FRM Part I Exam

Mock Questions - FRM Part I - Mock Exam #2

Offered by AnalystPrep

Last Updated: Feb 22, 2025

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Q.1 An analyst performs a regression of a stock’s return on the overall market return using a
sample of 2 years of monthly returns. He estimates the slope coefficient to be 0.55 with a
standard error of 0.26. The analyst then performs a hypothesis test at a 5% level of significance
to determine if the slope coefficient is significantly different from zero. Which of the following
correctly describes the test statistic and result of this test?

A. The test statistic is 2.12, and the null hypothesis is rejected to conclude that the slope
coefficient is different from zero

B. The test is 2.12, and the null hypothesis cannot be rejected to conclude that the slope
coefficient is different from zero

C. The test is 0.47, and the null hypothesis cannot be rejected to conclude that the slope
coefficient is different from zero

[Link] test is 0.47, and the null hypothesis is rejected to conclude that the slope
coefficient is different from zero

Q.2 Which of the following cases most likely involved the mismanagement of hedging strategies?

A. Enron

B. Volkswagen

C. Metallgesellschaft

[Link] Bank

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Q.3 First Republic entered into a 2-year interest rate swap on August 9, 2020, in which it
received a 5.00% fixed rate premised on an agreement to pay LIBOR plus 1.25% on a notional
amount of USD 7.5 million. Payments were to be made every 6 months. The table below displays
the actual annual 6-month LIBOR rates over the 2-year period:

Date 6-month LIBOR

Aug 9, 2020 0.89%

Feb 9, 2021 1.20%

Aug 9, 2021 1.35%

Feb 9, 2022 1.40%

Aug 9, 2022 1.78%

Assuming no default, how much did First Republic receive on August 9, 2022?

A. USD 73,875

B. USD 88,125

C. USD 99,200

[Link] 68,750

Q.4 Which of the following correctly describes a protective put?

A. Long position in a put option and a short position in the underlying shares

B. Long position in a put option while the underlying shares are held

C. Short position in a put option and a long position in the underlying shares

[Link] position in a put option and short position in the underlying shares

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Q.5 Which of these statements about exchange-traded derivatives is false?

A. Exchange-traded derivatives have standardized contract terms

B. Exchange-traded derivatives have low liquidity risk

C. Exchange-traded derivatives have high credit risk

[Link]-traded derivatives have standard maturities

Q.6 Which of these correctly describes the numerator of the Sortino measure?

A. Difference between portfolio return and market return

B. Difference between portfolio return and minimum acceptable return

C. Downside deviation, as measured by the standard deviation of returns below the

target

[Link] between portfolio return and benchmark return

Q.7 Mathew Jelkins, FRM, was recently found guilty of violating the principle of professional
integrity and ethical conduct as outlined in the GARP Code of Conduct. Which of the following is
a potential consequence? Jelkins will be:

A. Required to participate in at least one ethical training workshop

B. Stripped of the GARP member’s right to use the FRM designation

C. Stripped of the GARP member’s right to work in the risk management profession

[Link] to pay a fine whose amount will be determined by the GARP’s penalty
committee

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Q.8 Jane Johnson, FRM, works as a full-time risk manager for the Washington Investment
Banking Group. Recently, one of Johnson’s long-time friends asked her to help with preparations
for an initial public offering (IPO) for a promising tech company based in Silicon Valley. This
would be a part-time role and would entail establishing earnings projections for the tech
company. Johnson should most likely:

A. Accept the work as long as the Washington Investment Banking Group agrees to all
the terms of engagement.

B. Accept the work as long as she does it in her free time.

C. Accept the role as long as, in her own assessment, it does not interfere with her duties
to the Washington Investment Banking Group.

[Link] accept the work as it violates the Code of Conduct by creating a conflict of
interest.

Q.9 If the leading and lagged values of the mean, variance and covariance of a time series do not
change with time, the time series is said to be:

A. Autocorellated

B. Autoregressive

C. Covariance stationary

[Link]

Q.10 A trader uses a model uses his valuation model to estimate the value of a bond portfolio at
CAD 276.060 million. The term structure is flat. Using the same model, he estimates that the
value of the portfolio would increase to CAD 278.935 million if all interest rates fell by 40 bps
and would decrease to CAD 272.650 million if all interest rates rose by 40 bps. Using these
estimates, determine the effective duration of the bond.

A. 2.85

B. 0.028

C. 0.023

D.0.285

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Q.11 A wealth management firm is contemplating motivational measures in an attempt to align
the interests of managers and shareholders. To this end, the board has plans to grant managers
securities that are tied to the firm’s stock. Even as it ponders such a move, the board is wary of
managerial incentives that could negatively affect risk management at the firm. Which of the
following securities provides the best example of rewards likely to reduce managerial incentives
to manage risk?

A. A long position in the firm’s stock

B. A deep out-of-the-money call option on the firm’s stock

C. At-the-money call option on the firm’s stock

D.A deep in-the-money call option on the firm’s stock

Q.12 You have been given the following information regarding a portfolio:

Return on the portfolio 12%

Return on the market 8%
Return on benchmark 9%
Beta of the portfolio 1.1
Tracking error of the portfolio 10%
Standard deviation of the portfolio 15%

Which of the following is closest to the information ratio of the portfolio?

A. 0.3

B. 0.2

C. 0.4

D.0.5

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Q.13 You have been given the following data for a managed portfolio:

Beta 1.55
Alpha 2.11%
Average return 12.5%
Risk-free rate 3%

Basing your calculations on Jensen's measure of portfolio performance, the return on the market
portfolio is closest to:

A. 1.77%

B. 7.77%

C. 8.36%

D.5.36%

Q.14 A strategy where a long position in a call option is combined with a long position in a put
option, such that both options have the same strike price and expiration date, is known as

A. Strangle

B. Bear spread

C. Straddle

[Link] option

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Q.15 The new CRO of a regional bank is trying to implement a new stress testing process for the
bank. He asks one of the colleagues to start the preparation of stress testing policies, procedures
and documentations. The CRO makes the following statements:

I. The policies should be transparent to third parties to ensure an understanding of the

bank's stress testing activities.
II. The policies should describe the frequency and priority with which stress-testing
activities should be conducted.
III. The policies should be reviewed and updated as necessary to ensure that stress testing
practices remain up to date with changes in market conditions and the bank’s strategies.
IV. The policies should describe the overall purpose of stress-testing activities.

Which of the statements is/are correct?

A. Statement I and

B. Statement II and III

C. Statement II, III and IV

[Link] of the statements are correct

Q.16 Which of these is most likely to be a disadvantage of having a central counterparty (CCP)?

A. Liquidity risk

B. Loss mutualisation

C. Lack of transparency

[Link] selection

Q.17 An insurance contract that lasts for a specified period and pays a lump sum either when the
policyholder dies or at the end of the period, whichever comes first, is known as:

A. Term life insurance

B. Whole life insurance

C. Endowment life insurance

[Link] life

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Q.18 An analyst at a bond trading desk wants to decompose the P&L of a $5,000,000 face value
U.S. Treasury 7 1/2s of April 31, 2030, over a six-month holding period. Currently, the bond
trades at par. The position is financed with direct repo which has an interest rate of 3%. If the
market experiences a +100 basis-point parallel shift in the yield curve at the end of the sixth
month, what is the cash-carry amount over the six-month period?

A. -$500,000

B. -$75,000

C. +$112,500

D.+$187,500

Q.19 An investor short sells 1,000 shares of XYZ Corporation in June when the price is USD50
per share. In September, a dividend of USD1.5 per share is paid by the company. The investor
closes out the position in October when the price of the share is USD45. Assuming there are no
borrowing costs involved, what is the profit or loss for the investor?

A. $3,500

B. $6,500

C. $5,000

D.$1,500

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Q.20 Risk managers of a regional bank are discussing the advantages of stress testing. They
make the following statements:

I. Based solely on historical data, stress testing provides forward-looking assessments of

risk.
II. Stress testing plays an important role in capital and liquidity planning procedures.
III. Stress testing is facilitating the development of risk mitigation or contingency plans
across a range of stressed conditions

Which of these statements is/are correct?

A. Statement I.

B. Statements I and II.

C. Statements I and III.

[Link] II and III.

Q.21 Portfolio Y has an expected return of 10%, volatility of 25%, and a beta of 0.5. The market
has an expected return of 12% and volatility of 25%. Assuming that the risk-free rate is 5%, what
is Jensen’s alpha for portfolio Y?

A. 6%

B. 2.0%

C. 3.5%

D.1.5%

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Q.22 You have been given the following details for two bonds:

US Treasury Bond Corporate Bond

Principal $100 $100
Coupon 5% 6%

If coupons are paid on March 5 and September 5 of each year for both bonds, what is the
interest accrued on both bonds between the period of March 5, 2017, and May 27, 2017?

A. $1.128 on the Treasury Bond and $1.353 on the Corporate Bond.

B. $1.128 on the Treasury Bond and $1.367 on the Corporate Bond.

C. $1.139 on the Treasury Bond and $1.353 on the Corporate Bond.

D.$1.139 on the Treasury Bond and $1.367 on the Corporate Bond.

Q.23 Which of the following risk management responsibilities rest with the board of directors of
a bank?

I. Approval of the bank’s risk management policies and procedures

II. Maintaining oversight of all risk management activities
III. Evaluating the performance of risk management activities
IV. Ensuring compliance with minimum or best practice standards

A. I and II only

B. I and III only

C. II and IV only

D.I, II, III, and IV

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Q.24 All of the following statements are true, except:

A. If the return distributions of two investments have the same mean and standard
deviation, the one which has more a negatively skewed distribution will be considered to
be riskier

B. Distributions with positive excess kurtosis are known as leptokurtic

C. If two investments have the same mean, standard deviation and skewness, then the
one with the lower kurtosis will be considered riskier

[Link] normal distribution has a kurtosis of 3

Q.25 You have been provided the following set of values for an independent variable A and a
dependent variable B:

A B
1 5
2 8
3 12
4 15

What are the slope and the intercept of the regression line?

A. The slope is 3.4, and the intercept is 1.5

B. The slope is 2.6, and the intercept is 2.2

C. The slope is 3.1, and the intercept is 1.3

[Link] slope is 2.8, and the intercept is 1.8

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Q.26 Two investors – A and B – invest $1000 each in two different financial instruments. Investor
A receives a return of 5% with semiannual compounding while Investor B receives a return of 5%
with quarterly compounding. After two years, what will be the terminal values of the two
investments?

A.

Investor A Investor B
$1,103.8 $1, 104.4

B.

Investor A Investor B
$1,104.4 $1, 103.8

C.

Investor A Investor B
$1,215.5 $1, 477.5

D.

Investor A Investor B
$1,477.5 $1, 215.5

Q.27 An asset that provides no income has a storage cost of USD3 per unit, paid at the end of the
year. If the spot price of the asset is USD220 and the risk-free rate is 5%, the futures price for
the asset, assuming the expiry date is exactly one year from today, is closest to:

A. $228.80

B. $238.11

C. $231.28

D.$234.28

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Q.28 A trader wants to price a bond with a 5% coupon rate and a maturity of 1.5 years. The
coupon payment is semiannual. Due to a bug in the system, the trader was not able to download
the complete structure of the market spot rates. The table below shows the data the trader was
able to gather.

Term in years Spot rates

0.5 1.10%
1.0 n/a
1.5 3.00%

Which of the following are the missing spot rate and the bond price if the 1-year discount factor
is 0.9831?

A. 1-year spot rate = 1.71%; Bond price = 102.967

B. 1-year spot rate = 2.10%; Bond price = 102.957

C. 1-year spot rate = 2.50%; Bond price = 102.947

D.1-year spot rate = 2.65%; Bond price = 104.944

Q.29 A zero-coupon bond with a notional value of USD100 and price x has the following
probability density function:

x
f (x) = fo r 0 ≤ x ≤ 100
5000

Determine the probability that the price of the bond is between $80 and $90 inclusively.

A. 0.0017

B. 81.00%

C. 17%

D.64.00%

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Q.30 If the covariance between Canadian and American interest rates is 0.092, and the variances
of interest rates in Canada and the U.S. are 12.32% and 11.04%, respectively, then which of the
following is closest to the correlation between Canadian and American interest rates?

A. 0.7889

B. 9.7641

C. 0.1478

D.1.2677

Q.31 Which of the following statements is (are) false?

I. An advantage of bootstrapping is that it allows to make inferences without making strong

assumptions about the distribution
II. Another advantage of bootstrap is that it is not affected by outliers in the data
III. Bootstrapping will be ineffective if the data are not independent of one another

A. I only

B. II only

C. II & III only

[Link] of the statements are false

Q.32 Which of the following statements is false?

A. Multicollinearity occurs when two or more of the independent variables in a multiple

regression are highly correlated with each other

B. Multicollinearity distorts the standard error of the regression and the coefficient of
standard errors

C. If there exists imperfect multicollinearity, then it is not possible to find the ordinary
least squares (OLS) estimators necessary for the regression results

[Link] a result of multicollinearity, there is a greater probability that it will be incorrectly

concluded that a variable is not statistically significant

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Q.33 The key risk for a Central Counterparty (CCP) is that of default of a clearing member. Such
an event can also have certain knock-on effects. These knock-on effects can include all of the
following, EXCEPT:

A. Failed auctions

B. Default of other clearing members

C. Resignations

[Link]-way risk

Q.34 An intern in a risk management department of a bank is struggling with the understanding
of the nature of credit ratings provided by the rating agencies. He overhears a discussion from
some of his colleagues regarding the recent downgrade of company XYZ by S&P from A to BBB.
What is the interpretation of XYZ’s credit rating downgrade from A to BBB?

A. Bonds issued by XYZ are currently overvalued in the market

B. Stocks of XYZ are expected to underperform the market benchmark in the nearest
future

C. XYZ’s capacity to meet its obligations slightly deteriorated from ‘extremely strong’ to
‘very strong’

[Link] still has an adequate capacity to meet its obligations, but now it is more
susceptible to a negative change in the business environment

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Q.35 An insurance company’s financial statements contain the following information:

(In million USD)

Premiums 120
Claims 65
Operating expenses 20
Investment income 5

The combined ratio for the insurance company is closest to:

A. 54%

B. 75%

C. 68%

D.71%

Q.36 If the variance of the residuals is not constant across all observations in a sample, the
regression is said to be:

A. Leptokurtic

B. Multicollinear

C. Platykurtic

[Link]

Q.37 Cytadela Bank from Poznan, Poland, needs to measure the yield of a coupon bond portfolio.
One of the bonds in the portfolio has the maturity exactly equal to the term of a key rate, and the
price of that bond is exactly par. How do the bond’s yield and the key rate compare?

A. They are identical

B. The bond’s yield is higher than the key rate

C. The bond’s yield is lower than the key rate

[Link] bond’s yield has no discernible relationship with the key rate

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Q.38 A Canadian lender intends to forecast the expected loss on a loan to a prospective mid-size
corporate borrower. As per the current estimates, the bank will suffer a 60% loss if the borrower
does not perform the financial obligation. This risk measure is:

A. the loss rate

B. the probability of default

C. the exposure at default

[Link] expected loss

Q.39 The stock price of AlphaFarm skyrocketed to USD200 after a recent announcement of a
drug approval by the FDA. Francesca Merc wants to quickly estimate the approximate price of
her European call option on Alpha’s stocks using the Black-Scholes-Merton model. The call
option has expiry in 3 months and a strike price of USD50. If the risk-free rate is 8%, then which
of the following is closest to the price of Merc’s call option?

A. $151

B. $158

C. $147

D.$140

Q.40 An analyst covers two companies – Xela Ltd. and Yena Inc. Yena Inc. is a subsidiary of Xela.
The probability that the return on equity (ROE) of Xela exceeds 20% this year is 0.10, while the
probability that the ROE of Yena exceeds 30% is 0.05 for the same time period. If the probability
that the ROE of Xela exceeds 20% and the ROE of Yena exceeds 30% is 0.02, then the probability
that the ROE of Yena exceeds 30% given that the ROE of Xela has already exceeded 20% is
closest to:

A. 0.20

B. 0.10

C. 0.05

D.0.025

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Q.41 You have been given the following information regarding a stock index:

Current index level $1, 120

Risk-free rate 6% per annum
Dividend yield 2% per annum

What is the futures price for a six-month contract on the index?

A. $1,142.63

B. $1,165.70

C. $1,154.11

D.$1,137.60

Q.42 A bank only uses VaR to measure the risk in its trading book. The bank has a one-day VaR of
USD25 million at a confidence level of 99%. During the last 200 trading days, this VaR was
exceeded only twice, with total losses of usd500 million and USD200 million being incurred.
According to the VaR measure on its own, the bank has been successful in managing its risk but,
in reality, it has lost USD700 million. In this scenario, the failure of risk management can most
likely be attributed to:

A. Failure to use appropriate risk metrics

B. Mismeasurement of known risk

C. Failure to take known risks into account

[Link] in communicating risk to top management

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Q.43 You have been provided the following information:

Weighted long-run variance 0.000010

Weighting on previous period’s return 0.15
Weighting on previous volatility estimate 0.80
Daily volatility estimate 1.5%
Recent market return 1%

Using the GARCH(1,1) model, the volatility per day on day n(σn ) is closest to:

A. 1.109%

B. 1.276%

C. 1.432%

D.1.231%

Q.44 An analyst runs a multiple regression of a variable Y on four independent variables for 50
observations. If the sum of squared errors for the regression is 125 and the total sum of squares
is 450, then what is the adjusted R2 of the regression?

A. 0.722

B. 0.786

C. 0.697

D.0.643

Q.45 The 2007-2008 financial crisis was primarily a result of two major risks. These are:

A. Credit and liquidity risk

B. Credit and market risk

C. Liquidity and operational risk

[Link] and operational risk

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Q.46 An investor can immunize their portfolio against large parallel shifts in the zero curve by:

A. Choosing a portfolio of assets and liabilities with a net duration of 1, and net convexity
of 0.

B. Choosing a portfolio of assets and liabilities with a net duration of 0, and net convexity
of 1.

C. Choosing a portfolio of assets and liabilities with a net duration of 0, and net convexity
of 0.

[Link] a portfolio of assets and liabilities with a net duration of 1, and net convexity
of 1.

Q.47 You have been given the following incomplete probability matrix about the return (in
foreign currency terms) on an investment made in a foreign country as compared to the
benchmark and the expected change in the exchange rate of the local currency against the
foreign currency:

Outperf orm Underperf orm

Appreciation 10% 15%
No change 20%
Depreciation 25%
Total 55%

What is the unconditional probability that the investment will outperform the market?

A. 45%

B. 40%

C. 55%

D.50%

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Q.48 A zero-coupon bond has a face value of USD 5,000 and a maturity of eight years. The 8-year
yield rate is 6% compounded semi-annually. What is the value of the effective duration if the yield
rate changes by four basis points?

A. 7.77

B. 6.78

C. 6.45

D.7.45

Q.49 Catherine Austin works at the arbitrage department of an investment bank. She finds that
an asset is trading at USD 2,[Link] price of a one-year futures contract on the asset is
USD2,244, and the price of a two-year futures contract is USD 2,295.50. Assume that the asset
exhibits no cash flows in the first two years. If the term structure of interest rates is flat at 2%,
which of the following would be an appropriate arbitrage strategy?

A. Short the 2-year futures, borrow USD 2,200 at 2% and buy the underlying asset

B. Buy the 2-year futures and short the underlying asset

C. Short the 2-year futures, borrow USD 2,200 at 2% and short the underlying asset

[Link] the 2-year futures, borrow USD 2,200 at 2% and short the underlying asset

Q.50 You have been given the following probabilities: P [A|B] = 25% P [B|A] = 50% P [A] = 30%
What is P [B]?

A. 60%

B. 15%

C. 75%

D.42%

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Q.51 Which of these probability distributions is most likely to be used to model stock prices?

A. Normal

B. Lognormal

C. Binomial

[Link]

Q.52 Amelia Stone plans to retire next year and is considering an investment that would help to
ensure her future financial stability. On average, Stone spends $70,000 annually. After
retirement, she plans to relocate to the countryside, a move that should cut her living expenses
by 20%. She was approached by her broker with the idea to start investing in perpetuities.
Specifically, he suggested a perpetuity that would yield 7% per year. Assuming the mentioned
reduction of costs, how much should Stone invest in the perpetuities to meet her new spending
needs?

A. $800,000

B. $8,000,000

C. $560,000

D.$5,600,000

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Q.53 An investment bank has a USD1,000,000,000 portfolio of senior unsecured loans evenly
distributed between 10 different clients, each with an internal rating B. The CRO of the bank
wants to stress the loan portfolio under a scenario of an economic slowdown with the GDP
dropping by 2% and unemployment increasing by 1%. Based on the prior experience, the CRO
knows the economic slowdown scenario will negatively impact the credit quality of the
borrowers, and lead to a rating deterioration from B to C for half of the clients. The recovery
rates of senior unsecured facilities are assumed to be 60% in normal conditions and 40% in
stress conditions.

Credit Rating PD
A 0%
B 3%
C 25%
D 100%

What is the bank’s loan portfolio expected loss in both the base and the stressed scenarios?

A. Loss (Base scenario) = USD12,000,000; Loss (Stressed scenario) = $56,000,000

B. Loss (Base scenario) = USD12,000,000; Loss (Stressed scenario) = $84,000,000.

C. Loss (Base scenario) = USD18,000,000; Loss (Stressed scenario) = $56,000,000.

[Link] (Base scenario) = USD18,000,000; Loss (Stressed scenario) = $84,000,000.

Q.54 Over a 15-year period, the manager of a certain fund used a covered call strategy in an
attempt to increase the return of the fund. The mean of the 15 portfolio returns is 0.0519, and
the minimum acceptable return is 4%. Given that the downside deviation, as measured by the the
standard deviation of returns below the target is 0.0017569, compute the Sortino ratio.

A. 6.77

B. -2247.2

C. 0.0119

D.0.04

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Q.55 Which of the following investment strategies does an equity market neutral fund follow?

A. Long-short equity

B. Dedicated short

C. Merger arbitrage

[Link] arbitrage

Q.56 Frank Ort is a junior trader at the options trading desk of an investment bank. He is
reviewing a recent analysis of Tempo Construction LLC. Stocks of Tempo are currently trading at
$47. According to the bank’s analysts, the price of the stock will either go up or down by $8 in
one year depending on the revenues that the company will generate. Since Ort is quite
pessimistic on the future development of the company, he is thinking about opening a short
position by buying put options on Tempo’s stocks with a strike price of $45. The risk-free rate is
assumed to be 2.1% per year. What is the no-arbitrage price of the option that Ort is looking to
buy?

A. $2.55

B. $2.57

C. $2.77

D.$2.97

Q.57 An ordinary least squares regression produces the following:

2
¯¯¯¯
∑(Y i − Y ) = 58
2
∑(Y i − Y^ ) = 10
2
¯¯¯¯
∑ (Y^i − Y ) = 48

What is the coefficient of determination for the regression?

A. 0.792

B. 0.208

C. 0.828

D.0.654

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Q.58 Which of the following statements about over-the-counter (OTC) derivatives is false?

A. OTC derivatives have flexible and negotiable terms

B. OTC derivatives have very good liquidity

C. The credit risk for OTC derivatives is bilateral

[Link] derivatives have negotiable and non-standard maturities

Q.59 You have been given the following information:

Price of European call option on stock X $1.5

Maturity of call option on stock X 6 months
Strike price of call option on stock X $42
Current price of a share of stock X $38
Expected dividend on stock X (to be paid two months from now) $0.75
Risk-free interest rate 6%

What is the price of a European put option that expires in 6 months and has a strike price of
$42?

A. $5.00

B. $4.50

C. $3.76

D.$4.00

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Q.60 Which of the following bond is the cheapest to deliver if the Treasury bond futures price is
100-08?

Price Conversion Factor

A 122 − 04 1.2001
B 134 − 08 1.3190
C 118 − 20 1.1568
D 141 − 24 1.3987

A. Bond A

B. Bond B

C. Bond C

[Link] D

Q.61 You have been provided the following information:

Daily volatility estimate 2%

Decay factor 0.75
Most recent market return 3%

Using the Exponentially Weighted Moving Average Method (EWMA), what is the new estimate
for volatility?

A. 2.101%

B. 2.783%

C. 2.291%

D.1.876%

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Q.62 An investor buys a European put option on the shares of Yullu Corp. for a strike price of
USD 25. Suppose the price of the share price falls to USD 20 at the time of the maturity of the
option. If the cost of the put option was $2, then what is the net profit for the investor?

A. $20

B. $2

C. $3

D.$5

Q.63 Patricia Rice, FRM, is evaluating the risk management of Bright Technologies. She is asked
to categorize the following events into various types of risk. Identify each numbered event as a
credit risk, market risk, business risk, operational risk, and legal risk.

1. A delayed launch of the latest model of an internet connectivity gadget leads to an

inventory pileup of the older product and a USD 100 million write-off of excess inventory.
2. Insufficient training leads to misuse of the check clearing system
3. Credit spreads widen following bankruptcies
4. Swap seller does not have the resources required to honor a contract
5. Credit swaps cannot be netted because they originated in Canada and Sydney

A. 1: operational risk; 2: business risk; 3: credit risk; 4: market risk; 5: credit risk

B. 1: business risk; 2: operational risk; 3: credit risk; 4: market risk; 5: credit risk

C. 1: business risk; 2: operational risk; 3: market risk; 4: credit risk; 5: legal risk

D.1: operational risk; 2: business risk; 3: credit risk; 4: market risk; 5: legal risk

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Q.64 A certain analyst uses the EWMA model with λ = 0.9 to carry out an update of correlation
and covariance between the returns of two assets - A and B. The analyst observes that on day n -
1, the return on A is 2% and that on B is 3%, and the correlation between A and B is 0.5. In
addition, the volatilities of the return on X and Y are 1% and 2%, respectively. Estimate the new
coefficient of correlation.

A. 0.55

B. 0.62

C. 0.45

D.0.5

Q.65 Peter Drury, FRM, serves as the chief risk officer at Capital bank. He recently finalized a
comprehensive risk assessment on a series of investments in credit default swaps. According to
his estimates, the portfolio had a 1% chance of losing USD 500 million or more over one year, a
big enough loss to trigger insolvency or attract takeover bids. Based on Drury’s assessment,
Capital Bank’s CEO authorized a large investment in additional swaps. At the end of the first
year, the portfolio had lost USD 650 million. The bank was immediately closed down by the
regulator, pending a comprehensive audit and review of the bank’s investment policies. Which of
the following statements is correct?

A. The outcome demonstrates risk management failure because the CRO failed to foresee
a move by the regulator, neither did he attempt to stop the shutdown

B. The outcome demonstrates an outright risk management failure because the

occurrence of a supposedly extreme event means the probability of such an outcome was
poorly estimated

C. The outcome demonstrates risk management failure because the CRO did not
eliminate the chance of a financial loss

[Link] the basis if the information provided, one cannot conclusively determine whether
this was a risk management failure

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Q.66 Bakster Bank is following the basic indicator approach for calculating the operational risk
amount for the year 2016. Some past financial details of the bank are given below:

Year Net interest income Non-interest income

2015 102 25
2014 104 22
2013 98 21
2012 91 17

(All amounts are in USD millions) Based on the original Basel Accord, the bank must hold capital
for operational risk for 2016 equal to:

A. USD 18 million

B. USD 18.6 million

C. USD 24.8 million

[Link] 31 million

Q.67 In the run-up to the 2007/2008 financial crisis, Trevor Smith inherited USD 10,000,000
from his grandfather. During the crisis, Smith suffered huge losses in his equity holdings, and he
now wants to invest the inheritance with minimal risks. He is considering the following options:

Product Interest rate Interest rate

compounding
Option 1 Deposit at an AA-rated bank 3.0500% monthly
Option 2 Deposit at an AA-rated bank 3.1000% semiannually
Option 3 Deposit at an AA-rated bank 3.1000% annually
Option 4 Deposit at an AAA-rated bank 3.0500% continuously

Which of these options has the highest monthly compounded interest rate?

A. Option 1 has the highest monthly compounded rate of 3.0500%.

B. Option 2 has the highest monthly compounded rate of 3.0802%.

C. Option 3 has the highest monthly compounded rate of 3.0568%.

[Link] 4 has the highest monthly compounded rate of 3.0539%.

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Q.68 For which of the following reasons are rating agencies most usually criticized?

A. Being too optimistic in the assessment of corporate ratings and too pessimistic in the
assessment of sovereign ratings

B. Failure to align ratings with each other before publishing (e.g., one rating agency may
downgrade a sovereign rating of the country to speculate grade, while the other can still
keep it with investment grade)

C. Taking too long to change a rating

[Link] high fees for publishing corporate and sovereign ratings

Q.69 Which of the following statements regarding recommendations to supervisors is incorrect?

A. Supervisors should evaluate whether the scenarios are consistent with the risk
appetite the bank has set for itself

B. Supervisors should take corrective actions if material deficiencies in the stress testing
program are identified or if the results of stress tests are not adequately taken into
consideration in the decision-making process

C. Supervisors should verify the active involvement of senior management in the stress
testing program and require a bank to submit at regular intervals the results of its firm-
wide stress testing program

[Link] should verify that stress testing forms an integral part of the ICAAP and
the bank’s liquidity risk management framework

Q.70 An investor who buys a put option with a strike price of $25 and sells a put option with a
strike price of $20 is most likely following which of these strategies:

A. Bull spread

B. Box spread

C. Butterfly spread

[Link] spread

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Q.71 A risk manager at an investment consultancy firm is projecting a return of 14% on Portfolio
Y. The market risk premium is 15%, the risk-free rate on interest is 5%, and the volatility of the
market portfolio is 18%. Portfolio Y has a beta of 0.6. According to the Capital Asset Pricing
Model, which of the following statements is true?

A. The expected return of portfolio Y is more than the expected return of the market
portfolio

B. The return of the portfolio has more volatility than the market portfolio

C. The expected return of portfolio Y is less than the expected return of the market
portfolio

[Link] expected return of portfolio Y is equal to the expected return of the market
portfolio

Q.72 Consider a $75 call option on a non-dividend paying stock where the stock price is $68.30,
the risk-free rate is 5%, the time to maturity is 120 days and N ′(d 1 ) = 0.3311 . A 1% increase in
the volatility will increase the value of the option by approximately:

A. 0.1424

B. 0.0743

C. 0.1297

D.2.4873

Q.73 Consider a random variable X with a known probability distribution. Suppose we define a
new random variable Y as a linear transformation of X, such that Y = aX + b, where a and b are
constants. Which of the following statements correctly describes the effect of this linear
transformation on the statistical properties of X?

A. The mean, median, and interquartile range of Y are all scaled by a and shifted by b,
while the variance, standard deviation, skewness, and kurtosis are unaffected.

B. The mean and median of Y are scaled by a and shifted by b; the variance and standard
deviation are scaled by a2; the skewness and kurtosis remain unchanged; and the
interquartile range is scaled by a.

C. The mean, variance, and standard deviation of Y are scaled by a and shifted by b, while
the skewness, kurtosis, median, and interquartile range remain unaffected.

[Link] mean, variance, standard deviation, skewness, kurtosis, median, and interquartile
range of Y are all scaled by a and shifted by b.

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Q.74 A European call option on a non-dividend paying stock has the following details:

Currentstockprice $21
Strikeprice $20
Timetomaturity 6 months
Risk − f reeinterestrate 10%

What is the lower bound for the option price?

A. $1.32

B. $0

C. $1.98

D.$2.90

Q.75 Which of the following statements is false?

A. The result of a single toss of a fair coin is a mutually exclusive event

B. The results of two coin tosses of a fair coin are independent events

C. The results of drawing two cards from a deck of cards are independent events

[Link] results of two rolls of a fair die are independent events

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Q.76 You have been given the following spot rates table:

Maturity Spot Rate

0.5 year 4.0%
1 year 4.3%
1.5 years 4.9%
2 years 5.5%

If a 2-year bond with a principal of $1000 pays a semiannual coupon of 8% per year, then which
of the following is closest to the theoretical price of the bond?

A. $1,046

B. $998

C. $1,002

D.$1,197

Q.77 An investor wants to implement a strangle using put and call options on the shares of
UUKL. Which of the following pairs of options is he most likely to choose?

A. Buy a call option with a strike price of $30 expiring in 6 months and a buy a put option
with a strike price of $30 expiring in 6 months

B. Buy a call option with a strike price of $30 expiring in 6 months and a buy a put option
with a strike price of $30 expiring in 3 months

C. Buy a call option with a strike price of $30 expiring in 6 months and a buy a put option
with a strike price of $25 expiring in 6 months

[Link] a call option with a strike price of $30 expiring in 6 months and a buy a put option
with a strike price of $25 expiring in 3 months

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Q.78 A fixed-income trader summarizes in the table below the prices of Treasury Bonds with
semiannual coupon payment. The data is as of 01/01/17.

Maturity Coupon Rate Price (per 100 face value )

Tranche 1 30/06/2017 3.5% 99 − 00
Tranche 2 31/12/2017 4% 100 − 16
Tranche 3 30/06/2018 5% 101 − 04

What are the discount factors for 0.5, 1, and 1.5 years?

A. d(0.5) = 0.9730; d(1) = 0.9662; d(1.5) = 0.9393

B. d(0.5) = 0.9551; d(1) = 0.9422; d(1.5) = 0.9102

C. d(0.5) = 0.9633; d(1) = 0.9523; d(1.5) = 0.9085

D.d(0.5) = 0.98990; d(1) = 0.9782; d(1.5) = 0.8787

Q.79 An increase in one of the following factors is likely to cause the price of an American call
option to decrease. Which one?

A. Current stock price

B. Strike price

C. Volatility

[Link]-free rate

Q.80 The price of a Treasury bond, which has a coupon of 10% p.a., paid semi-annually on April
25 and October 25, is quoted as 103-05. The last coupon was paid on October 25, 2017. If the
current date is March 28, 2018, and the bond will mature on October 25, 2030, the cash price of
the bond is closest to:

A. $107.39

B. $111.66

C. $103.46

D.$112.24

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Q.81 The collapse of Enron was most likely a result of:

A. Unauthorized trading activity

B. Unanticipated market moves

C. Dubious accounting practices

[Link] of the above

Q.82 A risk manager in an investment bank was asked to forecast the sovereign rating of
countries where the bank has significant holdings. The risk manager found sovereign transition
rates across the Major Rating Categories 1995-2008 published by Fitch.

Annual Rating Transitions (%, Average Annual)

AAA AA A BBB BB B CCC to C D Total

AAA 99.42 0.58 − − − − − − 100.00
AA 4.12 94.12 1.18 − − 0.59 − − 100.00
A − 3.55 92.91 3.55 − − − − 100.00
BBB − − 8.11 87.84 3.38 0.68 − − 100.00
BB − − − 9.04 83.51 5.85 − 1.60 100.00
B − − − − 12.12 84.09 3.03 0.76 100.00
CCC to C − − − − − 23.08 53.85 23.08 100.00

Given the table above, which of the below statements is correct?

A. A country has a 98.13% chance to have a rating of AA.

B. A country with a rating of BB has a 5.85% chance of a downgrade in one year.

C. AAA-rated countries will have the same rating in the future with a 99.12% probability.

[Link] is a 7.97% probability that a country with a rating of AA will have an improved
AAA rating in two years.

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Q.83 An increase in which of the following factors is likely to cause the price of a European put
option to increase?

A. Current stock price, dividends and volatility

B. Strike price, dividends and volatility

C. Dividends, risk-free rate and volatility

[Link]-free rate and volatility

Q.84 What is the duration of a 1.5-year 6% semiannual coupon bond with a face value of $100, if
the yield on the bond is 10% per annum with continuous compounding?

A. 1.3918

B. 1.4009

C. 1.4553

D.1.4949

Q.85 Suzy Wong, a finance student at the University of Tokyo, regularly invests her extra income
in stocks and derivatives. She owns stocks of Safe Home Cleaning Inc., which is currently
trading at USD29. She believes the stock will trade below USD29 if new regulations on cleaning
companies are introduced next month. If she is interested in entering in an option position that
gives her the right to sell her stocks at USD29 if the price of the stock goes below $29, then
suggest the most appropriate option position for Wong.

A. Long call option with the strike price of $29

B. Short call option with the strike price of $29

C. Long put option with the strike price of $29

[Link] put option with the strike price of $29

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Q.86 The current stock price of LLP Limited is USD22. The volatility is 20%, and the risk-free
rate is 7%. According to the Black-Scholes-Merton model, what should be the price of a
European call option on LLP’s stocks with a strike price of USD20 and expiration of 3 months if
N (d 1 ) and N(d 2 ) are assumed to be 0.5522 and 0.5027, respectively?

A. $2.27

B. $2.59

C. $2.98

D.$4.33

Q.87 What is the role of the internal audit in stress testing governance?

A. Establishing adequate stress testing policies and procedures and ensure compliance
with them

B. Monthly statistical back-testing of the stress test estimates against realized outcomes

C. Provision of an independent evaluation of the ongoing performance, integrity, and

reliability of stress-testing activities

[Link] resource allocation to ensure proper functioning of stress-test processes

Q.88 An investor in a hedge fund requires a net return after fees of 18%. If the hedge fund
charges fees of 1 plus 25%, how much will the hedge fund have to earn for the investor to get his
desired return? Assume that the incentive fee is applied after the management fee has been
subtracted

A. 22.30%

B. 25.00%

C. 25.70%

D.24.00%

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Q.89 The result of a two-variable regression analysis produces the following data:

Coef f icient
Constant 2.1
Slope 1.2

Degrees of freedom Sum of squares

Regression 1 35.4
Residual error 8 14.6

What is the correlation coefficient of the two variables?

A. 0.841

B. 0.708

C. 0.588

D.0.767

Q.90 A bank has the following internal rating transition matrix:

Annual Rating Transitions (%, Average Annual)

A B C D
A 98.50 1.00 0.50 −
B 1.00 88.00 7.50 3.50
C − 10.00 75.50 14.50

Based on the matrix, what is the probability of default over 2 years of a company with a rating of
B?

A. 2.5%

B. 4.6%

C. 6.8%

D.7.7%

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Q.91 When the futures price is above the expected future spot price, the situation is known as:

A. Normal backwardation

B. Normal Contango

C. Contango

[Link]

Q.92 The failure of Long Term Capital Management almost brought the financial markets to a
standstill and has since become a marker buoy to show just how far certain risk management
safeguards can go to alleviate the risk of failure. Which of the following statements about
LTCM’s failure is incorrect?

A. LTCM relied too much on theoretical market risk models and too little on stress
testing, gap risk, and liquidity risk.

B. LTCM scantily disclosed its positions and exposures, and counterparties had few ways
to find out LTCM’s exposure to other counterparties.

C. In most of its repo and swap transactions’ LTCM did not pay an initial margin as would
other non-bank counterparties.

[Link] was no moral hazard at play in the run-up to LTCM’s failure.

Q.93 Which of the following parts of GARP's Code of conduct requires members to comply with
all applicable laws, rules, and regulations (including the Code itself) governing the GARP
Members' professional activities?

A. Fundamental responsibilities

B. Professional integrity and ethical conduct

C. Conflict of interest

[Link] accepted principles

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Q.94 Next week, Global Tech has declared its intention to bring to the market a 15-year senior
bond issue at par with a coupon rate of 18%, offering a spread of 800 basis points over the
corresponding 15-year Treasury issue. An investor is keen to enter into a total return swap that
matures in one year with the senior bonds that are about to be issued as the reference
obligation. Under the terms of the contract, payments will be exchanged semiannually, where the
total return receiver will pay the six-month Treasury rate plus 350 basis points. What is the 15-
year Treasury rate at the time the bonds are issued?

A. 8%

B. 2%

C. 10%

D.4.5

Q.95 Alex is a financial analyst at a boutique investment firm, Stellar Capital. As part of his
training program, he is studying various option pricing models. Alex has been examining the
binomial option pricing model and its properties. He learns that the binomial model's calculated
value tends to change as time periods are added. Alex decides to delve further into the topic and
understand the convergence behavior of the binomial model as time periods increase. Based on
his findings, which of the following best describes how the value calculated using a binomial
model converges as time periods are added?

A. The model's calculated value becomes erratic and deviates substantially from the
actual option price.

B. The model's calculated value becomes less precise, leading to increased estimation
errors.

C. The model's calculated value remains unchanged regardless of the number of time
periods added.

[Link] model's calculated value gradually approaches the true continuous-time option
price as more time periods are added.

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Q.96 An unwanted result of deposit insurance is that it can cause banks to engage in risky
behavior in the knowledge that depositors are well insured by the Federal Deposit Insurance
Corporation (FDIC). This is an example of:

A. Adverse selection

B. Moral hazard

C. Asymmetric information

[Link] risk

Q.97 A random variable Y has an equal probability of having a value of 0, 1, 2 or -1. Given that X
= 3Y, what is the covariance of Y and X?

A. 3.25

B. 3.00

C. 3.50

D.3.75

Q.98 An analyst gathers monthly data about the returns of a stock for the past five years. If the
mean monthly return is 6% and the standard deviation of the series of returns is 1.8%, then what
is the standard deviation of the mean over the period?

A. 0.45%

B. 0.23%

C. 0.52%

D.1.39%

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Q.99 For a variable v, the value of α is 2, and the probability that v > 100 is 0.1. What is the
probability that v is greater than 200?

A. 0.025

B. 0.050

C. 0.105

D.0.225

Q.100 John Wick, FRM, manages two assets – A and B. The correlation between A and B is 0.2.
The table below outlines further details on the two assets:

Asset Annual Volatility Value

A 20% $200
B 25% $100

If Wick sells $100 worth of A and buys $100 worth of B, what would be the change in the daily
VaR at the 99% level of confidence? Assume 260 trading days.

A. 8.000

B. 0.897

C. 7.403

D.0.102

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