FRM Part 1: Mock Exam - Solutions

Answers
Q1: Ans. B
Sol: The phenomenon of fat tails is most likely the result of the volatility and/or the mean of the
distribution changing over time.
Q2: Ans. b
Sol. The standard error of sample mean sx =
So, n =

=5

= 36.

Q3: Ans. D
Sol. All the first three options correspond to the sources of basis risk.
Q4: Ans. A
Sol: Using CAPM model, the cost of capital = Rf+ m-Rf) = 3+1.2(6) = 10.2%
Discounting the cash flows at 10.2% will give the present value of $189,865
Q5: Ans. A
Sol: VaR(95%) = VaR(99%) x (Z95%/ Z99%) = 6500 x 1.65/2.33 = $4603
Q6: Ans: A
Sol: the probability of downgrade of a AA bond = sum of probabilities of it becoming A and BBB and BB
and B and CCC and D =7.78+0.58+0.06+0.11+0.02+0.01 = 8.56%
Q7: Ans. B
Sol: The minimum variance hedge ratio h =

Optimal number of contracts = = h

Va
Vf

= 0.7 X

s
f
,

= 0.84 * 0.035/0.042 = 0.7

,

= 35

Q8: Ans. B
Sol.
6-month forward exchange rate should be = 0.79 e(0.08 0.06)*0.5 = 0.798. As 0.81 > 0.798, borrow
US$ and sell the forward contract in Swiss Franc. Borrow $ 1000,000 at 8% per annum for 6 months,
convert to 1,000,000/0.79 = 1,265,000 Swiss Franc and invest the $ 1,265,000 Swiss Franc at 6% which

FRM Part 1: Mock Exam - Solutions

will grow to 1,303,500 Swiss Franc after 6 months. Enter into a forward contract to sell 1,303,000 Swiss
Franc for 1,303,000*0.81 = $1,055,835. The amount needed to pay off the US$ borrowing is
1000e0.08*0.5 = 1,040,810 US$. Profit = 1,303,000-1,040,810 = $262,190
Q9. Ans. C
When an asset is strongly negatively correlated with interest rates, futures prices will tend to be slightly
lower than forward prices. When the underlying asset increases in price, the immediate gain arising
from the daily futures settlement will tend to be invested at a lower than average rate of interest due to
the negative correlation .In this case futures would sell for slightly less than forward contracts, which are
not affected by interest rate movements in the same manner since forward contracts do not have a
daily settlement feature
The other three choices would all most likely result in the futures price being higher than the forward
price.
Q10. Ans. A
Sol. The dealer is interested only in finding out whether the resistance is greater or equal to the claimed
Oh s. o the lo e tail is i sig ifi a t a d it s a ight tailed test. a ple size is g eate tha
a d
population standard deviation is known. So Z-test.
Z-stat = ( 73-70 )/1.4 = 2.14
Q11: Ans. D
Sol. Payoff at the end of the agreement = 150,000,000 x (0.06 0.0610) x (6/12) = -75000.
Payoff at the start of the agreement = -75000/ (1+0.0610*0.5) = -72780
Q12: Ans. D
Sol: Rm-Rf=7.5%; E(Rp)=15%.
=

= 0.85x24.5/17 = 1.225

E(Rp)=Rf+ m-Rf) => 15% = Rf+1.225x7.5 => Rf = 5.8125%

Rm-Rf=7.5%; Rm=7.5+5.8125 = 13.3125%
Q13: Ans: a
Positive correlation means that, on average, a positive movement in one variable is associated with a
positive movement in the other variable. Because correlation is scale-free, this has no implication for the
actual size of movements.
Q14: Ans. d
Sol:
The up-tick and down- tick factors are

FRM Part 1: Mock Exam - Solutions

U = e T = e

= 1.1275;

D = e- T = 0.887
The risk neutral probability of an up move is Pu =

Pd = 0.36

= (e0.04 0.887)/(1.1275-0.887) = 0.64

40x1.1275= $45.1
Pay-off Cu = 0

0.64
$40
0.36

40x0.887 = $35.48
Pay-off = 42-35.48
Cd=$6.52

Expected Put option value in one year = CuPu + CdPd = 0 + 6.52x0.36 = $2.347
Present value of the put option = 2.347 x e-0.04 = 2.255
Q15: Ans. C
Sol. The number of options needed to hedge = 10,000/0.55 = 18,182
So short 18,182 call options are needed to hedge the long position is the stock.
Q16: Ans. c
Sol. To get a margin call, the money deposited in the margin account should come down to $200. So the
loss should be $50 on the contract of 100 gallons, i.e., $ 0.5 per gallon. So the price is $ 93
Q17: Ans. b
Sol. Conditional probabilities for constant stock price can be obtained; P(Constant/Excellent results) =
P(C/E) = 1-0.75-0.05 = 20%, P(C/M)= 40%, P(C/B) = 20%
Let the probability that the results were mediocre given the stock price was constant be
The

Ba e s theo e ,

0.

. .
. . + . . + . .

Q18: Ans. b
ol. Opti al u

e of o ta ts N* =

V
V

Here V and V a e sa e fo

oth po tfolios. o N*

FRM Part 1: Mock Exam - Solutions

Therefore, Portfolio B needs three times as many index futures contracts as Portfolio A.
Q19: Ans. b
Sol: Both Nick Leeson from Barings and John Rusnack from AIB created fake trades and tried to
manipulate the back office clearing.
Q20: Ans. b
Sol:
The delta of a forward position is always equal to 1 because of the one-to-one relationship with the
underlying asset.
Q21: Ans. c
Sol:
a.
b.
c.
d.

Wrong. The assumption is that investors can borrow/lend unlimited amounts at riskfree rate
Correct.
Wrong. The assumption is that unlimited short-selling is allowed.
Correct.

Q22: Ans. a
Sol: As it is given that correlation is zero between fixed income and equity,
VaR(Portfolio)2 = VaR(equity)2 + VaR(Fixed)2
1,670,0002 = 1,230,0002+ VaR(Fixed)2
Va Fi ed = ,

-1,230,0002) = 1,129,601.7

Q23: Ans: d
Sol: alpha=CAPM expected return of portfolio-Actual return
Although we know the actual return of the portfolio here, we need the CAPM expected return of
portfolio which in-turn needs beta and risk-free rate. Alpha can be negative or positive depending on
the beta.
Q24: Ans: d
Payoff at the end of the agreement = 150,000,000 x (0.06 0.0620) x (6/12) = -150000.
Payoff at the start of the agreement = -150000/(1+0.0620*0.5) = - $145489.82

FRM Part 1: Mock Exam - Solutions

Q25: Ans. b
Solution:
i.
ii.
iii.
iv.

Wrong. Interbank deposits are actually riskier than treasury bonds.

Correct. Because the treasury bonds are almost always over-priced due to excess demand,
the rate indicated is lower than what a risk free rate should have been.
Correct. Treasury bond are not taxed and so the interest rate implied is artificially low.
Wrong because (i) is wrong.

Q26: Ans. b
Sol:
r = 0.015
(0.2X0.3)
= 0.25

Q27: Ans: a.
Sol. Z=1.96 for 95% confidence level
The confidence interval is (-z, +z) = (8-1.96X3.25, 8+1.96X3.25) = (1.63, 14.37)
Q28: Ans: a
Sol: Joe did not maintain the confidentiality of his client thus violating the GARP code.
Q29: Ans. b
Sol:
Using put-call parity,
S0+P = C+Ke-rT
P = -50 + 4 + 55 e-0.04x0.25 = 8.45
Q30: Ans. b
Sol: High le e age as the easo LTCM s losses e e ag ified. Due to the size of the fu d s positio ,
it was difficult for them to liquidate the positions and they had to sell at a huge discount following the
Russian default which made the investors flight to quality.
But it s i o e t that LTCM e ui ed i esto s to i est fo sho t pe iod. A tuall the fu d eeded
investors to invest for 3 years which reduced the funding risk.

Q31: Ans: c

FRM Part 1: Mock Exam - Solutions

Sol.
a. Wrong. Covariance is not always a finite quantity.
b. Wrong. Correlation coefficient is less than or equal to 1 but not always positive. It ranges from -1 to
+1
c. Correct.
d. Wrong. Positively correlated random variables need not always move together but on an average
they move in tandem more often than not.
Q32: Ans. c
Sol. Theoretical price of the bond = 4e-0.062x0.5 + 4e-0.065x1 + 4e-0.069x1.5 + 104e-0.071x2 = $
101.46
Now to calculate yield y,
4e-yx0.5 + 4e-yx1 + 4e-yx1.5 + 104e-yx2 = $ 101.46
Using TI-BA II plus, PMT=4, N=4, PV=-101.46, FV=100 CPT -> I/Y = 3.57. So y=3.57*2=7.14%
Q33: Ans. d
Sol:
To make the position gamma neutral, 4000/1.33 = 3000 options should be bought.
3000 x 0.5 = 1500 units of underlying should be sold.
Q34: Ans. d
ol. P X

=P

+P

+P

. Usi g Poisso s dist i utio , P

P X = e-3(1+31+(32/2!)) = 0.423 = 42.3%

=e-

^x
!

Q35:Ans: c
Sol: Trenor ratio = ( Rp-Rf)/B = ( 0.12-0.06)/0.8 = 0.075
Q36: Ans. a
Sol: Gamma is the rate of change in option price with respect to change in delta.
Q37. Ans. d
Sol:
a. Wrong. There should be a linear relationship between the dependent and independent variables
b. Wrong. Multicollinearity, which is the high correlation between the independent variables
should not be there.
c. Wrong. Expected value of the error term, conditional on the independent variable .should be
zero

FRM Part 1: Mock Exam - Solutions

d. Correct. The key assumptions in OLS regression is that all observations are independent and
identically distributed (i.i.d.).

Q38: Ans. d
Sol. The forward rate between 6th and 12th month, Rforward=
6.5%

R T R T
T T

= (5.5x1-4.5x0.5)/0.5 =

Rforward = 2(e0.065/2 -1) = 6.6%

Value of FRA = 100,000 x (0.07-0.066) x (0.5) x e-0.055x1 = $189.3
Q39: Ans. a
Sol. Using binomial distribution, the probability for atleast 7 wins is
P(7)+P(8)+P(9)+P(10) = 10C7 (0.5)7(0.5)3+10C8 (0.5)8(0.5)2+10C9 (0.5)9(0.5)1+10c10(0.5)10(0.5)0
= 0.172

Q40: Ans. c
Sol.
a. Wrong. For a symmetric unimodal distribution, all the mean, median and mode should be equal
b. Wrong. For a positively skewed distribution, the mode is less than the median, which is less than
the mean
c. Correct. For a negatively skewed distribution, the mean is less than median, which is less than
the mode
d. Wrong. Skewness affects mean more than median and mode and the mean is dragged towards
the skew
Q41: Ans. d
.

Sol. To calculate the 6-month spot rate r1, 101.65 = (100+ ) e-r1/2
So r1 = 2 ln (

) = 0.0303 = 3.03%

To calculate the one year spot rate, 103.42 = (

x e-0.0303) + (100 +

So r2 = 0.0322 = 3.22%

Q42: Ans. b
Sol. Change in the bond price = Duration effect + Convexity effect

)x e-r2

FRM Part 1: Mock Exam - Solutions

= ( -Y du atio

x Convexity x Y

= (-0.005 x 8) + ( x 110 x (-0.005)2)

= -0.04 + 0.00138 = -0.03863 = -3.86%
Q43: Ans. c
Sol: Only option C is false. VaR is not sub-additive.
Q44: Ans. c
Sol.:
Bond

Face Value

Market price

Weights

5 million

4 million

4.912/8.3745 =
0.586
0.414

Total

9 million

5 x 0.98245 = 4.912
million
4 x 0.865625 =
3.462 million
$ 8.3745 million

Weighted
duration
0.586 x 8.27 =
4.85
0.414 x 6.4 =
2.65
7.5

Q45: Ans. a
Sol: We should find d(1). Initially solving for d(0.5). Coupon for bond A is $2.5 semi-annually
(100+2.5) d(0.5) = 102.345 i.e. d(0.5) = 0.9985
Now use the bond B. Coupon is $4 semi-annual
4 x d(0.5) + 104 d(1) = 102.655
4 x 0.9985 + 104 d(1) = 102.655
So d(1) = 0.949
Q46: Ans. c
Sol.
i.

ii.
iii.
iv.
Q47: Ans. a

Correct. The convexity effect = ( x Convexity x Y ) is always positive for an option-free

bond no matter which direction the interest rates move because convexity and Y are
positive
Wrong. Duration becomes inaccurate for large changes in yield due to convex and curved
relationship between yield and price of the bond.
Correct.
Convexity adjustment is typically smaller quantity than duration adjustment.

FRM Part 1: Mock Exam - Solutions

Sol: The correct answer is Convexity.
Convexity measures how interest rate sensitivity changes with interest rates.
Mathematically, convexity is defined as: C= (1/P)(SECOND DERIVATIVE OF P WITH RESPECT TO Y) where
P is the price of the bond and y is the yield-to-maturity.
Q48: Ans. c
Sol: Expectations of lower interest rates in the future (II) could cause a downward sloping yield curve.
Investors preference for short-term instruments (I) would lower the yields for short-term instruments
which would not cause a downward-sloping yield curve. Credit risk concerns (III) usually lead to upward
sloping yield curve since cumulative probability of defaut increases on a longer-term horizons. And, an
expected increase in inflation generally leads to an upward sloping yield curve.
Q49: Ans. c
ol. Ga h ,

odel is gi e

2n =+ U2n-1 + 2n-1

Whe e = VL = 0.03*0.000167 = 0.000005

= -- = -0.05-0.03=0.92
So, the Garch(1,1) model is 2n =0.000005+0.05 U2n-1+0.92 2n-1
Q50: Ans. d
Sol: Both i and ii are correct.

Q51: Ans. b
Sol: When the forward contract is underpriced, the arbitrageur sells the stock, invest the proceeds to get
risk free return and enter into forwards contracts.
Q52: Ans. c
Sol:
This question is applicable to Mortgage Backed Securities as well as callable bonds. We see that the
callable bond behaves like a straight bond when market yields are high, or when the bond price is low.
So, option C is correct and the others must be wrong.
Q53: Ans. c
Sol: Delta without dividend = N(d1) = 0.6
Delta with 1% dividend yield = 0.6 e -0.01x2 = 0.588
Q54: Ans. b
Sol: Input the following into TI-BA II plus

FRM Part 1: Mock Exam - Solutions

N=30; PMT=3; FV=100; I/Y=7/2; CPT->PV = 90.8 = V0
N=30; PMT=3; FV=100; I/Y=7.05/2; CPT->PV = 90.374 = V+
N=30; PMT=3; FV=100; I/Y=6.95/2; CPT->PV = 91.236 = V

+
2 x x Y

= (91.236-90.374)/(2x90.8x0.0005)
= 9.494

Q55: Ans: a.
Sol: a is correct. With the given data, the value of a European call option is USD 6.56 and the value of a
European put option is USD 11.20. We know that American options are never less than corresponding
European option in valuation. Also, the American call option price is exactly the same as the European
call option price under the usual Black-Scholes world ith o di ide d. Thus o l a is the o e t
option.
Q56: The correct answer is b
IR= (Average Rtn on the Portfolio Ave Rtn on the benchmark)/Tracking Error Volatility,
IR = 13.2 12.3/6.5 = 0.138
Q57: Ans. d
Sol: In the first year, the probability for an A rated firm to default is 1% and there is 90% chance that it
retains the rating.
In year 2, There is a 90% chance for the firm to remain A and the corresponding default rate is 1%
There is a 7.5% chance for the firm to be downgraded to B and default rate is 5%
There is a 1.5% chance for the firm to be downgraded to C and default rate is 20%
Probability of default in year 2 = 0.9x1+0.075x5+0.015x20 = 1.575%
Probability of default over two year period = 1% + 1.575% = 2.575%
Q58:

Ans. c
Sol: CAPM estimated expected return = Rf+ m-Rf) = 13%
Alpha = 15.5%-13% = 2.5%

Q59: Ans. b
Sol. As the sample size is less than 30, t-test must be done.
t-stat =

/n

= (32.5-32)/(2.8/29 = 0.96. t-critical = T99%,1-tailed,df 28 = 2.467

FRM Part 1: Mock Exam - Solutions

t-stat < t-critical. So failed to reject the null hypothesis
Q60: Ans. c
Sol. Consumption assets cannot be priced with the simple arbitrage argument because individuals and
companies who own consumption assets are reluctant to sell them in the spot market and buy the same
in futures because consumption assets are needed in their daily operations.
Q61: Ans. a
Sol. Multicollinearity is a statistical phenomenon in which two or more predictor variables in a multiple
regression model are highly correlated, meaning that one can be linearly predicted from the others with
a non-trivial degree of accuracy. Therefore option A.
Q62: Ans: b
Sol: The expected return of the portfolio as per CAPM is 4%+(10-4)x1.2 = 11.2%. As the actual value is
less than, we can say that the portfolio has underperformed.
Q63: Ans. d
Sol. Quoted price or clean price = 97-24 = 97+(24/32) = $97.75
Bond matures on July 10 which must be the last coupon date. Therefore the two coupon payment dates
are January 10 and July 10 which are 181 days apart.
No of days between January 10 and March 23 = 72
So accrued interest = (72/181) x $3 = $1.193
Dirty price = Clean price + accrued interest = 97.75 + 1.193 = $98.94

Q64: Ans. a
Sol. The cheapest to deliver bond will have the cheapest cost of delivering.
The cost of delivering each of these bonds is given by the equation:
Cost = Quoted price (Conversion factor x The most recent Settlement price)
Bond 1: 126.14 - 1.36x92.5 = $0.34
Bond 2: 119.33 1.22x92.5 = $6.48
Bond 3: 98.44 1.06x92.5 = $0.39
Bond 4: 134.50 1.43x92.5 = $2.225
Q65: Ans: c
Sol: For equal weighted portfolio, return = arithmetic average = (12+15)/2 = 13.5%
Standard deviation if equal weighted and correlation - = |1- 2| = 0.5 x 6 = 3%

FRM Part 1: Mock Exam - Solutions

Q66: Answer: a, 5.44%

Sharpe Ratio = 1.95
(Portfolio Return Risk Free Rate) / Standard Deviation = 1.95
(Portfolio Return 4.2%) / 5.2% = 1.95
Portfolio Return = 14.34%
Now, Information Ratio = 1.68
(Portfolio Return Nifty Return)/ Tracking Error = 1.68
(14.34% - Nifty Return) / 5.3% = 1.68
Nifty Return = 5.44%
Q67: Answer: C. III and IV
I is a principle in GARP Code of Conduct. See Standard 1.3
II is a principle in GARP Code of Conduct. See Standard 2.1
III is not a principle in GARP Code of Conduct. GARP members must be diligent about not overstating the
accuracy or certainty of results or conclusions (Standard 4.4).
IV is not a principle in GARP Code of Conduct. GARP members must have ethical responsibilities and
cannot outsource or delegate those responsibilities to others (Standard 4.2)
Q68: Answer: d, Fraud and deception
Fraud and deceptio as t espo si le fo the isis at Metallgesells haft. It as the ti i g
differences in the cash flows of its long and short positions, size of its portfolio impacted market
price and conservative financial reporting principles that did not recognize the gains on the forward
contracts.
Q69: Ans. a
Sol: SSR is lower if more variables are included
Q70: Ans: d
Sol: Bond price = [(2.5/(1+0.06/2) ) + (102.5/(1+0.07/2)2)] = 98.11
Q71: Ans. c
Sol. Euro-dollar futures contracts are designed in such a way that each basis point increase in the quoted
price will lead to a gain of $25 for the long or a loss of $25 for the short and vice-versa.
Here, the quoted price increased by 17 basis points so the gain = 17x25 = $425
Q72: Ans. c

FRM Part 1: Mock Exam - Solutions

Solution. The kurtosis is greater than 3 which means the distribution is more peaked (leptokurtic) than
a normal distribution. The skewness is negative which means a longer left tail (negatively skewed).
Q73: Answer: c, Contingent Assets
The sovereign ratings do not o side Co ti ge t Assets fo the ati g ut Co ti ge t Lia ilities.
He e, optio

C o e t.

Q74):Ans. b
Sol. 94-02 = 94.0625. So Vf=94,062.5; P=20,000,000
The number of futures contracts required to hedge against an uncertainty in interest rate changes is
given by:

PDP
F DF

N =V

Q75: Ans. a

,
x

.
.

= 172. So the manager should short 172 contracts

Sol. For standard normal distribution, variance=1. Therefore Var(X)=Var(Y)=1.

Var(aX+bY) = a2 Var(X) + b2 Var(Y) + 2.a.b.Covar(X,Y)
So Var(X+3Y)= 1 + 32 . 1 + 2 . 1 . 3 . 0.5 = 13
Q76: Ans. b
Sol:
Of the 20-year bond constitutes a perfect hedge. Calculating the optimal hedge ratio (HR) gives: HR =
yield beta * (DV01 of the Position / DV01 of the hedging instrument) = 0.87 * (0.16243 / 0.14131)
=1.00003 = 1 (approximately) To completely hedge the position, for every $1 par value of the 20-year
bond, we have toshort $1 of par of the 10-year bond.
Q77: Ans. d
Sol. As an asset is meant to receive the interest rates, one should be receiving floating rate which is
LIBOR and in return should pay fixed rate as per the terms of a swap.
Q78: Ans. c
ol. We a alue a i te est ate s ap eithe i te
FRA approach here.

s of o d p i es o i te

s of FA s. Let s use the

Here the institution receives a fixed cash flow of 4 million (100x0.08x0.5) semi-annually but the cash
outflow is floating dependent on the LIBOR. The floating rate of the first outflow i.e. at T=0.25 years
from now was the 6-month LIBOR rate at the last payment date i.e 9.2%.
The next outflow which occurs at time 0.75 years from now is dependent on the current LIBOR which
can be calculated using the 3-month and 9-month LIBOR rates. i.e

FRM Part 1: Mock Exam - Solutions

.

x . .
.

= 9.7 % with continuous compounding or 9.99% with semi-annual compounding.

Similarly the next cash outflow occurs at time = 1.25 from now and the floating rate is determined
similarly. i.e.
.

Time

.
.

0.25
0.75
1.25

x .

= 10.75% with continuous compounding = 11.044% with semi-annual compounding

Fixed cash
In-flow
4
4
4
TOTAL

Floating cash
outflow
4.6
4.995
5.52

Net cash flow

Discount factor
Using LIBOR
0.97775
0.93123
0.8825

-0.6
-0.995
-1.52

Present value
of net cashflow
-0.587
-0.926
-1.341
-2.854

Q79: Answer: b, IV only

I is false. Hamanaka took a dominant long position in futures contracts and purchased large
quantities of physical copper to manipulate the market.
II is false. Hamanaka sold put options on copper prices, further exposing Sumitomo to the risk of
falling copper prices.
III is false. u ito o s la k of supe isio of Ha a aka eated a high deg ee of operational risk,
which could have been reduced using proper internal controls.
IV is true. Ha a aka s auto o
accumulate more copper

allo ed hi

to gi e po e of atto e to

oke age fi

s to help

Q80: Ans. d
Sol. The maximum payoff in both bull and bear spreads is the difference between the strike prices
i.e. $45-$38 = $7. Cost of options in both cases is $5 - $3 = $ 2.
Therefore maximum profit possible = 7-2 = $5 in both cases.

Q81: Ans. a
Sol. whichever p+S0 and c+Ke-rT comes greater, short that and long the other.
Q82: Ans. b
Sol. From the given data, a regression model can be built with S&P as an independent variable.
The slope of regression b1=

, &
&

&

,&

The coefficient b0 is given by b0= Mean(dow) b1* Mean(S&P) = 7 - 0.71*8 = 1.32

So the regression model for returns is: DowJones=1.32+0.71(S&P500)

= 0.71

FRM Part 1: Mock Exam - Solutions

Estimated annual return for Dow Jones in 2013 = 1.32+0.71*9 = 7.71%
Q83: Ans. a
ol: = ; K=
d =

ln

S
K

; = .

+(r+
T

)T

; = . ; T=
= -0.566; d2=d1- T = -0.566- . .

= -0.682

N(d1) = 0.714; N(d2) = 0.752

C = S N(d1) K e-rT N(d2) = 50(0.714) 55 e-0.07x0.33(0.752) = 0.958

Q84: Ans. a
Sol: The portfolio dollar duration of a basis point (DV01) = (portfolio modified duration X market value of
portfolio)/10,000.
The portfolio modified duration is obtained by taking the weighted average of the modified duration of
the bonds in the portfolio. Mathematically, it is as follows: w1D1 + w2D2 + w3D3 ++ kDk
where
wi = market value of bond i/market value of the portfolio
Di = modified duration of bond I,
K = number of bonds of the portfolio.
Based on the above, the market values are as follows:
bond A = 101.43 x 3,000,000/100 = 3,042,900,
bond B = 84.89 x 5,000,000/100 = 4,244,500,
bond C = 121.87 x 8,000,000/100 = 9,749,600.
Total market value of the portfolio = 3,042,900+4,244,500+9,749,600=17,037,000
Portfolio modified duration is calculated as follows: (3,042,900/17,037,000)2.36
+(4,244,500/17,037,000)4.13 + (9,749,600/17,037,000)6.27 = (0.1786)2.36+(0.2491)4.13+(0.5723)6.27 =
0.4215+1.0289+3.5881=5.0385
Therefore, the portfolio dollar duration of a basis point (DV01) is obtained as follows: (5.0385 x
17,037,000)/10,000 = 8,584
Q85: Ans: b
The required probability = [P (first card is non face card) AND P(second card is a face card) AND P(third
card is a face card)] OR [P (first card is a face card) AND P(second card is a face card) AND P (third card is
a face card)]

FRM Part 1: Mock Exam - Solutions

The required probability = [P (first card is non face card) P (second card is a face card) P (third card is
a face card)] + [P (first card is a face card) P (second card is a face card) P (third card is a face card)]
The required probability = [(40/52) (12/51) (11/51)] + [(12/52) (11/51) (11/51)] = 11/221
He e optio B is correct.
Q86: Ans. d
Sol. Debentures are unsecured and so offer higher interest. Convertible debentures are convertible into
common stock which lowers the interest rate. Subordinated debentures are unsecured and are at the
bottom of seniority claim. So offer high interest rate.
Q87: Ans: c
Sol:The standard error of the sample mean is estimated by dividing the standard deviation of the sample
by the square root of the sample size: sx = s / (n)1/2 = 30 / (400)1/2 = 30 / 20 = 1.5.
Q88: Ans. a
E[ra | rb = ] = a + a a / a

= .

+ .9 *

0.02) = 0.029

Q89: Ans. b
Sol. The regime switching model captures the conditional normality and allows for conditional means
and volatility accounting for fatter tails.
Q90: Ans. b
Sol.
a. Wrong. In a loan default the principal is lost but in interest rate swap, the principal is just
notional so only the difference in interest payments is lost.
b. Correct. Currency swap generally involves exchange of principal amounts in two different
currencies at the end of the life of swap. So it has a greater value at the time of a default.
c. Wrong.
d. Wrong.
Q91: Ans. a
Sol. The long-run average variance is 0 in EWMA.

Q92: Ans. d
Sol: The Macaulay duration of a zero coupon bond = the time to maturity = 15 years
Modified duration = Macaulay duration/(1+Y) = 15/1.0714 = 14
Q93: Ans. d
Sol. Deep-in-the-money means delta = 1

FRM Part 1: Mock Exam - Solutions

So 1x3300 = 3300 units of underlying should be sold to hedge the long hedge.
Q94: Ans. a
ol. The futu e ost of sto age fo th ee

o ths

,T is

0.04(1+1.01+1.012) = $0.1212
F ,T = e T +

,T = e .

* + .

=$ .

Q95: Answer: a.
Sol: a: is correct. With the given data the value of European call option is USD 30.25 and value of
European put option is USD 9.48. We know that American options are never less than corresponding
European option in valuation. Also, the American call option price is exactly the same as the European
call option price under the usual Black- holes o ld ith o di ide d. Thus o l a is the o e t
option.

Q96: Ans. c
Sol. The no arbitrage forward price of the 90 day contract should be:
FT = 1.08 x
Q97:

.
.

Ans. a

9 /

9 /

= 1.077 AD/CAD

Sol. The present value of the dividends I = 2 x e-(4/12)x0.06 + 2 x e-(8/12)x0.06 = 3.88

Forward price F0 = (S0-I)erT = (51.7-3.88) e

x .

= $50

Q98: Ans: c
Sol: Converting months to years, R(0,0.5) = 4%, R(0,1) = 5%, R(0,1.5) = 5.5%, R(0,2) = 6%
The required forward rate R(1.5,2) =2x[(1+(R(0,2)/2)]4/[1+(R(0,1.5)/2)3)-1] = 7.5%
Q99: Ans. d
Sol: The number of exceptions = (1 confidence interval) * (number of days) = (1 0.95) * (250) = 12.5.
So 13 days
Q100: Answer: d, 15.99
Correlation coefficient between the return on portfolio and return on market index = 0.65

FRM Part 1: Mock Exam - Solutions

So, Beta = [Correlation Standard Deviation of Portfolio Standard Deviation of Market] / Standard
Deviation of Market2
Therefore, Standard Deviation of Portfolio = [1.4 12.42] / [0.65 12.4] = 26.71%
But, Sharpe ratio = [E(Rp) Rf] / Standard Deviation of Portfolio
Therefore, [E(Rp) Rf] = Sharpe ratio Standard Deviation of Portfolio = 1.15 26.71 = 30.72%
Now, Treynor Ratio = [E(Rp) Rf] / Beta = 30.72 / 1.4 = 21.94
But, Treynor Ratio = Alpha / Beta + [E(Rm) Rf]
Therefore, Alpha = [21.94 10.52] 1.4 = 15.99