FRM Formulas FRM

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Financial Risk Management (University of Sydney)
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FRM Examination Guide: Part I Exam
In preparing for the FRM Examinations, we encourage students to plan ahead so that no time will be
wasted in trying to cover all necessary areas before exam day and that adequate time will be available
for practicing questions
Make a special note of the sectional percentage weightings and plan accordingly
In addition to this, spend a bit more time on your weaker subject areas to better understand the
essential concepts and practice more questions surrounding these problematic topics
Please use the following information only as a general guide
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Contents
Part I
Foundation of Risk Management Formulas Page 6

FRM Level I
Quantitative Analysis Formulas Page 14

FRM Level I
Financial Markets and Products Formulas Page 23

FRM Level I
Valuation and Risk Models Formulas Page 31

FRM Level I
Part II
Market Risk Measurement and Management Formulas Page 37

FRM Level II
Credit Risk Measurement and Management Formulas Page 41

FRM Level II
Operational Risk and Resiliency Formulas Page 45

FRM Level II
Liquidity and Treasury Risk Measurement Formulas Page 47

FRM Level II
Risk Management and Investment Management Formulas Page 59

FRM Level II
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Financial Risk Manager Formulas
FRM Examination Part 1
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Level: FRM Part I

Section: 1 of 4
Topic: Foundations of Risk Management
FRM Formulas
Correlation coefficient between two Securities:
Correlation coefficient = Covariance between Security A and Security B

(Standard Deviation of Security A x Standard Deviation of Security B)
Variance of Two Securities
Variance = (WeightA)2 x (Standard Deviation of A)2

+
(WeightB) x (Standard Deviation of B)2
2
+
( 2 x Correlation CoefficientAB x Standard Deviation of A x Standard Deviation of B x WeightA x WeightB )
Perfect Positive Correlation
ρ=1
Perfect Negative Correlation
ρ = -1
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Standard Deviation
= (Variance)0.5
Risk Adjusted Ranking
Based on the Morningstar Rating System, an investment fund’s risk adjusted ranking may be
calculated by:
( Fund Return / Average Peer Return ) – (Fund Risk / Average Peer Risk)
Sharpe Ratio
= (Rp – Rf) / σp
Where:
Rp Portfolio Return
Rf Treasury-Bill Returns (or the Risk Free Rate)
σp Portfolio Standard Deviation of Return
Sortino Ratio
= Return on Portfolio – Minimum Accepted Return

Standard Deviation of Returns Below Minimum Accepted Return
Treynor Measure
= (Return on Portfolio – Risk free rate) / Portfolio Beta
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Jenson’s Alpha
= Return on Portfolio – CAPM predicted Return
Information Ratio
= Return on Portfolio – Benchmark Return

Tracking Error
A portfolio’s beta using the respective weightings:
Portfolio beta = w1R1 + w2 R2 + w3 R3
Portfolio Expected Return
= Rf + R(Rm – Rf)
Expected Return (Capital Asset Pricing Model, CAPM)
We recall the CAPM formula:
Expected Return, ER = Rf + β*(Rm – Rf)
Now the part of the formula “(Rm – Rf)” is actually termed the “risk premium”
Thus, expected return on the security will be:
= Risk Free Rate + [ Security’s Beta *( Equity Risk Premium) ]
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Adjusted Exposure
= Outstandings + (Unused Portion of Commitments) x Usage Given Default
Expected Loss
= AE × EDF × LGD
Where:
AE Adjusted Exposure
EDF Probability of Default
LGD Loss Given Default = ( 1 – Recover Rate %)
Expected Loss is defined as:
Exposure × (1 – Recovery Rate) × (Probability of Default)
Basis
Basis = Spot price of hedged asset – Futures price of contract.
Market Coefficient of Variation
Market Coefficient of Variation = Standard Deviation of Market / Market Expected Return
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Standard Deviation of Market
Standard Deviation of Market = Market Coefficient of Variation x Market Expected Return
Standard deviation of a two-stock portfolio
Standard deviation of a two-stock portfolio, we may use the formula:
s = [WA2σA 2 + WB 2σB 2 + 2WAWBσAσBrA,B]1/2
Correlation Coefficient
For two assets ‘A’ and ‘B’
Correlation coefficient = CovarianceAB / [(Standard deviationA x Standard deviationB)]
Rearranged, we have:
CovarianceAB = (Correlation coefficient) x [(Standard DeviationA x Standard DeviationB)]
Covariance
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Total Risk
Total Risk = Market Risk + Firm Specific Risk
Or
Total Risk = Systematic Risk + Unsystematic Risk
Note:
“Market risk” can also be called “Systematic risk” or “Un-diversifiable risk”
”Firm Specific Risk” can also be called “Unsystematic risk”
Expected Return
Expected Return = Stock’s Alpha + (Stock’s Beta X % Market Movement)
Excess Return = Expected Return – Risk Free Rate
Correlation coefficient and covariance of two assets ‘A’ and ‘B’
Correlation coefficient = CovarianceAB / (Standard deviationA x Standard deviationB)
Standard Deviation of Market
Standard Deviation of Market = Market Coefficient of Variation x Market Expected Return
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Beta
The calculation of beta on a given Security A and the market
Beta = Covariance between Security A & the Market / Variance of Market Return
Value at Risk
The Value at Risk (risk adjusted) performance measure can be stated as follows:
( Portfolio Return – RFR ) / (Portfolio Value at Risk / Initial Portfolio Value )
Where RFR = Risk Free Rate
Capital Markets Line
The Capital Markets Line is from the given equation:
RF + [E(RM) − RF] / σM
Where:
Intercept = RF
Slope = [E(RM) − RF] / σM
Expected Residual Return
Expected Residual Return = Information Ratio X Residual Risk
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Covariance for Markets A and B
Covariance formula for Markets A and B:
Cov (A, B) = βA,1 βB,1 σ2F1 + βA,2 βB,2 σ2F2 + (βA,1 βB,2 + βA,2 βB,1) Cov (F1, F2)
Equation of a Straight Line
The equation of a straight line: y = m(x) + c, also expressed as:
Y = Slope (x) + Intercept
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Level: FRM Part I

Section: 2 of 4
Topic: Quantitative Analysis
FRM Formulas
Exceptions
Exceptions = ( 1 – Confidence Interval ) X ( Amount of Days )
Portfolio’s Value-at-Risk
VaR = Value of Portfolio X [ E ( R ) – z*σ ]
Or:
Portfolio Value-at-Risk
= ( 1-Day VaR ) X ( n ½ ) , with n = The Number of Days
Semi-annual comparable yield
The semi-annual pay comparable yield for a given annual pay bond will be determined by the
following relationship:
= 2 X [ ( 1 + YTM for Annual Pay Bond )½ – 1 ]
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Standard Deviation
The Standard Deviation of a given Sample Average is represented by:
‘ σ ( X ) / n½ ‘
Given that n is sufficiently large
GARCH
GARCH ( I , I ) Volatility Estimate = [ ω + α u2n−1 + β σ2n−1 ] ½
Combinations
n
Cr
= n!
( r! ) X ( n – r )!
(The amount of ways we can select r out of n)
Standard Error
Standard Error of a Mean will be given:
= ( Standard deviation ) X ( 1 / n½ )
To calculate the standard error of the sample mean, we will divide the standard deviation of the
sample by the sq root of the sample size:
sx = sd / ( n )0.5
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Standard Deviation of Returns
Standard Deviation of Returns may be calculated through the formula:
Return Standard Deviation = [ Σi ( xi – X )2 / ( n – 1 ) ] 1/2
Basis
Basis = ( Hedged Security’s Spot Price - Futures Contract Price used in Hedge )
Bayes’ Theorem
P (A / B) = [P(B/A)*P(A) ]
P( B )
P (AB) = P (B/A) X P(A)
Expectations
E (cX) = E (X) * c
E (X + Y) = E (X) + E (Y)
E (XY) = E (X) * E (Y) (Assuming both X and Y are independent of each other)
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Value of the z-statistic
The value of the z-statistic may be determined using the following formula:
( Sample Mean − Hypothesized Mean ) / ( Standard Deviation of Population / ( Sample Size ) ½
Or
z = (x – mean)/standard deviation
Sample Standard Deviation
Sample Standard Deviation = ( Sample Variance ) ½
General Regression Equation
[ Yi = b0 + b1 Xi + b2 X2 i + ei ]
Coefficient of Determination
Coefficient of Determination = ( Total Variation – Unexplained Variation ) / Total Variation
or
Coefficient of Determination = ( Explained Variation ) / ( Total Variation )
Standard Error
Standard Error = [ Sum of Squared Error / ( n – 2 ) ] ½
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Correlation Coefficient = Cov ( X , Y ) / ( Standard Deviation X * Standard Deviation Y )
Or
Correlation Coefficient = ( Coefficient of determination ) ½
F-Statistic
F-Statistic = MSR / MSE
= ( RSS / 1 ) / [ SSE / ( n – k – 1 ) ]
Kurtosis
K = SUM [ ( xi - μ )4 ]
σ4
Variance
Variance of X: = Sum of Squared Deviations in X / ( n – 1 )
Covariance
Covariance: = Sum of Product-of-Deviations / ( n – 1 )
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Slope Coefficient
Slope Coefficient = Cov ( X , Y ) / Var ( X )
Regression
The Regression’s Intercept Term, bo,
The Intercept Term ( bˆ0 ) = Y – ( X * bˆ) 1
Coefficient of Determination, R2
= ( Summation of Squares explained through Regression ) / ( Sum Total of Squares )
Standard Error of the Estimate
Standard Error of the Estimate ( SEE ) will be given:
= [ RSS / ( n – k – 1 ) ] ½
Where:
n = The size of the Sample

k = The Number of Independent Variables
RSS = The Summation of e2 (or the Residual Sum of Squares)
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Standard Deviation of Fund X will be given:
Standard Deviation = [ ( Xi – X )2 / ( n – 1 ) ] ½
Population Regression
Dependent Variable,
Y = (y Intercept) + (Slope Coefficient * Independent Variable) + Residual Term
Vasicek Model
The Vasicek model which defines a risk‐neutral process for r:
dr= a(b− r )dt+ σdz, Where:
 a is a constant
 b is a constant
 σ is a constant
 r represents the rate of interest
Chi Square Test
n – 1 ) s2
σ2
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F Test
F = S2a / S2b
Where:
S2a is the Variance of Sample a
S2b is the Variance of Sample b
Bond Survival Rate
= ( 1 – Marginal Mortality Rate )
Total Variation
Total Sum of Squares =
( Sum of Squares Error/Residual Sum of Squares )

+
( Sum of Squares Regression/Explained Sum of Squares )
That is,
TSS = RSS + ESS
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Risk-Adjusted Return
The Risk-Adjusted Return that will be employed in the computation of RAROC will be given:
= ( Expected Revenue) – ( Expenses ) – ( Expected Loss )
Business Line RAROC
The Business Line RAROC will be:
= Risk-Adjusted Return / Risk-Adjusted Capital
Variance
Var ( aX + bY ) = a2 Var (X) + b2 Var (Y) + 2ab * Cov (X, Y)
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Level: FRM Part I

Section: 3 of 4
Topic: Financial Markets and Products
FRM Formulas
Price of a Bond:
= [ Present Value of Coupon Payments ] + [ Principal Payment at End of Life ]
= [ SUM [ Ce –rt ] ] + P e -rT
Where:
C is the Coupon Payment

P is our Principal
t is the time to Maturity
r is the Interest Rate
Forward Pricing
Forward Pricing (for a continuous compounding rate, r) is given by:
Fo = So e rt
Where:
Fo is the Forward Price

So is the Spot Price
t is the Time of Contract
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Forward Pricing
Forward Pricing (for an annual rate, r) is given by:
Fo = So (1+r)t
Where:
Fo is the Forward Price

t is the Time of Contract
Value of a Long Forward
Value of a Long Forward, f (for a continuous dividend yield):
f = So e –qt – K e -rt
Where:

K is the Price of Delivery
t is the time of Payoff
q = Continuous return % / Total Asset Price
Value of a Long Forward, f (for a discrete dividend):
f = So – I – K e -rt
Where:

I is the asset’s Present Value
K is the Price of Delivery
t is the time of Payoff
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Maximum Bond Values
Maximum Value of American Call = St

Maximum Value of American Put = X
Maximum Value of European Call = St

Maximum Value of European Put = X / ( 1 + Rf)t
Minimum Bond Values
Minimum Value of American Call = Ct ≥ Max ( 0 , St – ( X / 1 + Rf )t )

Minimum Value of American Put = Pt ≥ Max ( 0 , ( X – St ) )
Minimum Value of European Call = Ct ≥ Max ( 0 , St – ( X / 1 + Rf )t )

Minimum Value of European Put = Pt ≥ Max ( 0 , X / ( 1 + Rf )t ) – St
Special Note:- For American options, the following relationship must hold:
S0 – X ≤ C – P ≤ S0 – X * e-rt
Value of a Swap
V = (Present Value of Payments) – [ (Present Value of Par Values) + (Accrued Interest) ] * e -rt
(Asset’s Spot Price) - (Futures Price) = “Basis”
Once: Futures Price = Spot Price, Basis = 0
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Forward Rate Agreement
Forward Rate Agreement Payment to Long:
= Principal X [ ( Settlement Rate – Forward Rate ) X ( # of Days / 360 ) ]

1 + ( Settlement Rate ) X ( # of Days / 360 )
Dollar Default Rate
Dollar Default Rate during a particular year may be considered as:
= (Par Value of defaulted bonds) / (Total Par Value of all outstanding bonds)
Required Rate of Return
Required Rate of Return will be given as:
= Risk Free Rate + [ (Beta) * (Market Risk Premium) ]
Cheapest to Deliver
Cheapest to Deliver bond is the bond with the lowest cost of delivering.
Cost of delivering = Quoted price – (Current Futures Price x Conversion Factor)
USE: “Current Futures Price” or “Settlement Price”
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Riskless Pure Discount
Riskless Pure Discount Position through the formula:
X / (1 + Rf)T = P0 + S0 – C0
KMV Model
The KMV model ( which measures a normalized distance ), is given:
( Expected Assets – Weighted Debt ) / ( Assets’ Volatility )
Convexity
C = (1 / B) X ( d2B / dy2 )
Interest Rate Parity
Ft = St * e (rf −q) * (T−t) , where:
rf is the risk-free-rate
q is our dividend yield
T−t is the time until contract maturity
Ft is the theoretical contract price
St is the underlying security’s spot price
Interest Rate Parity for Currencies
Forward = Spot [ (1 + Local Currency Rate) / (1 + Foreign Currency Rate) ] T
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The Value of a given European Call assuming that there will be no income payment on the
security, we have:
c = [ S * N(d1) ] − [ K * e ( −rτ ) ] X [ N(d2) ]
Interest Earned between Dates
= [ ( # of Days between Dates ) X ( Interest Earned for Period ) ] / ( # of Days in Ref Period )
On Currencies, The interest rate parity theory contends that:
Ft = So * e ( rbc−rfc ) T
Fair Value of a Futures Contract:
F = S * e ( −r *T ) / e ( −r*T )
No-Arbitrage Forward Price will be calculated as:
F ( 0 , T ) = S 0 ( 1 + r )T
Short Position’s Value at Expiration may be calculated from the formula:
VT ( 0, T ) = ST – F (0,T)
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Put-Call Parity Formula:
Call Premium + PV of Strike = Put Premium + Asset Price
Or
C + X * e −rT = P + S , where:
C is the Call premium

X e−rT is the PV of the strike
P is the put premium
S is the underlying asset’s current price
Re‐arranging, we see that: S = C − P + X * erT
Amount of Contracts to sell may be given:
N = ( Beta X Position Size ) / ( Size of single futures contract )
β = Cov ( Spot futures ) / Var ( futures )
Cov = σ spot X σ futures X correlation
The Optimal Hedge Ratio for a Fund:
h = ρ * ( σ fund / σ hedge )
Where:
Ρ is the Correlation Coefficient between σ fund and σ hedge

σ is the Standard Deviation (the change during the hedging period)
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The Value of the Fixed Payment, i.e. Bfix
Bfix = (fixed rate coupon)e(-1Yr LIBOR) + (nominal amount + fixed rate coupon)e(-2Yr LIBOR*2)
Fixed Rate Coupon = Given notional value X Annual fixed rate %
Cost of Carry
Cost of Carry = Interest Cost + Storage Cost – Income Earned
Convenience Yield for a Consumption Asset
Fo = So e (c-y)T
Issuer Default Rate
= ( # of Issuers Defaulting ) / ( Total # of Issuers at Start )
Dollar Default Rate
= ( Dollar Sum of All Default Bonds )

( Dollar Sum of all Issues X Wt. Avg. of Amount of Years Outstanding )
Key Rate Duration
= ( -1 / Bond Value ) X ( Bond Value Change / Key Rate Change )
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Level: FRM Part I

Section: 4 of 4
Topic: Valuation and Risk Models
FRM Formulas
Put Option’s Value
To find a put option’s value, we may utilize the following formula:
Put Value = { [ Strike Price X e( – RFR * T ) ] X [ 1 – N ( d2 ) ] } – [ Stock Price X ( 1 – N ( d1 ) ]
Call Option’s Value
To find the value of the call option, we may utilize the following formula:
Call Value = [ Stock Price X N ( d1 ) ] – [ Strike Price X e ( – r X days/365)

] X [ N ( d2 ) ]
PutUp = Max ( 0, Strike Price – StockUp )
PutDown = Max ( 0, Strike Price – StockDown )
Π = [ ( 1 + RFR ) – Down Volatility ] / ( Up Volatility – Down Volatility )
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The put-call parity relationship:
Call Price – Put Price = Stock Price – [ Strike Price / ( 1 + RFR )T ]
Rearranging:
Call Price = Stock Price – [ Strike Price / ( 1 + RFR )T ] + Put Price
Or
Put-call parity relationship:
P0 + S0 = C0 + X / ( 1 + Rf )T
Where:
C = Call Premium
P = Put Premium
X = Strike Price of Call & Put
r = Annual Interest Rate
t = Time in Years
So = Initial Price of Underlying Security
Value at Risk
To calculate the Value at Risk, we may utilize the following formula:
VaR = [ Expected Change in Value ] – [ Z-Score X Price Change Standard Deviation ]
Annual Standard Deviation
Annual Standard Deviation = Daily Standard Deviation X ( 365 ) ½
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Convexity Adjustment
Convexity Adjustment = Convexity X 100 X ( Δy )2
Where: Δy is the change in interest rates in decimal form.
Synthetic Call Price
Formula to determine the synthetic call price:
c0 = ( p0 + S0 ) − [ X / (1 + r)T ]
Covered Call
Consider the following as a quick reminder:
‘ Covered Call = Stock + Short Call ‘
The Unexpected Loss formula:
Unexpected Loss, UL = EA X ( PD X σ2 LR + LR2 X σ2 PD ) ½ , Where:
LR = loss rate = ( 1 – recovery rate),
EA = exposure amount,
PD = probability of default
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Daily Standard Deviation
Please note: If information is based on a sample, ‘ N – 1 ‘ will be used in the denominator
Daily Standard Deviation = [ ( Sum of Squared Deviations from Mean / ( N – 1 ) ) ] ½
Implied 1‐Yr Forward Rate
From the Pure Expectations Theory: The expected 1-Yr spot rate, one (1) year from now will be
equivalent to finding the forward rate for the second year, thus:
The Implied 1‐Yr Forward Rate is given:
= [ ( 1 + Two-Yr Spot Rate )2 / ( 1 + One-Yr Spot Rate ) ] – 1
Risk Neutral Probability
We may calculate the risk neutral probability from the given formula:
Π = ( 1 + RFR ) – ( 1 – % Down ) ) / ( ( 1 + % Up ) – ( 1 – % Down ) )
Risk Neutral Probability
The risk neutral probability of a stock going up in a single step may be calculated as follows:
pup = ( e rΔt – d ) / ( u – d )
Dirty Price
Dirty Price = Quoted Price + Interest Accrued from last Coupon Date
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Daily Delta Normal VaR
Daily Delta Normal VaR formula is as given:
= [ R – ( z )( sigma ) ] X ( Portfolio Value ) , where;

 R is our portfolio’s expected one‐day return
 z is our z‐value with respect to the significance level
 Sigma is the standard deviation ( one‐day returns )
Mean Loss Rate
Mean Loss Rate = Probability of Default X ( 1 – Recovery Rate )
Portfolio’s Beta:
Beta, β = Correlation Coefficient X ( Portfolio Standard Dev / Instrument’s Standard Dev )
Sample-Mean
Sample-Mean may be calculated as:
= ( Summation of change in each day’s yield ) / ( The Number of Observations – 1 )
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Financial Risk Manager Formulas
FRM Examination Part 2
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Level: FRM Part II

Section: 1 of 6
Topic: Market Risk Measurement and Management
FRM Formulas
Value at Risk, VaR
VaR = −μ + ( σ * Zscore )
Or
VaR = μ − ( σ * Zscore )
Sharpe Ratio
= (Rp – Rf) / σp
Rp Portfolio Return
Sortino Ratio

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Treynor Measure
Jenson’s Alpha
Information Ratio

Tracking Error
A portfolio’s beta using the respective weightings:
Portfolio beta = w1R1 + w2 R2 + w3 R3
Portfolio Expected Return
= Rf + R(Rm – Rf)
Hedging Relationships
FaceR = – FN X DV01N X β
DV01R
Where:
N is the Core and R is the Hedge
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Correlation for two assets ‘A’ and ‘B’
Correlation coefficient = CovarianceAB / [(Standard deviationA x Standard deviationB)]
Rearranged, we have:
Also:
Correlation Coefficient = ( Coefficient of determination ) ½
St − St−1 = a * ( μS − St−1 )
The Vasicek Model
dr dW
dr k * ( r ) * dt ] dw
Binomial Distribution
Binomial Distribution of Exceedances = ( x – pT )

[ p ( 1 – p )T ] ½
Where:
T is the amount of trading days in the year
x is the amount of exceedances
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Forward Pricing
P( T* + T ) = P(T*) X F( T* , T)
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Level: FRM Part II

Section: 2 of 6
Topic: Credit Risk Measurement and Management
FRM Formulas
Firm Value
[ Firm Value * N ( d1 ) ] – [ Debt * e –rT * N ( d2 ) ]
Netting Factor
Netting Factor = ( ( n + n*(n – 1)½ / n
Expected Loss
Expected Loss = KN ( –e2 ) – At * e u ( T – t ) * N ( -e1 )
Debt Value
Value of Debt = Value of Risk Free Debt – Value of Put Option
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Debt Value Continued
Value of Debt = Value of Risk Free Debt – Value of Put Option
St = Vt N * ( k + v ( T – t ) ½ ) – K e –r(T – t) * N ( k )
F’ ( t ) = e - t
F(u) = 1 – exp ( – hu )
Where:
h = ( Spread ) / ( 1 – Recovery )
Credit Spread
Credit Spread = yD ( t,T ) – y P*( t,T ) = 
Conditional Prepayment Rate (CPR)
Conditional Prepayment Rate = 1 – ( 1 – Single Month Mortality Rate )12
CPR = 1 – ( 1 – SMM )12
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Credit Valuation Adjustment (CVA)
CVA = Loss Given Default * Exposure at Default * Default Probability
CVA = LGD * EAD * DP
CVA = ( 1 – Recovery Rate ) *  [ ( Discount Factor ) * ( Exposure ) * ( Probability of Default ) ]
Average Life
Average Life = ( t * Principal time t ) / ( 12 * Total Principal ) ]
CPR = 1 – ( 1 – SMM )12
Probability of Default
Default Probability = 1 – e t
NB:
 = Spread
1 – Recovery Rate
Default Correction
ab = ab – ( a * b )
[ a * ( 1 – a ) ] ½ * [ b * ( 1 – b ) ] ½
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Exposure at Default (EAD)
EAD = Amount Drawn + ( Amount Limit – Amount Drawn ) * Loan Equivalent Ratio
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Level: FRM Part II

Section: 3 of 6
Topic: Operational Risk and Resiliency
FRM Formulas
Risk-adjusted return on capital (RAROC)
RAROC = ( Risk Adjusted Return ) / ( Risk Adjusted Capital )
RAROC = Revenues – Costing – Taxation – Expected Losses + Return on Capital +/- Transfers
Risk Adjusted Capital
Adjusted RAROC = RAROC – β ( Market Return – Risk Free Rate )
f ( n ) = (  e –d ) / n!
r e = L * ra – ( L – 1 ) * rd
Probability of Default
Default Probability = 1 – e t
NB:
 = Spread
1 – Recovery Rate
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Worst Case Default Rate (WCDR)
WCDR = N * [ N-1 * ( PD ) + ½ * N-1 ( 0.999 ) / ( 1 –  )½ ]
Default Correction
ab = ab – ( a * b )
[ a * ( 1 – a ) ] ½ * [ b * ( 1 – b ) ] ½
Liquidity Cost
Liquidity Cost = ( Notional Amount X Spread Value ) / 2
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Level: FRM Part II

Section: 4 of 6
Topic: Liquidity and Treasury Risk Measurement
FRM Formulas
One measure of the market liquidity of an asset is its bid–offer spread. This can be measured
either as a dollar amount or as a proportion of the asset price
The dollar bid–offer spread is given:
p = Offer price - Bid price
The proportional bid–offer spread for an asset is defined as:
s = ( Offer price - Bid price ) / Mid-market price
Cost of liquidation (normal market) =
Σi ( si * αi / 2 )
Where;
si is an estimate of the proportional bid–offer spread in normal market conditions for the ith
financial instrument held by a financial institution
and
αi is the dollar value of the position in the instrument
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Liquidity-Adjusted VaR (normal market)
Liquidity-Adjusted VaR = VaR + Σi ( si * αi / 2 )
Define i and σi as the mean and standard deviation of the proportional bid–offer spread for
the ith financial instrument held. Then:
Cost of liquidation (stressed market) =
Σi [ [ ( i + σi ) αi ] / 2 ]
The parameter  gives the required confidence level for the spread.
For example, if we are interested in considering “worst case” spreads that are exceeded only
1% of the time, and if it is assumed that spreads are normally distributed, then  = 2.326
Liquidity-Adjusted VaR (stressed market)
Liquidity-Adjusted VaR = VaR + Σi [ [ ( i + σi ) αi ] / 2 ]
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Basel III introduced two liquidity risk requirements:
The liquidity coverage ratio (LCR) requirement:
( High-quality liquid assets / Net cash outflows in a 30-day period ) ≥ 100%
The net stable funding ratio (NSFR) requirement :
( Amount of stable funding / Required amount of stable funding ) ≥ 100%
The Leverage Ratio = 1 + ( D/E )
Where:
D = Debt
E = Equity
Investment officers for a financial firm subject to the corporate income tax could compare
potential yields using the formula:
After-tax gross yield = Before-tax gross yield * ( 1 - Firm’s marginal income tax rate )
The Tax Equivalent Yield ( TEY ) can usually be found using the following relationship:
TEY = After-tax return on a tax-exempt investment / (1 - Investing firm’s marginal tax rate)
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The net after-tax return of bank-qualified municipals is calculated as follows:
Net after-tax return on municipals (in % ) =
[ Nominal return on municipals after taxes (in %) – Interest expense incurred in acquiring the
municipals (in %) ] + Tax advantage of a qualified bond
Where, the tax advantage of a qualified bond is given:
[ Bank’s marginal income tax rate (in %) * Percentage of interest expense that is still tax
deductible (if any) * Interest expense of acquiring the municipals (in %) ]
Percentage change in Investment Price =
- Duration * [ (Change in interest rate) / ( 1 + (1/m)*(Initial Rate) ]
Where m is the number of times during the year that the security pays interest
A Financial Firm’s Net Liquidity Position, Lt
= Supplies of Liquidity Flowing into the Firm – Demands of the Firm for Liquidity
Where;
Supplies of Liquidity Flowing into the Firm
= Incoming Deposits + Revenues from Services + Customer Loan Repayments + Sale of Assets +
Borrowings
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Demands of the Firm for Liquidity
= Deposit Withdrawals – Loan Requests – Borrowing Repayments – Operating Expenses –

Dividend Payments to Stockholders
Expected Liquidity Requirement =
Probability of Outcome A * (Estimated liquidity surplus of deficit in Outcome A)

+
Probability of Outcome B * (Estimated liquidity surplus of deficit in Outcome B)
+
Probability of Outcome C * (Estimated liquidity surplus of deficit in Outcome C)
+
+…
Cash position indicator: Cash and deposits due from depository institutions / total assets
Liquid securities indicator: U.S. government securities / total assets
Net federal funds and repurchase agreements position:
(Federal funds sold and reverse repurchase agreements – Federal funds purchased and
repurchase agreements) / total assets
Capacity ratio: Net loans and leases / total assets
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Pledged securities ratio: Pledged securities / total security holdings
Hot money ratio:
= Money market (short-term) assets / volatile liabilities
= (Cash and due from deposits held at other depository institutions + holdings of short-term
securities + Federal funds loans + reverse repurchase agreements) / (large CDs + Eurocurrency
deposits + Federal funds borrowings + repurchase agreements)
Deposit brokerage index: Brokered deposits / total deposits
Core deposit ratio: Core deposits / total assets
Deposit composition ratio: Demand deposits / time deposits
Loan commitments ratio: Unused loan commitments / total assets
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Unit price charged the customer for each deposit service =
Operating expense per unit of deposit service +
Estimated overhead expense allocated to the deposit-service function +
Planned profit margin from each service unit sold
Marginal cost = Change in total cost =
[New interest rate * Total funds raised at new rate] – [Old interest rate * Total funds raised at
old rate]
Marginal cost rate = Change in total cost / Additional funds raised
Annual Percentage Yield (APY) is calculated using:
APY earned = 100 [ ( 1 + Interest earned/Average account balance )(365/Days in period) – 1 ]
Available funds gap (AFG) =
[ Current and projected loans and investments the lending institution desires to make ] – [
Current and expected deposit inflows and other available funds ]
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Effective cost rate on deposit and non-deposit sources of funds
[ Current interest cost on amounts borrowed + Non-interest costs incurred to access these
funds ]
Net investable funds raised from this source
Where:
Current interest cost on amounts borrowed =
Prevailing interest rate in the money market * Amounts of funds borrowed
Non-interest costs incurred to access these funds =
Estimated cost rate representing staff time, facilities, transaction costs * Amounts of funds
borrowed
Net investable funds raised =
Total amount borrowed – legal reserve requirements (if any), deposit insurance assessments (if
any), and funds placed in non-earning assets
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Pooled deposit and non-deposit funds expense =
All expected operating expenses / All new funds expected
Hurdle rate of return over all earning assets =
All expected operating costs / Dollars available to place in earning assets
Weighted Average Life ( WAL ) = ∑ ( pi / P ) ti
Where:
Pi = principal amount in distribution i,
P = amount of loan
ti = time (in years) of payment i
Funds Transfer Price ( FTP ) = Base Rate + Term Liquidity Premium + Liquidity Premium
Where:
Base Rate = rate depicted from the swap curve corresponding to the asset’s contractual/
behavioral maturity or repricing term, whichever is less
Term Liquidity Premium = spread between the swap curve and the bank’s marginal cost of
funds curve based on the contractual/ behavioral maturity of the asset
Liquidity Premium = cost of carrying liquidity cushion averaged over total assets of the bank
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Bank Discount Rate = [ ( 100 – Purchase Price on Security or Loan ) / 100 ] * ( 360 / # days to
Maturity )
YTM Equivalent Yield = [ ( 100 – Purchase Price ) / Purchase Price ] * ( 365 / Days to Maturity )
Nominal (Published) Market Interest Rate on a Risky Security or Loan =
Risk Free Rate + Risk Premiums to Compensate Lenders
Net Interest Margin ( NIM ) = Net Interest Income / Total Earning Assets
= ( Interest from Loans and Investments – Interest Expense on deposits or borrowed funds )
Total Earning Assets
Interest Sensitive Gap = Interest Sensitive Assets – Interest Sensitive Liabilities
Relative IS GAP = IS GAP / Size of Financial Institution
Net Interest Income = Total Interest Income – Total Interest Cost
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Change in Net Interest Income =
Overall change in Interest Rate (in percentage points) * Size of the Cumulative Gap (in dollars)
Duration Gap =
Dollar Weighted Duration of Asset Portfolio – Dollar Weighted Duration of Liability Portfolio
Leverage Adjusted Duration Gap = Duration Gap * (Total Liabilities / Total Assets)
(Dollar Weighted Duration of Asset Portfolio – Dollar Weighted Duration of Liability Portfolio)
(Total Liabilities / Total Assets)
Dollar Weighted Asset Portfolio Duration =
∑( Duration of Each Asset in Portfolio ) * Market Value of Each Asset in Portfolio

Total Market Value of all Assets
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Current Leverage-Adjusted Position =
Average Asset Duration – [ Average Liability Duration * ( Total Liabilities / Total Assets ) ]
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Level: FRM Part II

Section: 5 of 6
Topic: Risk Management and Investment Management
FRM Formulas
Risk Aversion
A = IR / ( 2 P )
Where:
IR is the Information Ratio
P is the Portfolio’s Active Risk
Sharpe Ratio
= (Rp – Rf) / σp
Where:
Rp Portfolio Return
Sortino Ratio

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Treynor Measure
Jenson’s Alpha
Information Ratio

Tracking Error
Information Ratio
Information Ratio = Information Coefficient * ( Number of Forecasts ½ )
Marginal Contribution to Value Added ( MCVA )
MCVA = n - 2 a *  * Marginal Contribution to Active Risk
MCVA = n - 2 a *  * MCAR
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Level: FRM Part II

Section: 6 of 6
Topic: Current Issues in Financial Markets
FRM Formulas
There are no stated formulas for this segment
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GARP FRM® Exam Formulas

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FRM Examination Guide: Part I Exam

Please use the following information only as a general guide

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Foundation of Risk Management Formulas Page 6

Quantitative Analysis Formulas Page 14

Financial Markets and Products Formulas Page 23

Valuation and Risk Models Formulas Page 31

Market Risk Measurement and Management Formulas Page 37

Credit Risk Measurement and Management Formulas Page 41

Operational Risk and Resiliency Formulas Page 45

Liquidity and Treasury Risk Measurement Formulas Page 47

Risk Management and Investment Management Formulas Page 59

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Financial Risk Manager Formulas

FRM Examination Part 1

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Level: FRM Part I

Correlation coefficient between two Securities:

Correlation coefficient = Covariance between Security A and Security B

Variance of Two Securities

Variance = (WeightA)2 x (Standard Deviation of A)2

Perfect Positive Correlation

Perfect Negative Correlation

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Risk Adjusted Ranking

Rf Treasury-Bill Returns (or the Risk Free Rate)

σp Portfolio Standard Deviation of Return

= Return on Portfolio – Minimum Accepted Return

= (Return on Portfolio – Risk free rate) / Portfolio Beta

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= Return on Portfolio – CAPM predicted Return

= Return on Portfolio – Benchmark Return

A portfolio’s beta using the respective weightings:

Portfolio beta = w1R1 + w2 R2 + w3 R3

Portfolio Expected Return

Expected Return (Capital Asset Pricing Model, CAPM)

We recall the CAPM formula:

Expected Return, ER = Rf + β*(Rm – Rf)

Thus, expected return on the security will be:

= Risk Free Rate + [ Security’s Beta *( Equity Risk Premium) ]

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