question did not
count when the exam was graded)
Holding
Period in Confidence
Portfolio VaR Days Interval
1 10 5 99
2 10 5 95
3 10 10 99
4 10 10 95
5 10 15 99
6 10 15 95
a. 5,3,6,1,4,2
b. 3,4,1,2,5,6
c. 5,6,1,2,3,4
d. 2,1,5,6,4,3
115. Consider the following call option with 6-months till expiry. The strike price is
$50, the current stock price is $55 and the value of the option is $5. What does
this imply about the level of 6-month interest rates?
116. Which one of the following statements is FALSE about Latin American stock
markets?
a. The Chilean stock index IPSA is usually less volatile than the Argentinean
stock index MERVAL.
b. The market capitalization of the Brazilian stock market is much larger than
the market capitalization of the Venezuelan stock market.
c. You can only find derivatives contracts on Latin American stock indexes
listed in derivatives exchange in the United States.
d. Two of most important stock indexes in the region are the Argentinean
MERVAL and the Brazilian IBOVESPA.
117. What is the main reason why convertible bonds are generally issued with a call?
c. To reduce duration.
118. When pricing an option with a discrete time model using the same volatility
assumption, as compared to a continuous time model, the value will tend to go:
a. Up
b. Down
d. Up or down, no rules
119. A corporate bond is convertible at 40 and the corporation has called it for
redemption at 106. The bond is currently selling at 115 and the stock's current
market price is 45. Which of the following would a bondholder most likely do?
a. Volatility risk remains, as well as basis risk and interest rate risk
121. In what case is a position to be revalued with accrual methods instead of mark-
to-market?
123. Which of the following Greeks contributes most to the risk of an option that is
close to expiration and deep in the money?
a. Vega
b. Rho
c. Gamma
d. Delta
125. What is the most general way accounting discrepancies are dealt with? These
are:
b. Make money used for weapons trade more discrete, for political. purposes
a. For an investor there is an upside but limited downside; for the issuer, the
equity is sold at a higher price.
b. Both investor and issuer benefit from a better tax and regulatory
treatment.
c. The investor can buy the equity with a trial period; the issuer can spread
the dilution effect in time, which is better against unwanted takeovers.
d. The issuer can sell the volatility of the equity, which he knows better than
the investor does.
November 17, 2001 II - 17 2001 GARP
Global Association of Risk Professionals 2001 Financial Risk Manager Exam
128. Compared to traditional ways to invest, hedge funds generally are, as a vehicle
for investment:
b. Less risky, because they are managed by small, more efficient teams.
129. FASB's latest decision about banks' losses related to the events of 11th
September 2001 is that these:
d. Must appear in the relevant places in the P&L, according to their nature.
a. I and II
b. II and III
c. I and III
d. I and IV
Answer Key
Question Answer
1 c
2 c
3 b
4 b
5 a
6 d
7 b
8 a
9 a
10 a
11 c
12 b
13 a
14 b
15 a
16 b
17 b
18 c
19 c
20 d
21 a
22 d
23 c
24 a
25 b&c
26 a
27 a
28 d
29 b
30 c
31 c
32 a
33 d
34 c
35 c
36 d
37 c
38 b
39 d
40 a
41 d
42 a
43 b
44 d
45 a
46 d
47 a
48 c
49 b
50 d
51 c
52 a
53 b
54 b
55 d
56 c
57 b
58 b
59 c
60 a
61 b
62 b
63 a
64 d
65 c
66 b
67 c
68 a
69 b
70 b
71 d
72 a
73 c
74 c
75 a&c
76 a
77 a
78 b
79 a
80 c
81 d
82 b
83 c
84 b
85 b
86 b
87 c
88 c
89 d
90 c
91 c
92 b
93 b
94 a
95 c
96 d
97 c
98 c
99 b
100 d
101 a
102 c
103 b
104 b
105 a
106 b
107 c&d
108 b
109 c
110 a
111 d
112 b
113 a
114 a
115 c
116 c
117 d
118 b
119 a
120 a
121 d
122 b
123 d
124 c
125 d
126 c
127 d
128 c
129 d
130 c