2016

FRM EXAM REVIEW

COVERS
ALL TOPICS
IN PART I

FRMPART I

FORMULA SHEETS
Cover image: Loewy Design
Cover design: Loewy Design

Copyright 2016 by John Wiley & Sons, Inc. All rights reserved.

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ISBN 978-1-119-34823-8 (ebk)

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10 9 8 7 6 5 4 3 2 1
Foundations of Risk Management (FRM)
Elton, Chapter 13

Elton, Chapter 13

E ( Rm ) R f
E(R f ) = R f + X
m

E ( Ri ) = RF + i ( E ( RM ) RF )

Where:

E ( R p ) = expected return of asset (of portfolio) i

RF = risk-freee rate of return
E ( RM ) = expected rate of return of the market portfolio
Cov( Ri , RM )
1 =
Var( RM )

Equation of CML:

E (Rm ) R f
E (R p ) = R f + p
m

Cov( Ri , Rm ) i , m i , m i , m i
i = = =
2m 2m m

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 Amenc, Chapter 4

Amenc, Chapter 4

Rp Rf
Sharpe ratio =
p

Rp Rf
Treynor ratio =
p

p = R p [ R f + p (R m R f )]

TrackingError = (ActiveReturn BenchmarkReturn)

RP RB
IR =
s(RP RB )

R T
S=
DR

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Bodie, Chapter 10

Bodie, Chapter 10

E ( R p ) = RF + 1 p,1 + ... k p,K

Required return = Risk-free rate + (Risk premium)1 + (Risk premium)2 + . . .

+ (Risk premium)k
Risk premiumi = Factor sensitivityi Factor risk premiumi

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Quantitative Analysis (QA)
Miller, Chapter 2

Miller, Chapter 2

P(A or B) = P(A) + P(B) P(AB)

P(A and B) = P(A) P(B)

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 Miller, Chapter 3

Miller, Chapter 3

N
Xi
= i =1
N

N
( X i )2
i =1
=
N

Cov(XY) = E{[X E(X)][Y E(Y)]}

Cov(R A ,R B ) = P(R A,i , R B,J )(R A,i ER A )(R B,j ER B )

i j

Cov(R A , R B )
Corr(R A , R B ) = (R A , R B ) =
(A )(B )

N
E(R p ) = w i E(R i ) = w1E(R1 ) + w2 E(R 2 ) + ... + w N E(R N )
i =1

N N
Var(R p ) = w i w jCov(R i , R j )
i =1 j=1

Var(R p ) = w2A 2 (R A ) + w2B2 (R B ) + 2w A w BCov(R A , R B )

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Miller, Chapter 4

Miller, Chapter 4

n!
P(r ) = pr q n r
r !(n r )!

L = e
(+0.52 ) 2L = e
(2+2 ) e2 1

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 Miller, Chapter 6

Miller, Chapter 6

P(Information|Event) P(Event)
P(Event |Information) =
P(Information)

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Miller, Chapter 7

Miller, Chapter 7

s2 =
(X X ) 2

n 1

Formula of Standard Error

s
90% confidence interval: X 1.645
n
s
95% confidence interval: X 1.960
n
s
99% confidence interval: X 2.575
n

Sample statistic Hypothesized value

Test statistic =
Standard error of sample statistic

10 2016 Wiley
 Hull, Chapter 11

Hull, Chapter 11

COVn = COVn 1 + (1 ) X n 1Yn 1

COVn = + xn 1 + Yn 1 + cov n 1

1 = Z1
2 = Z1 + Z 2 1 2

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Stock, Chapter 4

Stock, Chapter 4

Regression model equation = Yi = b0 + b1 Xi + i, i = 1,...., n

Regression line equation = Yi = b0 + b1 Xi , i = 1, ..., n

n
( )
2
ESS = Yi Y
i =1

1/ 2 1/ 2
n
( ) n
2
Yi b0 b1 Xi ( i )
2
1/ 2
SSE
SEE = i =1
= i =1 =
n2 n2 n2

Explained variation Total variation Unexplaiined variation

R2 = =
Total variation Total variation
Unexplained variation
=1
Total variation

12 2016 Wiley
 Stock, Chapter 5

Stock, Chapter 5

b j (tc sb )
j

estimated regression coefficient (critical t -valu

ue)(coefficient standard error)

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Stock, Chapter 6

Stock, Chapter 6

2
Var (Slope) =
( x x )2

MSR RSS/k
F -stat = =
MSE SSE/[n (k + 1)]

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 Stock, Chapter 7

Stock, Chapter 7

n 1
Adjusted R 2 = R 2 = 1 (1 R )
2

n k 1

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Diebold, Chapter 5

Diebold, Chapter 5

e 2
t
s2 = t =1
,
T k

2k

e 2
t
AIC = e T t =1
T

k

e 2
t
SIC = T T t =1
.
T

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 Hull, Chapter 23

Hull, Chapter 23

2n = VL + U n21 + 2n 1

2n = + U n21 + 2n 1

b0
xt =
1 b1

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Financial Markets and Products (FMP)
 Hull, Chapter 1

Hull, Chapter 1

VT(0, T) = ST F(0, T)

F(0, T) = S0 (1+ r )T

Vt (0, T) = St [ F(0, T) / (1+r )T t ]

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Hull, Chapter 3

Hull, Chapter 3

s
MinimumVarianceHedgeRatio =
r

MDTarget MDPortfolio MVPortfolio

# of Futures = Yield
MDFutures MVFuturres Contract

Target Portfolio MVPortfolio

# of Futures =
Futures MVFutures Contract

20 2016 Wiley
 Hull, Chapter 4

Hull, Chapter 4

PMT PMT PMT + FV

PV = 1
+ 2
+ ... +
(1 + Z1 ) (1 + Z 2 ) (1 + Z N )N

relationship between multiperiod spot rates and forward rates:

(1 + 1s0 ) (1 + 1f1 ) = (1 + 2s0 )

2

(1 + 2s0 ) (1 + 1f2 ) = (1 + 3s0 )

2 3

B 1
= Dy + C (y)2
B 2

Convexity adjustment = Convexity estimate (r )2 100

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Hull, Chapter 5

Hull, Chapter 5

FFC/DC = SFC/DC
(1 + i FC )
(1 + i DC )

FFC/BC = SFC/BC
(1 + i FC )
(1 + i BC )

( i i ) Actual
FFC/DC SFC/DC = SFC/DC 360
FC DC

DC (
1 + i Actual
360 )

( i i ) Actual
FFC/BC SFC/BC = SFC/BC 360
FC BC

BC (
1 + i Actual
360

)

F0 = S0 e rT
r = Continuously compounded risk-free rate
F0 = S0 e( r+U ) T

F0 = S0 e( r+U Y ) T

22 2016 Wiley
 Hull, Chapter 6

Hull, Chapter 6

AI = the boxed
formula

(days between dates/days in period ) * interest earned during the period

BC0 ( T + Y ) 1 + r0 ( T ) FV ( CI, 0, T )
T

f0 ( T ) =
CF ( T )
CF ( T ) = Conversion factor on CTD bond

1
Forward Rate = Futures Rate 2T1T2
2

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Hull, Chapter 7

Hull, Chapter 7

1 B0 ( N )
Swap fixed rate = 100
B (1) + B ( 2 ) + B (3) + ... + B ( N )
0 0 0 0

24 2016 Wiley
 Hull, Chapter 11

Hull, Chapter 11

cS

CS

pK

pK

c max (0, S0 Ke rT )

C = max(0, ST K )

p max( Ke rT S0 , 0)

C + X/ (1+r )t = S0 + P

C0 c 0

P0 p0

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Hull, Chapter 12

Hull, Chapter 12

Bear spread valueT = MAX(0, StrikeH AssetT) MAX(0, StrikeL AssetT)

PayoffBear spread = Bear spread valueT PutStrikeH + PutStrikeL

Bull spread valueT = MAX(0, Asset T Strike L ) MAX(0, Asset T Strike H )

PayoffBullspread = Bull spread valueT CallStrikeL + CallStrikeH

Butterfly spread valueT = MAX(0, AssetT StrikeL) 2MAX(0, AssetT

StrikeM) + MAX(0, AssetT StrikeH)
PayoffButterfly spread = Butterfly spread valueT CallStrikeL + 2CallStrikeM
CallStrikeH

Box strategy valueT = StrikeH StrikeL

PayoffBox strategy = StrikeH StrikeL CallStrikeH PutStrikeH + PutStrikeL

Breakeven Straddle Asset T = Strike (Call 0 + Put 0 )

PayoffStraddle = Straddle valueT Call 0 Put 0

26 2016 Wiley
 McDonald, Chapter 6

McDonald, Chapter 6

Fo,T = S0 e( r )T

F0 = S0 e( r +U )T

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Saunders, Chapter 13

Saunders, Chapter 13

(Forward rate Spot rate) ( IRDomestic IRForeign )

=
Spot rate (1 + IRForeign )
and
Forward (1 + IRDomestic )
=
Spot (1 + IRForeign )

Real exchange rate DC/FC = SDC/FC ( PFC / PDC )

28 2016 Wiley
 Tuckman, Chapter 20

Tuckman, Chapter 20

Prepayment in month t
SMM t =
Beginning mortgage balance for month t Scheduled principal payment in month t

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Valuation and Risk Models (VRM)
 Allen, Chapter 3

Allen, Chapter 3

PortfolioVaR = VaR underlying

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Dowd, Chapter 2

Dowd, Chapter 2

1
ES =
1
(greatest loss) * pr (loss)

32 2016 Wiley
 Hull, Chapter 13

Hull, Chapter 13

c+ c
n=
S+ S

c + + (1 )c
c=
(1 + r )

(1 + r d )
=
(u d)

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Hull, Chapter 15

Hull, Chapter 15

Pi Pi 1
Ri = , i = 1 to N
Pi 1

Ric = ln(1 + Ri ), i = 1 to N

(R c
i Ric )2
=
2 i =1

N 1

= 2

c = S0N(d1) KerT N(d2)

and
p = KerT N(d2) S0N(d1)

where
ln(S0 / K ) + (r + 2 / 2)T
d1 =
T
ln(S0 / K ) + (r 2 / 2)T
d2 = = d1 T
T

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 Hull, Chapter 19

Hull, Chapter 19

Change in option price

Delta =
Change in underlying price

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Tuckman, Chapter 1

Tuckman, Chapter 1

Days
PV = FV 1 DR
Year

Year FV PV
DR =
Days FV

PVFull = PVFull + AI

AI = t/T PMT

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 Tuckman, Chapter 2

Tuckman, Chapter 2

1
d (t ) =
r (t ) 2 t
(1 + )
2

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Tuckman, Chapter 3

Tuckman, Chapter 3

Pt +1 + c Pt
R=
Pt

2T

C 1
P(T ) = 1
i y
1+
2

38 2016 Wiley
 Tuckman, Chapter 4

Tuckman, Chapter 4

P P+
Effective duration =
2 P0 (y)

Price = y Duration Price

Face A DV 01A
FaceB =
DV 01B

PV y PV+ y
2( PV0 )y

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Tuckman, Chapter 5

Tuckman, Chapter 5

1 P
DV 01k =
10, 000 y k

1 P
Dk =
P y k

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 Schroeck, Chapter 5

Schroeck, Chapter 5

UL = EA PD 2LR + LR 2 2PD

n n
ULP = UL UL
i =1 j =1
i j ij i j

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