FRM Part I Formula Sheet 2021

Book 1 – Foundations of Risk Management
Beta of Stock
Calculation:
𝐶𝑜𝑣(𝑅𝑖 , 𝑅𝑀 )
Expected Use: 𝐵𝑒𝑡𝑎𝑖 =
-Beta in CAPM calculation 𝜎𝑀2
-Hedge Ratio calculation (Slightly
FRM Part 1 2021 Formula Sheet – Falconedufin.com
different)
Accident Point
In denominator it is sigma of
market square. Do not confuse it
with sigma of stock.
CAPM Required Rate of
Return
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑠𝑡 𝑃𝑟𝑖𝑐𝑖𝑛𝑔 𝑚𝑜𝑑𝑒𝑙 ∶
Expected Use:
-To derive expected return of a
security/portfolio = 𝑅𝐹
-Market Risk Premium/beta
calculation + 𝐵𝑒𝑡𝑎𝑖 [𝐸 (𝑅𝑀 ) − 𝑅𝐹 ]
Accident Point
Calculating market return
premium as risk-free rate –
expected market return
(E(Rm) – Rf) is Market Risk
premium and E(Rm) is expected
market risk premium.
CML calculation
Expected Use:
-To derive expected return of a 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑀𝑎𝑟𝜎𝜎𝑘𝑒𝑡 𝐿𝑖𝑛𝑒: 𝐸 (𝑅𝑃 )
diversified portfolio [𝐸 (𝑅𝑀 ) − 𝑅𝐹 ]
-Sharpe Ratio Calculation = 𝑅𝐹 + [ ] 𝜎𝑃
𝜎𝑀
Accident Point:
-Getting confused and using sigma
of portfolio in
denominator instead of sigma of
market.
-Not multiplying sigma of portfolio
in equation
- Also note slope is Sharpe Ration
(Marked in Red)
Treynor Ratio
calculation
Expected Use:
-Excess return per unit of 𝐸 (𝑅𝑃 ) − 𝑅𝐹
systematic risk 𝑇𝑟𝑒𝑦𝑛𝑜𝑟 𝑚𝑒𝑎𝑠𝑢𝑟𝑒: [ ]
𝛽𝑃
- Useful for well diversified
portfolio
Accident Point
-Getting confused and using sigma
of portfolio in
denominator instead of beta of
portfolio.
Sharpe Ratio calculation
Expected Use:
-excess return per unit of total 𝐸 (𝑅𝑃 ) − 𝑅𝐹
risk
𝑆ℎ𝑎𝑟𝑝𝑒 𝑚𝑒𝑎𝑠𝑢𝑟𝑒: [ ]
𝜎𝑃
- Useful for un diversified portfolio
/ asset
Accident Point
-Getting confused and using beta
of portfolio instead of sigma of
portfolio in denominator.
Alpha calculation 𝐽𝑒𝑛𝑠𝑒𝑛′ 𝑠 𝑎𝑙𝑝ℎ𝑎: 𝛼𝑃 =
Expected Use:
-excess return over return 𝐸(𝑅𝑝 ) − 𝑅𝐹 − [𝐸 (𝑅𝑀 ) − 𝑅𝐹 ]𝛽𝑃
predicted by CAPM
Accident Point
- You might get question
specifying required rate of return
which is just later term after E(Rp)
(Marked red)
Sortino calculation
Expected Use:
-Variation of Sharpe, useful where 𝐸(𝑅𝑝 ) − 𝑅𝑚𝑖𝑛
returns are not symmetric 𝑆𝑜𝑟𝑡𝑖𝑛𝑜 𝑟𝑎𝑡𝑖𝑜:
√𝑀𝑆𝐷𝑚𝑖𝑛
Accident Point
-using risk-free rate in numerator
when minimum acceptable return
is provided.
Information Ratio 𝑖𝑛𝑓𝑜𝑟𝑚𝑎𝑡𝑖𝑜𝑛 𝑟𝑎𝑡𝑖𝑜
calculation 𝐸(𝑅𝑝 ) − 𝐸(𝑅𝐵 ) 𝛼𝑝
Expected Use: = [
𝜎𝑒𝑝
]=
𝜎𝑒𝑝
-to check manager’s efficiency
Accident Point
Multifactor Model (Less 𝑀𝑢𝑙𝑡𝑖𝑓𝑎𝑐𝑡𝑜𝑟 𝑚𝑜𝑑𝑒𝑙: 𝑅𝑖 =
likely to be asked in
𝐸 (𝑅𝑖 ) + 𝛽𝑖1 𝐹1 + 𝛽𝑖2 𝐹2 + ⋯ + 𝛽𝑖𝑘 𝐹𝑘 + 𝑒𝑖
exam)
Expected Use:
-to calculate return based on 𝑤ℎ𝑒𝑟𝑒
several factors 𝑅𝑖 = 𝑟𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑠𝑡𝑜𝑐𝑘 𝑖
Accident Point
𝐸𝑅𝑖 = 𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑟𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑠𝑡𝑜𝑐𝑘 𝑖
- NA
𝛽𝑖𝑗 = 𝑗𝑡ℎ 𝑓𝑎𝑐𝑡𝑜𝑟 𝑏𝑒𝑡𝑎 𝑓𝑜𝑟 𝑠𝑡𝑜𝑐𝑘 𝑖
𝐹𝑗 = 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛 𝑜𝑓 𝑚𝑎𝑐𝑟𝑜𝑒𝑐𝑜𝑛𝑜𝑚𝑖𝑐 𝑓𝑎𝑐𝑡𝑜𝑟
𝑗 𝑓𝑟𝑜𝑚 𝑖𝑡𝑠 𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑣𝑎𝑙𝑢𝑒

𝑒𝑖 = 𝑓𝑖𝑟𝑚 − 𝑠𝑝𝑒𝑐𝑖𝑓𝑖𝑐 𝑟𝑒𝑡𝑢𝑟𝑛 𝑓𝑜𝑟 𝑠𝑡𝑜𝑐𝑘 𝑖
APT Model 𝐴𝑃𝑇 𝑚𝑜𝑑𝑒𝑙: 𝐸 (𝑅𝑖 ) =

Expected Use:
- Expected rate of return using APT 𝑅𝐹 + 𝛽𝑖1 [𝐸(𝑅1 ) − 𝑅𝐹 ]
Accident Point
- APT questions are generally very +𝛽𝑖2 [𝐸(𝑅2 ) − 𝑅𝐹 ] + ⋯
elaborate and direct like put value
and get result. +𝛽𝑖𝑘 [𝐸(𝑅𝑘 ) − 𝑅𝐹
Fama-French Model 𝐹𝑎𝑚𝑎 − 𝐹𝑟𝑒𝑛𝑐ℎ 𝑡ℎ𝑟𝑒𝑒 𝑓𝑎𝑐𝑡𝑜𝑟 𝑚𝑜𝑑𝑒𝑙:

Expected Use:
- Calculation of Ri – Rf 𝑅𝑖 − 𝑅𝐹 = 𝛼𝑖 + 𝛽𝑖,𝑀 (𝑅𝑀 − 𝑅𝐹 )
- Calculation of required return.
Accident Point +𝛽𝑖,𝑆𝐵𝑀 𝑆𝑀𝐵 + 𝛽𝑖,𝐻𝑀𝐿 𝐻𝑀𝐿 + 𝑒𝑖
-Understand how SMB, HML is used
in calculation. You will get
information in form of long and
short.
Book 2 – Quants
Joint Probability
Calculation:
Use case:
𝑗𝑜𝑖𝑛𝑡 𝑝𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦. 𝑃(𝐴𝐵) = 𝑃(𝐴 𝐵) = 𝑃(𝐴|𝐵) × 𝑃(𝐵)
-Calculating probability of
both events occurring
Accident Point
-Learn to use this formula in

theory form as question is
more likely to be in theory
form.
Conditional Probability
Calculation:
Use case:
-calculating probability of ‘A 𝑃(𝐴𝐵)
given the occurrence of B’ 𝑐𝑜𝑛𝑑𝑖𝑡𝑖𝑜𝑛𝑎𝑙 𝑝𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦: 𝑃(𝐴|𝐵) =
𝑃(𝐵)
Accident Point
-Learn to use this formula in
theory form as question is
more likely to be in theory
form.
Independent probability
Rule (not meant for
calculation)
Use case:
-when occurrence of A is not 𝑖𝑑𝑒𝑝𝑒𝑛𝑑𝑒𝑛𝑡 𝑒𝑣𝑒𝑛𝑡𝑠: 𝑃(𝐴|𝐵) = 𝑃(𝐴)
related to occurrence of B
Accident Point
-All these probabilities can
be very confusion. In
conditional probability see
word “given” or any other
indicative word.
Expected Value
Calculation (use calculator
directly- Formula is not needed
𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑣𝑎𝑙𝑢𝑒: 𝐸(𝑋) = ∑𝑃(𝑋𝑖 )𝑋𝑖
for calculation):
Expected Use:
-weighted average of
possible outcomes of a
random variable.
Accident Point
- Understand meaning of
expected value.
Variance Calculation:
(use calculator directly- Formula
is not needed for calculation): 𝑣𝑎𝑟𝑖𝑒𝑛𝑐𝑒: 𝑉𝑎𝑟(𝑋) = 𝐸[(𝑋 − 𝜇)2 ]
Expected Use:
-dispersion in values around
the
mean
Accident Point
You can use TI BA II Plus
calculator
for this using 1 V function. It

will
save time.
Covariance Calculation:
(use calculator directly- Formula
is not needed for calculation): 𝑐𝑜𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒: 𝐶𝑜𝑣(𝑅𝑖 , 𝑅𝑗 ) = 𝐸{[𝑅𝑖 − 𝐸(𝑅𝑖 )][𝑅𝑗 − 𝐸(𝑅𝑗 )]}
Expected Use:
-provides information of how
two
asset are related to each
other
Accident Point
-Use calculator function Lin
for covariance.
Correlation Calculation:
Expected Use:
-measures strength of linear
relationship
between two variables 𝐶𝑜𝑣(𝑅𝑖 , 𝑅𝑗 )
𝑐𝑜𝑟𝑟𝑒𝑙𝑎𝑡𝑖𝑜𝑛: 𝐶𝑜𝑟𝑟(𝑅𝑖 , 𝑅𝑗 ) =
Accident Point 𝜎(𝑅𝑖 )𝜎(𝑅𝑗 )
-This formula will only
calculate linear
correlation. 0 correlation
using
this formula dose not mean
there is
no correlation between
variables.
There can be non linear
correlation.
Portfolio Variance 𝑝𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑣𝑎𝑟𝑖𝑛𝑐𝑒: 𝑉𝑎𝑟(𝑅𝑃 )
Calculation:
= 𝑊𝐴2 𝜎 2 + 𝑤𝐵2 𝜎 2 (𝑅𝐵 )
Expected Use: + 2𝑊𝐴 𝑊𝐵 𝜎(𝑅𝐴 )𝜎(𝑅𝐵 )(𝐶𝑜𝑟 𝑅𝐴 , 𝑅𝐵 )
-for calculating variance of
portfolio
Accident Point
Skewness Calculation
(Less likely to be tested):
𝐸[(𝑅 − 𝜇)3 ]
𝑠𝑘𝑒𝑤𝑛𝑒𝑠𝑠 =
𝜎3
Expected Use:
-explains the symmetry of
data distribution
around the mean
Kurtosis Calculation:
(Less likely to be tested):
𝐸[(𝑅 − 𝜇)4 ]
Expected Use: 𝑘𝑢𝑟𝑡𝑜𝑠𝑖𝑠 =
-explains the degree of 𝜎4
peakedness/clustering in
data distribution
Poisson Distribution: 𝜆𝑥 𝑒 −𝜆
𝑃𝑜𝑖𝑠𝑠𝑜𝑛 𝑑𝑖𝑠𝑡𝑟𝑖𝑏𝑢𝑎𝑡𝑖𝑜𝑛: 𝑃(𝑋 = 𝑥) =
Expected Use: 𝑥¡
-To determine probability of
a discrete event provided x= number of successes per unit
average expected λ = average or expected number of successes per
occurrences. unit
Accident Point
-using lambda in
denominator instead of x
Binomial Distribution: 𝑏𝑖𝑛𝑜𝑚𝑖𝑎𝑙 𝑝𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑓𝑢𝑛𝑐𝑡𝑖𝑜𝑛:
Expected Use: 𝑛𝐶𝑟 𝑋 𝑃 𝑥 𝑋 (1 − 𝑝)𝑛−𝑥
-To determine probability of
a specific number of
successes in n independent
trials.
Accident Point
-interchanging power terms
Expected value 𝐸(𝑋) = 𝑛𝑝
Use:
- Expected value of binomial
random variable
Variance of a binomial
random variable
Use :
In finding variation and
𝑛𝑝(1 − 𝑝) = 𝑛𝑝𝑞
standard deviation of
binomial random variable.
Point:
Similar variation of this
formula is used in finding
variance of probability
of default of unexpected loss
Mean of uniform
distribution
𝑎+𝑏
Expected Use: 𝑚𝑒𝑎𝑛 𝑜𝑓 𝑢𝑛𝑖𝑓𝑖𝑟𝑚 𝑑𝑖𝑠𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛: 𝐸(𝑥) =
2
Mean only when the
distribution is
uniform.
Variance of uniform 𝑉𝑎𝑟(𝑥) =
(𝑏 − 𝑎)2
distribution 12
Bayes Theorem
Expected Use:
-determine probabilities of 𝑃(𝐵|𝐴) × 𝑃(𝐴)
𝐵𝑎𝑦𝑒𝑠 ′ = 𝑃(𝐴 |𝐵) =
event based on events 𝑃(𝐵)
already occurred
-useful for updating
probabilities based on
hypothesis
Accident Point
Language in Bayes can be
very tricky but fundamental
remains the same.
Population mean(use
calculator directly- Formula is
not needed for calculation): ∑𝑁
𝑖=𝑙 𝑋𝑖
Expected Use: 𝑃𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛 𝑚𝑒𝑎𝑛: 𝜇 =
𝑁
-determining average value
out of the population
Accident Point
Sample mean(use calculator
for calculation): ∑𝑛𝑖=𝑙 𝑋𝑖
𝑆𝑖𝑚𝑝𝑙𝑒 𝑚𝑒𝑎𝑛: 𝑋̅ =
Expected Use: 𝑛
-determining average value
out of
the sample drawn out of
population
Accident Point
mean is not divided by n-1 in
case
of sample mean
Variance of
Population(use calculator
∑𝑁
𝑖=𝑙(𝑥𝑖 − 𝜇)
2
𝑝𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛 𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒: 𝜎 2 =
for calculation): 𝑁
Expected Use:
-measure squared deviation
around
the mean of population data
Accident Point:
-Identify the data given
before applying
formula for variance of
sample or population.
Standard Deviation of ∑𝑁 (𝑥𝑖 − 𝜇)2
Population (use calculator 𝑝𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛 𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑖𝑎𝑡𝑖𝑜𝑛: 𝜎 2 = √ 𝑖=𝑙
𝑁
for calculation):
Expected Use:
-square root of variance,
measures
deviation around the mean
Variance of Sample(use ∑𝑛𝑖=𝑙(𝑋𝑖 − 𝑋̅)2
2
𝑠𝑎𝑚𝑝𝑙𝑒 𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒: 𝑠 =
calculator directly- Formula is 𝑛−1
not needed for calculation):

Expected Use:
-measure squared deviation
around the mean of sample
data
Standard Deviation of ∑𝑛(𝑋𝑖 − 𝑋̅)2
Sample(use calculator directly- 𝑠𝑎𝑚𝑝𝑙𝑒 𝑠𝑡𝑎𝑛𝑑𝑒𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛: 𝑠 = √ 𝑖
𝑛−1
Formula is not needed for
calculation):
Expected Use:
-square root of variance,
measures deviation around
the mean
Covariance of Sample 𝑠𝑎𝑚𝑝𝑙𝑒 𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒: 𝑐𝑜𝑣𝑎𝑟𝑖𝑎𝑛𝑐𝑒 =
Expected Use: 𝑛
-depict how two variables (𝑋𝑖 − 𝑋̅)(𝑌𝑖 − 𝑌̅ )
∑
are related 𝑛−1
𝑖=𝑙
to each other
Accident Point
-using n in denominator
instead of n-1
Correlation Calculation: 𝑠𝑎𝑚𝑝𝑙𝑒 𝑐𝑜𝑟𝑟𝑒𝑙𝑎𝑡𝑖𝑜𝑛 𝑐𝑜𝑒𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑡: 𝑟𝑋𝑌 =
𝐶𝑜𝑣(𝑋, 𝑌)
Expected Use: (𝑌𝑋 )(𝑆𝑌 )
-measures strength of linear
relationship between two
variables
Accident Point
Z score calculation: 𝑧=
𝑜𝑏𝑠𝑒𝑟𝑣𝑎𝑡𝑖𝑜𝑛 − 𝑝𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛 𝑚𝑒𝑎𝑛 𝑥 − 𝜇
=
Expected Use: 𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛 𝜎
- It gives the number of
standard deviations from the
mean a data point is.
-Hypothesis testing
Accident Point
Do not interchange
numerator
terms like population mean
–observation.
This is common blunder in
this calculation.
Sampling error of the 𝑠𝑎𝑚𝑝𝑙𝑖𝑛𝑔 𝑒𝑟𝑟𝑜𝑟 𝑜𝑓 𝑡ℎ𝑒 𝑚𝑒𝑎𝑛
mean
= 𝑠𝑎𝑚𝑝𝑙𝑒 𝑚𝑒𝑎𝑛 − 𝑝𝑜𝑝𝑢𝑙𝑎𝑡𝑖𝑜𝑛 𝑚𝑒𝑎𝑛 = 𝑋̅ − 𝜇
Use case:
Sampling error of the mean
𝜎
Standard Error 𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑒𝑟𝑟𝑜𝑟 𝑜𝑓 𝑡ℎ𝑒 𝑠𝑎𝑚𝑝𝑙𝑒 𝑚𝑒𝑎𝑛: 𝜎𝑋̅ =
Calculation: √𝑛
Expected Use:
- It gives us an estimate of
how far the sample mean is
likely to be from the
population mean
Accident Point:
Chi-square Calculation: 2
𝑋𝑛−1 =
(𝑛 − 1)𝑠 2
Expected Use: 𝜎02
- hypothesis tests
concerning the variances of
normally distributed
population
Accident Point
F-test: 𝑠21
𝐹𝑡𝑒𝑠𝑡 = 2
Expected Use: 𝑠2
- hypotheses concerned with
the equality of the variances
of two populations
Accident Point
t-test: =
𝑠𝑎𝑚𝑝𝑙𝑒 𝑠𝑡𝑎𝑡𝑖𝑠𝑡𝑖𝑐 − ℎ𝑦𝑝𝑜𝑡ℎ𝑒𝑠𝑖𝑧𝑒𝑑 𝑣𝑎𝑙𝑢𝑒
Expected Use: 𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑒𝑟𝑟𝑜𝑟 𝑜𝑓 𝑡ℎ𝑒 𝑠𝑎𝑚𝑝𝑙𝑒 𝑠𝑡𝑎𝑡𝑖𝑠𝑡𝑖𝑐
- hypothesis testing
Accident Point
Regression Equation: 𝑠𝑎𝑚𝑝𝑙𝑒 𝑟𝑒𝑔𝑟𝑒𝑠𝑠𝑖𝑜𝑛 𝑓𝑢𝑐𝑡𝑖𝑜𝑛: 𝑌𝑖 = 𝑏0 + 𝑏1 + 𝑋𝑖 + 𝑒𝑖
Expected Use:
- determining value of 𝑟𝑒𝑠𝑖𝑑𝑢𝑎𝑙: 𝑒𝑖 = 𝑌𝑖 − (𝑏0 + 𝑏1 + 𝑋𝑖 )
dependent variable using
independent variable
Slope Equation (use 𝑟𝑒𝑔𝑟𝑒𝑠𝑠𝑖𝑜𝑛 𝑠𝑙𝑜𝑝𝑒 𝑐𝑜𝑒𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑡 ∶ 𝑏1

calculator directly- Formula is
not needed for calculation): ∑𝑛𝑖=𝑙(𝑋𝑖 − 𝑋̅)(𝑌𝑖 − 𝑌̅)
=
Expected Use: ∑𝑛𝑖=𝑙(𝑋𝑖 − 𝑋̅)2
- represents the rate of
change in y
as x changes
Book 3 – Financial Markets and Products
Ratio for insurance 1. 𝐶𝑜𝑚𝑏𝑖𝑛𝑒𝑑 𝑅𝑎𝑡𝑖𝑜: 𝑙𝑜𝑠𝑠 𝑟𝑎𝑡𝑖𝑜 + 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 𝑟𝑎𝑡𝑖𝑜
firm
Use case: 2. 𝐶𝑜𝑚𝑏𝑖𝑛𝑒𝑑 𝑅𝑎𝑡𝑖𝑜 𝑎𝑓𝑡𝑒𝑟 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠:
Combined ratio is
used to find 𝐶𝑜𝑚𝑏𝑖𝑛𝑒𝑑 𝑅𝑎𝑡𝑖𝑜 + 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠
out total impact of
3. 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑟𝑎𝑡𝑖𝑜:
loss ratio
and expense ratio. 𝐶𝑜𝑚𝑏𝑖𝑛𝑒𝑑 𝑅𝑎𝑡𝑖𝑜 𝑎𝑓𝑡𝑒𝑟 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 – 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑖𝑛𝑐𝑜𝑚𝑒
Note:
Multiple variation
of same formula is
possible. But basic
framework remains
the same.
Net asset value of 𝑁𝑒𝑡 𝑎𝑠𝑠𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 ∶ 𝑁𝐴𝑉
fund
Use case: 𝑓𝑢𝑛𝑑 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝑓𝑢𝑛𝑑 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
=
Calculation of net 𝑡𝑜𝑡𝑎𝑙 𝑠ℎ𝑎𝑟𝑒 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔
asset value of
mutual fund.
Note:
You can expect
direct question on
this concept.
Payoff of option
Use case:
5 Call option 𝐶𝑎𝑙𝑙 𝑜𝑝𝑡𝑖𝑜𝑛 𝑝𝑎𝑦𝑜𝑓𝑓: 𝐶𝑇 = 𝑚𝑎𝑥 (0, 𝑆𝑇 − 𝑥)
payoffs
6 Put option 𝑃𝑢𝑡 𝑜𝑝𝑡𝑖𝑜𝑛 𝑝𝑎𝑦𝑜𝑓𝑓: 𝑃𝑇 = 𝑚𝑎𝑥(0, 𝑋 − 𝑆𝑇 )
payoff.
Using this
combination of
formula, you can
get question on
payoff calculation
of option strategy.
Note:
Payoffs can not be
negative in
case of plain
vanilla option but
it is possible in
case of barrier
option.
Forward contract 𝐹𝑜𝑟𝑤𝑎𝑟𝑑 𝑐𝑜𝑛𝑡𝑟𝑎𝑐𝑡 𝑝𝑎𝑦𝑜𝑓𝑓: 𝑝𝑎𝑦𝑜𝑓𝑓 𝑝𝑎𝑦𝑜𝑓𝑓
payoff
Use case: = 𝑆𝑇 − 𝑘
Forward contract
payoff 𝑊ℎ𝑒𝑟𝑒
𝑆𝑇 = 𝑠𝑝𝑜𝑡 𝑝𝑟𝑖𝑐𝑒 𝑎𝑡 𝑚𝑎𝑡𝑢𝑟𝑖𝑡𝑦
calculation
𝑘 = 𝑑𝑒𝑙𝑖𝑣𝑒𝑟𝑦 𝑝𝑟𝑖𝑐𝑒
Basis Risk 𝑏𝑎𝑠𝑖𝑠 = 𝑆𝑡 − 𝐹0
Use case: Finding
basis of 𝑊ℎ𝑒𝑟𝑒
forward/future 𝑆𝑡 = 𝑐𝑎𝑠ℎ (𝑜𝑟 𝑠𝑝𝑜𝑡) 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑢𝑛𝑑𝑒𝑟𝑙𝑦𝑖𝑛𝑔 𝑎𝑠𝑠𝑒𝑡 𝑎𝑡 𝑡𝑖𝑚𝑒
contract. 𝐹0 = 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑓𝑢𝑡𝑢𝑟𝑒𝑠 𝑐𝑜𝑛𝑡𝑟𝑎𝑐𝑡 𝑡
Note: Understand
concept of
widening of the
basis risk, how
basis risk is
connected to
contango/
backwardation
Hedge Ratio 𝜎𝑆
𝐻𝑒𝑑𝑔𝑒 𝑟𝑎𝑡𝑖𝑜: 𝐻𝑅 = 𝜌𝑆, 𝐹
Use case: 𝜎𝐹
Finding hedge ratio,
which is then used
in calculation of
number of contract
to hedge. Note:
Beta calculation 𝐶𝑜𝑣𝑆,𝐹
𝐵𝑒𝑡𝑎: 𝜎𝐹2 = 𝛽𝑆, 𝐹
Use case: Beta
calculation
same as CAPM
𝐶𝑜𝑣𝑆,𝐹
equation. 𝐶𝑜𝑟𝑟𝑒𝑙𝑎𝑡𝑖𝑜𝑛: 𝜌 = 𝜎𝑆𝜎𝐹
Same beta is then
used in
hedging in beta
hedging.
Correlation same
as CAPM and later
can be used in
hedging correlation
based
Note: Denominator
is
variance of futures
contract in use
instead of market.
Hedging using 𝐻𝑒𝑑𝑔𝑖𝑛𝑔 𝑤𝑖𝑡ℎ 𝑡ℎ𝑒 𝑠𝑡𝑜𝑐𝑘 𝑖𝑛𝑑𝑒𝑥 𝑓𝑢𝑡𝑢𝑟𝑒𝑠
index futures:
Use case: For 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑐𝑜𝑛𝑡𝑟𝑎𝑐𝑡𝑠
calculation of
𝑝𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑣𝑎𝑙𝑢𝑒
optimal number of = 𝛽𝑝𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 ⌈ ⌉
contracts to be 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑓𝑢𝑡𝑢𝑟𝑒 𝑐𝑜𝑛𝑡𝑟𝑎𝑐𝑡
used for hedging.
Note: Always look 𝑝𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑣𝑎𝑙𝑢𝑒
= 𝛽𝑝𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 ⌈ ⌉
for proper 𝑓𝑢𝑡𝑢𝑟𝑒 𝑝𝑟𝑖𝑐𝑒 × 𝑐𝑜𝑛𝑡𝑟𝑎𝑐𝑡 𝑚𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟
multiplier. In most
of the cases it will
be given.
Adjusted Bet 𝐴𝑑𝑗𝑢𝑠𝑡𝑖𝑛𝑔 𝑡ℎ𝑒 𝑝𝑜𝑟𝑡𝑓𝑜𝑙𝑖𝑜 𝑏𝑒𝑡𝑎: 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑐𝑜𝑛𝑡𝑟𝑎𝑐𝑡
Use case: For
calculation of 𝑃
= (𝛽˟ − 𝛽)
adjusted beta to 𝐴
calculate number
of contract
required
to adjust number
of contract to keep
hedge according to
beta.
Note: Once you get
number of contract
to adjust beta,
always look for
correct
position like you
should long or
short futures
contract to
adjust. This can be
very tricky.
Give it a shot
before exam
day.
Future value: 𝑅 𝑚×𝑛
𝐹𝑉 = 𝐴 [1 + ]
𝑚
Use case: Future
value using when
interest rate is
given is discreetly
compounded.
Note: Instead of
just mugging up
formula
understand how it
works
Future value 𝐶𝑜𝑛𝑡𝑖𝑛𝑢𝑜𝑢𝑠 𝑐𝑜𝑚𝑝𝑜𝑢𝑛𝑑𝑖𝑛𝑔: 𝐹𝑉 = 𝐴𝑒 𝑅×𝑛
Use case:
Calculation future
value using
discrete
compounding
Note:
To convert
continuous
compounding to
effective we use TI
BA II plus
calculator LN
function. Practice
some
questions to learn
exact
process.
FRA
Use case: Finding 𝐹𝑜𝑟𝑤𝑎𝑟𝑑 𝑟𝑎𝑡𝑒 𝑎𝑔𝑟𝑒𝑒𝑚𝑒𝑛𝑡: 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 (𝑖𝑓 𝑟𝑒𝑐𝑒𝑖𝑣𝑖𝑛𝑔 𝑅𝐾 )
cash flow to FRA
holder. = 𝐿 × (𝑅𝐾 − 𝑅) × (𝑇2 − 𝑇1 )
Note:
You do not need to
remember two
formulas
given for payable
and
receivable.
Calculate FRA
Payoff using any
one formula
and then apply
common
sense will it be
payable or
receivable.
FRA: Same as above 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 (𝑖𝑓 𝑝𝑎𝑦𝑖𝑛𝑔 𝑅𝐾 )
but for paying FRA
holder. = 𝐿 × (𝑅 − 𝑅𝐾 ) × (𝑇2 − 𝑇1 )
Forward price: 𝐹𝑜𝑟𝑤𝑎𝑟𝑑 𝑝𝑟𝑖𝑐𝑒: 𝐹0 = 𝑆0𝑒 𝑒 𝑟

𝑇
Use case:
Calculation of
forward price using
cost of carry
model.
Note: This is basic
formula where only
consideration is
interest rate.
Forward Price: 𝐹𝑜𝑟𝑤𝑎𝑟𝑑 𝑝𝑟𝑖𝑐𝑒 𝑤𝑖𝑡ℎ 𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑐𝑜𝑠𝑡𝑠:
Use case:
𝑇
Forward price 𝐹0 = (𝑆0 − 𝐼)𝑒 𝑟
calculation
when cost of
carrying like
storage cost is
given.
Note: There are
multiple
ways to give
carrying cost in
question it can be
in dollar
form or in the form
of
percentage. Also
check if
storage cost is paid
in the
beginning of
contract, mind
or in end of the
contract. All
three have very
different
treatment, formula
given
here is showing
treatment for
storage cost
incurred in the
beginning of the
period.
Forward pricing: 𝐹𝑜𝑟𝑤𝑎𝑟𝑑 𝑝𝑟𝑖𝑐𝑒 𝑤ℎ𝑒𝑛 𝑡ℎ𝑒 𝑢𝑛𝑑𝑒𝑟𝑙𝑦𝑖𝑛𝑔
Use case: 𝑎𝑠𝑠𝑒𝑡 𝑝𝑎𝑦𝑠 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑:

Calculation of
𝑇
forward price when 𝐹0 = 𝑆0𝑒 𝑒 (𝑟−𝑞)
dividend is given in
case of stock.
Note: Dividend
adjustment is
crucial step for
correct
calculation. It can
be in the
form of percentage
or in the form of
value. Treatment is
different in both
the cases.
Accrued interest. 𝐴𝑐𝑐𝑢𝑟𝑒𝑑 𝑖𝑛𝑡𝑟𝑒𝑠𝑡 = 𝑐𝑜𝑢𝑝𝑜𝑛
Use case:
Calculation of 𝑜𝑓 𝑑𝑎𝑦𝑠 𝑓𝑟𝑜𝑚 𝑙𝑎𝑠𝑡 𝑐𝑜𝑢𝑝𝑜𝑛 𝑡𝑜 𝑡ℎ𝑒 𝑠𝑒𝑡𝑡𝑙𝑒𝑚𝑒𝑛𝑡 𝑑𝑎𝑡𝑒
×
interest accrued 𝑜𝑓 𝑑𝑎𝑦𝑠 𝑜𝑛 𝑐𝑜𝑢𝑝𝑜𝑛 𝑝𝑒𝑟𝑖𝑜𝑑
from the
settlement date to
valuation date.
Cash price of bond: 𝐶𝑎𝑠ℎ 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑏𝑜𝑛𝑑: 𝑐𝑎𝑠ℎ 𝑝𝑟𝑖𝑐𝑒
= 𝑞𝑢𝑜𝑡𝑒𝑑 + 𝑎𝑐𝑐𝑟𝑢𝑒𝑑 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡
Annual rate of T 360
𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑟𝑎𝑡𝑒 = (100 − 𝑦)2
Bill: 𝑛
Cheapest to deliver 𝐶ℎ𝑒𝑎𝑝𝑒𝑠𝑡 − 𝑡𝑜 − 𝑑𝑒𝑙𝑖𝑣𝑒𝑟 𝑏𝑜𝑛𝑑:
bond:
Use case: 𝑞𝑢𝑜𝑡𝑒𝑑 𝑏𝑜𝑛𝑑 𝑝𝑟𝑖𝑐𝑒 – (𝑄𝐹𝑃 × 𝐶𝐹)
Used to calculate
cheapest to deliver
bond at the time of
settlement
Note: Calculation is
bit tricky and
confusing. Give it a
try one day before
exam and
remember steps.
Eurodollar Futures 𝐸𝑢𝑟𝑜𝑑𝑜𝑙𝑙𝑎𝑟 𝑓𝑢𝑡𝑢𝑟𝑒𝑠 𝑝𝑟𝑖𝑐𝑒
price:
Use case: = $10,000[100 − (0.25)(100 − 𝑍)]
Calculation of
Eurodollar futures.
Note: Question of
Eurodollar feels
very intimidating,
but calculation is
very simple. Key to
solve this type of
question
identifying
information useful
for you and
ignoring the scrap
information.
Convexity 𝐴𝑐𝑡𝑢𝑎𝑙 𝑓𝑜𝑟𝑤𝑎𝑟𝑑 𝑟𝑎𝑡𝑒
adjustment in = 𝑓𝑜𝑟𝑤𝑎𝑟𝑑 𝑟𝑎𝑡𝑒 𝑖𝑚𝑝𝑙𝑖𝑒𝑑 𝑏𝑦 𝑓𝑢𝑡𝑢𝑟𝑒𝑠 – (0.5 × 𝜎 2 × 𝑡1
forward rate: × 𝑡2 ) 𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛
Duration based 𝑃 × 𝐷𝑃
𝑁=−
hedge ratio: 𝐹 × 𝐷𝐹
Forward rate 𝑇1
𝐴: 𝑅𝑓𝑜𝑟𝑤𝑎𝑟𝑑 = 𝑅2 + (𝑅2 − 𝑅1 )
calculation 𝑇2− 𝑇1
from period T1 to
T2: 𝑅2𝑇2 − 𝑅1𝑇1
𝐵: 𝑅𝑓𝑜𝑟𝑤𝑎𝑟𝑑 =
Use case: 𝑇2− 𝑇1
calculation of
forward rate:
Note: Prefer this
formula. This gives
approximate result
as compared to
another formula
given in book. But
it is less
likely to affect
answer you
tick.
Put call parity: 1. 𝑝𝑢𝑡 − 𝑐𝑎𝑙𝑙 𝑝𝑎𝑟𝑖𝑡𝑦
Use case: You can
calculate 𝑆 = 𝑐 − 𝑝 + 𝑋𝑒 −𝑟𝑇
any of the four
variables given 𝑃 = 𝑐 − 𝑆 + 𝑋𝑒 −𝑟𝑇
other 3.
𝑐 = 𝑆 + 𝑝 ∓ 𝑋𝑒 −𝑟𝑇
+𝑋𝑒 −𝑟𝑇 = 𝑆 + 𝑝 − 𝑐
Upper and lower Lower and upper bounds for options:

bound for option option minimum value maximum
prices: value
Note: Theory and European call c ≥ max (0,𝑆0 − 𝑋𝑒 −𝑟𝑇 ) 𝑆0
numerical
American call C ≥ max (0, 𝑆0 − 𝑋𝑒 −𝑟𝑇 ) 𝑆0
Both type of
questions are European put p ≥ max (0,𝑋𝑒 −𝑟𝑇 − 𝑆0) 𝑋𝑒 −𝑟𝑇
possible on this American put P ≥ max (0,𝑋 − 𝑆0) 𝑋
section. This part
can be very
confusing hence 4. 𝐵𝑢𝑙𝑙 𝑐𝑎𝑙𝑙 𝑠𝑝𝑟𝑒𝑎𝑑: 𝑝𝑟𝑜𝑓𝑖𝑡 = max(0, 𝑆𝑇 − 𝑋𝐿 ) −
recommended to max(0, 𝑆𝑇 − 𝑋𝐻 ) − 𝐶𝐿0 + 𝐶𝐻0
revise day before 5. 𝐵𝑒𝑎𝑟 𝑝𝑢𝑡 𝑠𝑝𝑟𝑒𝑎𝑑: 𝑝𝑟𝑜𝑓𝑖𝑡 = max(0, 𝑋𝐻 − 𝑆𝑇 ) −
exam. max(0, 𝑋𝐿 − 𝑆𝑇 ) − 𝑃𝐻0 + 𝑃𝐿0
6. 𝐵𝑢𝑡𝑡𝑒𝑟𝑓𝑙𝑦 𝑠𝑝𝑟𝑒𝑎𝑑 𝑤𝑖𝑡ℎ 𝑐𝑎𝑙𝑙𝑠:

𝑝𝑟𝑜𝑓𝑖𝑡 = max(0, 𝑆𝑇 − 𝑋𝐿 ) − 2 max(0, 𝑆𝑇 − 𝑋𝑀 )
+ max(0, 𝑆𝑇 − 𝑋𝐻 ) − 𝐶𝐿0 + 2𝐶𝑀0 − 𝐶𝐻0
𝑆𝑡𝑟𝑎𝑑𝑑𝑙𝑒: 𝑝𝑟𝑜𝑓𝑖𝑡 = max(0, 𝑆𝑇 − 𝑋) + max(0, 𝑋 − 𝑆𝑇 ) −
𝐶0 − 𝑃0
𝑆𝑡𝑟𝑎𝑛𝑔𝑙𝑒 : 𝑝𝑟𝑜𝑓𝑖𝑡 = max(0, 𝑆𝑇 − 𝑋𝐻 ) + max(0, 𝑋𝐿 − 𝑆𝑇 ) −
𝐶0 − 𝑃0
Forward pricing 𝑃𝑟𝑖𝑐𝑖𝑛𝑔 𝑎 𝑐𝑜𝑚𝑚𝑜𝑑𝑖𝑡𝑦 𝑓𝑜𝑟𝑤𝑎𝑟𝑑 𝑤𝑖𝑡ℎ 𝑎 𝑙𝑒𝑎𝑠𝑒 𝑝𝑎𝑦𝑚𝑒𝑛𝑡:

Use case:
Calculating 𝐹0,𝑇 = 𝑆0 𝑒 (𝑟−𝛿)𝑇
forward
price of commodity
when
lease rate is given.
Forward pricing: 𝐶𝑜𝑚𝑚𝑜𝑑𝑖𝑡𝑦 𝑓𝑜𝑟𝑤𝑎𝑟𝑑 𝑝𝑟𝑖𝑐𝑖𝑛𝑔 𝑤𝑖𝑡ℎ 𝑠𝑡𝑜𝑟𝑎𝑔𝑒 𝑐𝑜𝑠𝑡𝑠:
Use case:
Calculating 𝐹0,𝑇 = 𝑆0 𝑒 (𝑟−𝜆)𝑇
given.
storage cost is
forward price when
Book 4 Valuation and Risk Models
VaR calculation in % form. 𝑉𝑎𝑅 (𝑋%) = 𝑍𝑋%𝜎
Use:
-VaR Calculation. 𝑤ℎ𝑒𝑟𝑒
-Post VaR calculation also
know its theoretical 𝑉𝑎𝑅 (𝑋%) =
meaning of result.
𝑡ℎ𝑒 𝑋% 𝑝𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑟𝑖𝑠𝑘
Accident point:
-Always remember to use
one tail Z value 𝑍𝑋%𝜎 = 𝑡ℎ𝑒 𝑐𝑟𝑖𝑡𝑖𝑐𝑎𝑙 𝑧𝑣𝑎𝑙𝑢𝑒 𝑏𝑎𝑠𝑒𝑑 𝑜𝑛 𝑡ℎ𝑒 𝑛𝑜𝑟𝑚𝑎𝑙
and not two tail for VaR
calculation. 𝑑𝑖𝑠𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑎𝑛𝑑 𝑡ℎ𝑒 𝑠𝑒𝑙𝑒𝑐𝑡𝑒𝑑 𝑋% 𝑝𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦
Standard deviation should
be for same time period as 𝜎 = 𝑡ℎ𝑒 𝑠𝑡𝑎𝑛𝑑𝑎𝑟𝑑 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛 𝑜𝑓
required for VaR. Like for
annualVaR we need 𝑑𝑎𝑖𝑙𝑦 𝑟𝑒𝑡𝑢𝑟𝑛𝑠 𝑜𝑛 𝑎 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑏𝑎𝑠𝑖𝑠
annual SD.
VaR Calculation in Dollar 𝑉𝑎𝑅 (𝑋%)𝑑𝑜𝑙𝑙𝑎𝑟 𝑏𝑎𝑠𝑖𝑠

Terms
Use case: = 𝑉𝑎𝑅 (𝑋%)𝑑𝑒𝑐𝑖𝑚𝑎𝑙 𝑏𝑎𝑠𝑖𝑠
-Calculation of VaR in
dollar terms. Also know × 𝑎𝑠𝑠𝑒𝑠𝑡 𝑣𝑎𝑙𝑢𝑒
meaning of calculated
VaR. = (𝑍𝑋%𝜎 ) × 𝑎𝑠𝑠𝑒𝑠𝑡 𝑣𝑎𝑙𝑢𝑒
Accident Point: NA.
Changing Time period of

VaR (IMP)
Use case:
-Changing time period of
already calculated 𝑉𝑎𝑅 (𝑋%)𝐽−𝑑𝑎𝑦𝑠 = 𝑉𝑎𝑅 (𝑋%)𝐽−𝑑𝑎𝑦𝑠 √𝐽
Var
Accident Point: When you
are asked to change time
period of the VaR divided
with existing time and
multiply with asked time
period: Solve questions
given in Topic wise test
and mock test relating to
this topic.
Changing Confidence 𝑉𝑎𝑅 (𝑋%)𝐽−𝑑𝑎𝑦𝑠 = 𝑉𝑎𝑅 (𝑋%)𝐽−𝑑𝑎𝑦𝑠 𝑍
interval of VaR (Imp)
Use case:
Changing confidence level
of already calculated VaR.
Correcting VaR calculated
using wrong confidence
interval.
Accident Point:
This question can be fused

with error in z value. So
be prepared to calculated
it simultaneously.
Question is available in
Mock 2.
VaR calculation with rate
of return is given.
Use case: Calculation of
VaR in dollar terms.
Accident point:
This formula is used only 𝑉𝑎𝑅 = [𝑅̂𝑝 − (𝑧)(𝜎)]𝑉𝑃
when question explicitly
mentions rate of return in
calculation.
Avoid using it in daily VaR
calculation as daily
returns are vary
minuscule and dose not
impact calculation.
GARCH(1,1):
Use case:
Finding expected standard
deviation for next period.
After getting updated
probability value of 2 2
𝜎𝑡2 = 𝑎 + 𝑏𝑟𝑡−1,𝑡 + 𝑐𝜎𝑡−1
standard deviation can be
used in Var calculation.
Accident point / Note:
This is same formula we
learned in volatility
chapter in quants. Here
we are using it
in calculation of VaR.
Refer accident point in
Quants formula sheet.
Risk neutral probability 1. 𝑅𝑖𝑠𝑘 𝑛𝑒𝑢𝑡𝑟𝑎𝑙 𝑣𝑎𝑙𝑢𝑎𝑡𝑖𝑜𝑛
calculation
Use case: 𝜎
𝑈 = 𝑠𝑖𝑧𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑢𝑝𝑚𝑜𝑣𝑒 𝑓𝑎𝑐𝑡𝑜𝑟 = 𝑒 √𝑡
In calculation of risk
neutral probabilities for −𝜎
√𝑡
1 1
𝐷 = 𝑠𝑖𝑧𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑑𝑜𝑤𝑛 𝑚𝑜𝑣𝑒 𝑓𝑎𝑐𝑡𝑜𝑟 = 𝑒 = =
option pricing in binomial 𝜎
𝑒 √𝑡 𝑈
option pricing model.
Accident point / Note: 𝑒𝜋 − 𝐷
𝜋𝑢 = 𝑝𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑜𝑓 𝑎𝑛 𝑢𝑝 𝑚𝑜𝑣𝑒 =
U is calculated for leg and 𝑈−𝐷
not for whole period. Say

𝜋𝑑 = 𝑝𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑜𝑓 𝑎 𝑑𝑜𝑤𝑛 𝑚𝑜𝑣𝑒 = 1 − 𝜋𝑢
if you are asked to use
two step binomial model
for option maturing in
year. U is calculated for 6
months hence we use 6
months probability and
not annual.
There are different
methods to calculated U
which changes as per the
information given. Say
you are provided with
information that stock
price is likely to increase
by 20% then U should be
taken as 1.2. If
information is given as
stock price currently
trading at 100 and likely
to increase up to 115 then
U should be calculated as
115 / 100 = 1.15.
Remember these
variations.
Black Scholes option
𝑐
𝑐0 = [𝑆0 × 𝑁(𝑑1 )] − [𝑋 × 𝑒 −𝑅𝑓×𝑇 × 𝑁(𝑑2 )]
pricing model:
Use case: 𝑐
𝑝0 = {𝑋 × 𝑒 −𝑅𝑓×𝑇 × [1 − 𝑁(𝑑2 )]} − {𝑆0 × [1 − 𝑁(𝑑1 )]}
Option pricing using BSM
model. Calculation of Where
delta which is N(d1).
Accident point /Note: 𝑆
𝐼𝑛 [ 0 ] + [𝑅𝑓𝑐 + (0.5 × 𝜎 2 )] × 𝑇
Calculation of full BSM 𝑑1 = 𝑋
valuation starting d1 𝜎 × √𝑇
calculation to option
pricing is very unlikely. It 𝑑2 = 𝑑1 − (𝜎 × √𝑇)
is better if you remember
this formula but not
necessary. GARP is likely
to give you this (d1)
formula if in case you get
question. If d1 is given you
are expected to remember
d2 formula. Ln is S/x and
not x/S (most common
mistake by students. If
you get question on

implied volatility you will
need reverse calculation.
Using N(d1) find d1 (which
is nothing but z value
from left tail for call and
put value from right N(-
d1). Once you get d1 using
d1 formula find sigma.
Which is implied volatility
at the given point.
Expected stock price 𝐸(𝑆𝑇 ) = 𝑥0𝑒 𝑢𝑇
calculation
Use case
Calculation of expected
price given drift u.
Put call parity:
𝑐
𝑐0 = 𝑝0 + 𝑆0 − [𝑋 × 𝑒 −𝑅𝑓×𝑇 ]
Use case:
Calculation of any one Or
variable when other
3 variables are given in 𝑐
𝑝0 = 𝑐0 − 𝑆0 + [𝑋 × 𝑒 −𝑅𝑓×𝑇 ]
question. You can even
expect calculation of Rf
when all other values are
given.
Accident point:
Parity works for options
of same underlying. GARP
might ask you question
which you
feel like BSM question for
option calculation, but try
if it can be solved by using
Put call parity formula.
Answer from both method
is same but BSM will
consume lot of time,
Delta Calculation: 𝜕𝑐
𝑑𝑒𝑙𝑡𝑎 = 𝛥 =
Use case: 𝜕𝑠
-Calculation of delta for
delta hedging question In simple terms
-Delta calculation for Change in call price / Change in Stock Price
using it in BSM calculation
as N(d1) in case of call
and can be adjusted for
put delta.
Accident point/Note:
- Delta is always positive
for call and
negative for put
- Position delta will
change based on
long or short position.
- For short position sign
will be opposite of what is
in normal case.
𝑛
Portfolio Delta:
Use case: 𝛥𝑃 = ∑ 𝑤𝑖 ∆𝑖
- Finding portfolio delta 𝑖=𝑙
when individual delta of

position is give.
Gamma calculation: 𝜕2𝑐
𝑔𝑎𝑚𝑚𝑎: 𝑇 = 2
Use 𝜕𝑠
- Gamma calculation
Delta gamma theta 2. 𝑟𝑒𝑙𝑎𝑡𝑖𝑜𝑛𝑠ℎ𝑖𝑝 𝑎𝑚𝑜𝑛𝑔 𝑑𝑒𝑙𝑡𝑎, 𝑡ℎ𝑒𝑡𝑎, 𝑎𝑛𝑑 𝑔𝑎𝑚𝑚𝑎:

relationship
Use case: 3. 𝑟𝜋 = ө + 𝑟𝑆∆ + 0.5𝜎 2 𝑆 2 𝑇
- Calculation of any one
variable when one value is
given.
Rho calculation 4.
𝜕
𝑟ℎ𝑜 = 𝜕𝑐
Use case: 𝑟
- Calculation of rho that

is relationship of change
in call price and interest
rate change.
Accrued interest 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑑𝑎𝑦𝑠 𝑓𝑟𝑜𝑚 𝑡ℎ𝑒 𝑙𝑎𝑠𝑡 𝑐𝑜𝑢𝑝𝑜𝑛
calculation 𝐴𝐼 = 𝑐 [ 𝑡𝑜 𝑡ℎ𝑒 𝑠𝑒𝑡𝑡𝑙𝑒𝑚𝑒𝑛𝑡 𝑑𝑎𝑡𝑒 ]
Use case: 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑑𝑎𝑦𝑠𝑖𝑛 𝑎 𝑐𝑜𝑢𝑝𝑜𝑛 𝑝𝑒𝑟𝑖𝑜𝑑
- Calculation of accrued
interest. 𝑊ℎ𝑒𝑟𝑒
- Can be used in 𝐶 = 𝑐𝑜𝑢𝑝𝑜𝑛 𝑝𝑎𝑦𝑚𝑒𝑛𝑡
calculation of AI for
finding clean and dirty
price.
Accident points:
- Always remember to use
correct day count
convention.
- Count days properly
when actual
days are required.
Calculation of clean and 𝑐𝑙𝑒𝑎𝑛 𝑝𝑟𝑖𝑐𝑒 = 𝑑𝑖𝑟𝑡𝑦 𝑝𝑟𝑖𝑐𝑒 − 𝑎𝑐𝑐𝑟𝑢𝑒𝑑 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡
dirty price.
Use case:
- Calculation of clean
price
- Calculation of dirty price
- Calculation of accrued
interest
Accident point:
- This calculation can be
very confusing in exam
specifically relating to
which rates are to be used
for calculation of AI and
dirty price. Make sure you
look at calculation one
day before exam.
Calculation of spot rate 5.
Use case:
- Calculation of spot rate6.
- Calculation of discount
rate or interest rate that
1 1⁄
is reverse calculation 𝑠𝑝𝑜𝑡 𝑟𝑎𝑡𝑒: 𝑧(𝑡) = 2 [〈 〉 2𝑡 − 1]
𝑑(𝑡)
Accident point:
- Always focus on what is
asked in
spot rate. Like semi
annual rate, or
quarterly rate, effective or
continually compounded
rate and so on. Practice
on calculator and
remember by what
calculation, exactly what
result you are getting
that is rate calculated by
you
Future value of 𝑟 𝑚×𝑛
7. 𝐹𝑉𝑛 = 𝑃𝑉0 × [1 + 𝑚]
investment
Use case:
- Calculation of future 𝑊ℎ𝑒𝑟𝑒
value when otter data is
𝑟 = 𝑎𝑛𝑛𝑢𝑎𝑙 𝑟𝑎𝑡𝑒
given.
- This formula is also used 𝑚 = 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑐𝑜𝑚𝑝𝑜𝑢𝑛𝑑𝑖𝑛𝑔 𝑝𝑒𝑟𝑖𝑜𝑑𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
in clean
and dirty price as basic 𝑛 = 𝑛𝑢𝑚𝑏𝑒𝑟𝑠 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠
formula for
calculation of dirty price.
Accident point:
Holding period return: 𝐹𝑉
1
8. 𝐻𝑃𝑅: 𝑟 = 𝑚 [[𝑃𝑉𝑛 ]𝑚×𝑛 − 1]

0
Par rate calculation 𝐶𝑇 𝑡

2𝑇
Use case: 𝑝𝑎𝑟 𝑟𝑎𝑡𝑒, 𝐶𝑇 : × ∑ 𝑑 [ ] + 𝑑(𝑇) = 1

2 2
- Calculation of par rate 𝑡=𝑙
from given
data
Note:
- Not very likely to show
up in exam
Perpetuity calculation: 𝐶
𝑃𝑉 𝑜𝑓 𝑝𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦 =
Use case: 𝑌
- Calculation of value in
case of perpetual
payments for infinite or
very long period. Like if
you are likely to receive
coupon of $10 for infinite
period.
Realised return 𝐵𝑉𝑡 + 𝐶𝑡 − 𝐵𝑉𝑡−1
𝑅𝑡−1,𝑡 =
Use case: 𝐵𝑉𝑡−1
- When data is given in
dollar terms.
Return is in percentage
form for
given period.
Accident point:
- If you get data for more
than one
period you will get
realised return
for same period then you
are supposed to calculate
return for annum.
Bond price calculation: 𝐶1 𝐶2 𝐶3 𝐶𝑁
𝑃= + + +⋯
Use case: (1 + 𝑦)1 (1 + 𝑦)2 (1 + 𝑦)3 (1 + 𝑦)𝑁
- Calculation of bond price
when coupons for 𝑊ℎ𝑒𝑟𝑒
𝑃 = 𝑡ℎ𝑒 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑡ℎ𝑒 𝑠𝑒𝑐𝑢𝑟𝑖𝑡𝑦
different period is given. 𝐶𝑘 = 𝑡ℎ𝑒 𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 𝑖𝑛 𝑦𝑒𝑎𝑟 𝑘

- Same logic can be 𝑁 = 𝑡𝑒𝑟𝑚 𝑡𝑜 𝑚𝑎𝑡𝑢𝑟𝑖𝑡𝑦 𝑖𝑛 𝑦𝑒𝑎𝑟𝑠
applied in various 𝑌 = 𝑡ℎ𝑒 𝑎𝑛𝑛𝑢𝑎𝑙 𝑦𝑖𝑒𝑙𝑑 𝑜𝑟 𝑌𝑇𝑀 𝑜𝑛 𝑡ℎ𝑒 𝑠𝑒𝑐𝑢𝑟𝑖𝑡𝑦 ∆∆
calculations when periodic
payments are made.
Accident point:
- If coupon and yield is
flat you can directly solve
this calculation using
TVM function. However, in
case of
sloping yield curve (i.e.
discount rate
is different for all periods)
you need
to do calculation step
wise or learn
to use another bond
pricing function
which allows you to add
different
values for different period.
DV01 Calculation: 9.
∆𝐵𝑉
𝐷𝑉01 = 10,000×∆𝑦
Use case:
- Calculation of DV01 and
finding impact of interest 𝑊ℎ𝑒𝑟𝑒
rate change on bond
∆𝐵𝑉 = 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑎 𝑏𝑜𝑛𝑑 𝑣𝑎𝑙𝑢𝑒
value. DV01 is like beta of
bond. ∆𝑦 = 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑦𝑖𝑒𝑙𝑑
- Calculation of DV01 for
the purpose of DV01
hedging.
- Finding hedge ratio
using DV01
Accident point:
- When using calculator
you don’t
need to divide your
change with
1000, if you calculate
difference using simple
method, shock BV with
interest rate one Bips
down and up
find difference and divide
it by 2
bips (i.e. one up and one

down).
- This whole calculation
can be done
without use of formula
and by using
simple logic which is DV01
is change
in bond price wrt change
in yield.
Calculation of modified 10. 𝑚𝑜𝑑𝑖𝑓𝑖𝑒𝑑 𝑑𝑢𝑟𝑎𝑡𝑖𝑜𝑛 =
𝑀𝑎𝑐𝑢𝑙𝑎𝑟𝑦 𝑑𝑢𝑟𝑎𝑡𝑖𝑜𝑛
(1+𝑝𝑒𝑟𝑖𝑜𝑑𝑖𝑐 𝑚𝑎𝑟𝑘𝑒𝑡 𝑦𝑖𝑒𝑙𝑑 )
duration:
Use case:
1 ∆𝐵𝑉
- Calculation of modified 11. 𝑚𝑜𝑑𝑖𝑓𝑖𝑒𝑑 𝑑𝑢𝑟𝑎𝑡𝑖𝑜𝑛 = 𝐵𝑉 ∆𝑦
duration
with the help of Maculay’s
duration.
Accident point:
- Do not confuse in
durations like
maculay effective and
modified duration.
Effective Duration: 12. 𝑒𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝑑𝑢𝑟𝑎𝑡𝑖𝑜𝑛 =
𝐵𝑉−∆𝑦 −𝐵𝑉+∆𝑦
2×𝐵𝑉0 ×∆𝑦
Use case:
- Calculation of effective
duration 𝑊ℎ𝑒𝑟𝑒
- Finding change in price
𝐵𝑉−∆𝑦
of bond using duration
= 𝑒𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑝𝑟𝑖𝑐𝑒 𝑖𝑓 𝑦𝑖𝑒𝑙𝑑 𝑑𝑒𝑐𝑟𝑒𝑎𝑠𝑒𝑠 𝑏𝑦 𝑎 𝑔𝑖𝑣𝑒𝑛 𝑎𝑚𝑜𝑢𝑛𝑡, ∆𝑦
and convexity. (Imp) 𝐵𝑉+∆𝑦
Accident point: = 𝑒𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑝𝑟𝑖𝑐𝑒 𝑖𝑓 𝑦𝑖𝑒𝑙𝑑 𝑖𝑛𝑐𝑟𝑒𝑎𝑠𝑒𝑠 𝑏𝑦 𝑎 𝑔𝑖𝑣𝑒𝑛 𝑎𝑚𝑜𝑢𝑛𝑡, ∆𝑦
- This calculation can be 𝐵𝑉0 = 𝑖𝑛𝑖𝑡𝑖𝑎𝑙 𝑜𝑏𝑠𝑒𝑟𝑣𝑒𝑑 𝑏𝑜𝑛𝑑 𝑝𝑟𝑖𝑐𝑒
done in similar style same ∆𝑦 = 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑦𝑖𝑒𝑙𝑑, 𝑖𝑛 𝑑𝑒𝑐𝑖𝑚𝑎𝑙 𝑓𝑜𝑟𝑚
as DV01 with slight 𝐷𝑉01 = 𝑑𝑢𝑟𝑎𝑡𝑖𝑜𝑛 × 0.0001 × 𝑏𝑜𝑛𝑑 𝑣𝑎𝑙𝑢𝑒
modification. Again
instead of remembering
formula, remember
keystrokes on calculator
which is easy and reduces
scope of error.
Convexity calculation: 13.
Use case:
- Calculation of convexity.
14.
Accident:
- Calculation of convexity
𝐵𝑉−∆𝑦 +𝐵𝑉+∆𝑦 −2×𝐵𝑉0
can be done using similar15. 𝑐𝑜𝑛𝑣𝑒𝑥𝑖𝑡𝑦 = 𝐵𝑉0 ×∆𝑦
strokes like DV01 or
effective duration with

slight modification.
- Do not covert convexity
into percentage. Keep it in
decimal form unless
required for finding
percentage of price
change

FRM Part I Formula Sheet 2021

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FRM Part I Formula Sheet 2021

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Book 1 – Foundations of Risk Management

𝐹𝑗 = 𝑑𝑒𝑣𝑖𝑎𝑡𝑖𝑜𝑛 𝑜𝑓 𝑚𝑎𝑐𝑟𝑜𝑒𝑐𝑜𝑛𝑜𝑚𝑖𝑐 𝑓𝑎𝑐𝑡𝑜𝑟

𝑗 𝑓𝑟𝑜𝑚 𝑖𝑡𝑠 𝑒𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑣𝑎𝑙𝑢𝑒

APT Model 𝐴𝑃𝑇 𝑚𝑜𝑑𝑒𝑙: 𝐸 (𝑅𝑖 ) =

Fama-French Model 𝐹𝑎𝑚𝑎 − 𝐹𝑟𝑒𝑛𝑐ℎ 𝑡ℎ𝑟𝑒𝑒 𝑓𝑎𝑐𝑡𝑜𝑟 𝑚𝑜𝑑𝑒𝑙:

-Learn to use this formula in

for this using 1 V function. It

not needed for calculation):

Slope Equation (use 𝑟𝑒𝑔𝑟𝑒𝑠𝑠𝑖𝑜𝑛 𝑠𝑙𝑜𝑝𝑒 𝑐𝑜𝑒𝑓𝑓𝑖𝑐𝑖𝑒𝑛𝑡 ∶ 𝑏1

Forward price: 𝐹𝑜𝑟𝑤𝑎𝑟𝑑 𝑝𝑟𝑖𝑐𝑒: 𝐹0 = 𝑆0𝑒 𝑒 𝑟

Use case: 𝑎𝑠𝑠𝑒𝑡 𝑝𝑎𝑦𝑠 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑:

Upper and lower Lower and upper bounds for options:

6. 𝐵𝑢𝑡𝑡𝑒𝑟𝑓𝑙𝑦 𝑠𝑝𝑟𝑒𝑎𝑑 𝑤𝑖𝑡ℎ 𝑐𝑎𝑙𝑙𝑠:

Forward pricing 𝑃𝑟𝑖𝑐𝑖𝑛𝑔 𝑎 𝑐𝑜𝑚𝑚𝑜𝑑𝑖𝑡𝑦 𝑓𝑜𝑟𝑤𝑎𝑟𝑑 𝑤𝑖𝑡ℎ 𝑎 𝑙𝑒𝑎𝑠𝑒 𝑝𝑎𝑦𝑚𝑒𝑛𝑡:

VaR Calculation in Dollar 𝑉𝑎𝑅 (𝑋%)𝑑𝑜𝑙𝑙𝑎𝑟 𝑏𝑎𝑠𝑖𝑠

Changing Time period of

This question can be fused

not for whole period. Say

you get question on

when individual delta of

Delta gamma theta 2. 𝑟𝑒𝑙𝑎𝑡𝑖𝑜𝑛𝑠ℎ𝑖𝑝 𝑎𝑚𝑜𝑛𝑔 𝑑𝑒𝑙𝑡𝑎, 𝑡ℎ𝑒𝑡𝑎, 𝑎𝑛𝑑 𝑔𝑎𝑚𝑚𝑎:

- Calculation of rho that

8. 𝐻𝑃𝑅: 𝑟 = 𝑚 [[𝑃𝑉𝑛 ]𝑚×𝑛 − 1]

Par rate calculation 𝐶𝑇 𝑡

Use case: 𝑝𝑎𝑟 𝑟𝑎𝑡𝑒, 𝐶𝑇 : × ∑ 𝑑 [ ] + 𝑑(𝑇) = 1

different period is given. 𝐶𝑘 = 𝑡ℎ𝑒 𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤 𝑖𝑛 𝑦𝑒𝑎𝑟 𝑘

bips (i.e. one up and one

effective duration with

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