2016年5月FRM二级模拟考试一（题目）

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2016 年 5 月 FRM 二级模拟考试（一）
1. An analyst is reviewing a bond for investment purposes. The bond is expected to have a
default probability of 2%, with an expected loss of 80 bps in the event of default. If the
current risk-free rate is 4%, what is the minimum coupon spread needed on the bond for
its expected return to match the risk-free rate?
A. 90 bps
B. 120 bps
C. 200 bps
D. 280 bps
2. A risk manager is pricing a 10-year call option on 10-year Treasury using a successfully
tested pricing model. Current interest rate volatility is high and the risk manager is
concerned about the effect this may have on short-term rates when pricing the option.
Which of the following actions would best address the potential for negative short-term
interest rates to arise in the model?
A. The risk manager uses a normal distribution of interest rates.
B. When short-term rates are negative, the risk manager adjusts the risk-neutral
probabilities.
C. When short-term rates are negative, the risk manager increases the volatility.
D. When short-term rates are negative, the risk manager sets the rate to zero.
3. Melvin Brown manages a long portfolio of debt and equity investments for an insurance
company and has been trying to implement a new risk management program based on
estimating and reporting the daily value at risk (VaR) for each manager’s portfolio. Brown
is writing a report to gain support for his proposal. If Brown determines that daily VaR
(10%) for his portfolio is equal to $20,000, which of the following statements should he
including in his report?
A. Computationally, delta-normal VaR is more complex than standard deviation but
easier to interpret from a risk management perspective.
B. VaR was developed specifically for the purpose of measuring the economic capital
required to protect bank portfolios against losses.
C. The risk of losing more than $20,000 in Brown’s portfolio value in any given week is
10%.
D. Portfolio diversification is not fully accounted for using the VaR methodology.
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4. The rate parameter in the exponential distribution measures the rate at which it takes an
event to occur. In the context of waiting for a company to default, the rate parameter is
known as the hazard rate and indicates the rate at which default will arrive. Which of the
following statements about hazard rates (i.e. default intensity) is correct assuming a
constant default intensity of 0.2?
A. The cumulative default probability after 3 periods = EXP (-0.2 × 3)
B. The conditional default probability after 1 period = 2%
C. The unconditional default probability is memoryless
D. The default probability in the second period = 14.9%
5. How many of the following statements regarding risk budgeting are correct?
I. Tracking error is defined as the standard deviation of the difference between the
returns on a portfolio and the benchmark portfolio.
II. Using only information ratios allow risk on entire (firm) portfolios to be budgeted
(allocated) across various portfolios managed by separate managers.
III. The optimal weights of the allocations to various fund managers (of a firm) do not
necessarily have to sum to one.
IV. The benchmark portfolio cannot be assigned any weight under the optimal allocation
scheme across active fund managers of a firm.
A. One
B. Two
C. Three
D. Four
6. A firm uses VaR to estimate the probability of losses. However, management is concerned
that the estimation process gives equal weight to all observations. Therefore, alternative
approaches are considered. Which of the following statements accurately describes an
alternative weighted historic simulation approach?
I. Individual observations can be weighted based on volatility by substituting historical
returns with volatility-adjusted returns.
II. Historical returns can be revised using correlation-adjusted returns.
A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.
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7. The annual mean and volatility of a portfolio are 10% and 40%, respectively. The current
value of the portfolio is GBP 100,000. How does the 1-year 95% VaR that is calculated
using a normal distribution assumption (normal VaR) compare with the 1-year 95% VaR
that is calculated using the lognormal distribution assumption (lognormal VaR)?
A. Lognormal VaR is greater than normal VaR by GBP 13,040
B. Lognormal VaR is greater than normal VaR by GBP 17,590
C. Lognormal VaR is less than normal VaR by GBP 13,040
D. Lognormal VaR is less than normal VaR by GBP 17,590
8. Risk aggregation is one of the challenging areas within the economic capital
implementation framework. Risk aggregation involves identifying the individual risk types
and making certain choices in aggregating those risk types. Classification by risk types
(market, credit, operational, and business) may be approximate and prone to error. For
example, the definitions of risk types may differ across banks or within a given bank,
which complicates the aggregation process. Most banks begin by aggregating risk into
silos by risk-type across the entire bank. Other banks prefer using business unit silos,
while others combine both approaches. Which of the following statements regarding risk
aggregation is correct?
A. Combining two portfolios, for risk aggregation across different portfolios or business
units of a bank, will result in lower risk per investment unit in the combined portfolios
versus the weighted average of the two separate portfolios.
B. A simple summation method of risk aggregation adds together individual capital
components, differentiates between risk types, and produces unequal weighting.
C. A variance-covariance matrix risk aggregation method summarizes the
interdependencies across risk types and provides a flexible framework for
recognizing diversification benefits.
D. A full modeling/simulation method of risk aggregation combines marginal probability
distributions into a joint probability distribution through copula functions.
9. Grayson Ballentine, an analyst with Platinum Consultants, is analyzing the economic

effects of buying stock with borrowed funds for a high net worth individual client. Assume
that the client has $200 cash invested (i.e., no borrowed funds) and then uses the cash to
purchase stock. The client then decides to use 50% borrowed funds to purchase stock on
margin. After the margin transaction, the total assets on the full economic balance sheet
and the leverage ratio are closest to:
Total Assets Leverage Ratio
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A. $200 1.0
B. $300 1.5
C. $300 2.0
D. $400 2.0
10. A risk analyst is comparing the use of parametric and non-parametric approaches for
calculating VaR and is concerned about some of the characteristics present in the loss
data. Which of the following distribution characteristics would make parametric
approaches the favored method to use?
A. Skewness in the distribution
B. Fat tails in the distribution
C. Scarcity of high magnitude loss events
D. Heteroskedasticity in the distribution
11. As a result of the new Basel standards, every bank must now calculate explicit capital
charges to cover operational risk using one of three approaches: the basic indicator
approach (BIA), the standardized approach (SA), and the advanced measurement
approach (AMA). How many of the following statements are true with respect to these
operational risk approaches?
I. In practice the AMA is the most stringent approach for operational risk.
II. The most popular method to satisfy the AMA is the loss distribution approach.
III. The AMA allows a bank to build its own operational risk model and measurement
system comparable to market risk standards.
IV. BIA is widely used in insurance and actuarial science.
A. One
B. Two
C. Three
D. Four
12. Basel’s 1996 Amendment allows more sophisticated banks with well-established risk
management functions to use an internal model-based approach (IMA) for setting market
risk capital. Most large banks preferred to use the internal model-based approach
because it better reflected the benefits of diversification and led to lower capital
requirements. About this capital charge for market risk under the internal models
approach (IMA), including 2009 revisions to the original Amendment, each of the following
is true except which is not?
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A. The value-at-risk (VaR) measure used in the internal model-based approach is

calculated with a 10-day time horizon and a 99.0% confidence level; and regulators
explicitly stated that the 10-day 99.0% VaR can be calculated as the one-day 99.0%
VaR multiplied by the square root of ten; i.e., 10-day 99.0% VaR = one-day 99.0%
VaR×sqrt(10)
B. The capital requirement is equal to max[VaR(t – 1), m(c) ×VaR(avg)] + SRC, where
m(c) is a multiplicative factor with a minimum value of 3, SRC is a specific risk charge,
VaR(t – 1) is the previous day’s value at risk, and VaR(avg) is the average value at
risk over the past 60 days
C. The capital requirement adds two terms: value-at-risk (VaR) and specific risk charge
(SCR). In a corporate bond security, for example, the credit risk is captured by the
VaR term and the interest rate risk is captures by the SRC term.
D. The bank’s VaR risk model must contain a “sufficient” number of risk factors and the
bank must justify the omission of any risk factors that are otherwise used in pricing
(valuation).
13. Under the contingent claim approach to the firm’s capital structure, which of the following
statements is true? Assume the amount of senior debt, subordinated debt, and equity is
represented as F, U, and S, respectively.
A. The value of subordinated debt is less than the value of senior debt.
B. Subordinated debt can be represented by a long call with exercise price of F and
short call with exercise price of U.
C. Subordinated debt behaves more like equity in distress and more like debt when the
firm is not in distress.
D. The value of subordinated debt is always greater than the value of equity.
14. An analyst is examining a sample of return data. As a first step, the analyst construct a
QQ plot of the data as shown below.
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Based on an examination of the QQ plot, which of the following statements is correct?
A. The returns are normally distributed.

B. The return distribution has thin tails relative to the normal distribution.
C. The return distribution is negatively skewed relative to the normal distribution.
D. The return distribution has fat tails relative to the normal distribution
15. A firm’s financial planning department reports that a project’s proposed risk-adjusted
return on capital (RAROC) is 13%, the risk-free rate is 3%, the market return is 11%, and
the firm’s equity beta is 1.3. Use adjusted risk-adjusted return on capital (ARAROC) to
determine whether or not the project should be accepted. This firm should:
A. Reject the project because its expected ARAROC is higher than the market’s excess
return.
B. Accept the project because its expected ARAROC is higher than the market’s excess
return.
C. Accept the project because its expected ARAROC is lower than the market’s excess
return.
D. Reject the project because its expected ARAROC is lower than the market’s excess
return.
16. Analyst Barbara constructed an interest rate tree with monthly time steps, where (t) = 1/12.
The current short-term rate is 3%. Her term structure model assumes an annual basis
point volatility of 200 basis points with an annual (lambda) drift of 50 basis points. She
employs Tuckman’s Model 2 which assumes normally distributed rates and incorporating
drift. Here is her rate tree:
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What is the un-displayed missing value at node [2.0]; i.e., the rate in the tree not the
realized process?
A. 1.93%
B. 2.17%
C. 2.38%
D. 3.01%
17. Harrison Michaels, FRM, an analyst at Hudson Risk Analytics, is discussing the default
sensitivities of equity, mezzanine, and senior tranches and makes the following
statements. Which of the following statements is (are) most likely correct?
I. Default sensitivities are largest close to the attachment point between tranches.
II. Default sensitivities are computed by shocking the credit default swap (CDS) default
curve.
A. I only.
B. II only.
C. Both I and II.
D. Neither I nor II.
18. Under the loss distribution approach (LDA), Girling says the first step is to model
frequency. The next step (Step #2) is to model severity: “The next step in modeling
expected operational risk losses is to determine the likely size of an event given the fact
that an event has occurred. This is the severity of an event. Unlike frequency, severity
need not be an integer, but can fall anywhere along a continuum. When a loss occurs it
might be $1.50 or it might be $133,892.25 or any other value. The severity distribution
establishes the probability of an event occurring over a wide range of values, from zero to
very, very large losses.”
According to Girling, each of the following statements is true about the severity
distribution except which is false?
A. Regulators take a keen interest in how well the selected distribution demonstrates
“goodness of fit;” i.e., how certain are we that the sample comes from the population
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with the claimed distribution.

B. In addition to “goodness of fit,” a suitable severity model should probably meet the
following criteria: realistic, well-specified, flexible, and simple.
C. Whichever distribution is selected, the probability density function for severity will
have light (thin) tails and will also be skewed to the left.
D. The most common and least complex approach to modeling severity is to use a
lognormal distribution, although low frequency losses may fit better to other options
such as Generalized Gamma, Transformed Beta, Generalized Pareto, or Weibull.
19. The risk management group estimates the 1-day 99% VaR on a long-only, large-cap
equity portfolio using a variety of approaches. A daily risk report shows the following
information:
1-day 99% VaR Estimates (by approach):
 Delta-Normal VaR: USD 441,940
 Monte Carlo Simulation VaR: USD 473,906
 Historical Simulation VaR: 495,584
Which of the following is the most likely explanation for the variation in VaR estimates?
A. Data problems
B. Differences in model assumptions
C. Endogenous model risk
D. Programming errors
20. Suppose mean reversion exists for a variable with a value of 30 at time period t – 1.
Assume that the long-run mean value for this variable is 40 and ignore the stochastic term
included in most regressions of financial data. What is the expected change in value of
the variable for the next period if the mean reversion rate is 0.4?
A. -10
B. -4
C. 4
D. 10
21. Jorgens, Inc., (Jorgens) frequently enters into derivatives trades with its counterparties.
Which of the following termination events would Jorgens most likely find beneficial if it
wanted to maintain the ability to terminate a trade at pre-specified future dates?
A. Walkaway clause.
B. Break clause.
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C. Additional termination event.

D. Close-out.
22. Suppose an investor expects that the 1-year rate will remain at 5% for the first year for a
2-year zero-coupon bond. In addition, the investor estimates a 50% probability that 1-year
spot rates will be 6% in one year and a 50% probability that 1-year spot rates will be 4% in
one year. Which of the following inequalities most accurately reflects the convexity effect
for this 2-year bond using Jensen’s inequality formula?
A. $0.95247 > $0.95238
B. $0.91584 > $0.91575
C. $0.90711 > $0.90703
D. $0.89856 > $0.89847
23. Your assignment is to configure a model for financial market (price-based) losses at your
bank. For the extreme tail, you want to fit an EVT distribution, either GPD or GEV, to your
internal historical loss dataset. However, your bank’s loss data exhibits a high degree of
clustering; i.e., time dependency which violates an assumption that the losses are
independent and identically distributed (i.i.d.). Which is the best approach, POT or GEV?
A. The clustering is not relevant and you can use either POT or GEV: unlike CLT,
neither EVT distribution requires an assumption that the underlying losses are i.i.d.
B. Use the POT (GPD) approach: GEV (block maxima) requires i.i.d. but POT does not,
and in fact, anticipates clustering.
C. Use the GEV (block maxima) approach: with long enough time blocks, the clustering
effect should be mitigated.
D. Neither GEV nor POT can be used; there is no currently known method for dealing
with non-i.i.d. data under EVT.
24. You propose to compute the expected shortfall (ES) of a position by employing extreme
value theory (EVT) to characterize the loss tail with either a GPD (POT approach) or GEV
(block maxima approach) distribution. Your colleague Fred objects with the following
criticisms:
I. EVT is incompatible with expected shortfall (ES), you need to choose one approach
or the other.
II. We are “stuck with” GEV or GPD due to small samples. As the sample size increases,
the central limit theorem (CLT) justifies a normal distribution for the extreme loss tail.
If our sample is sufficiently large, we should assume a normal distribution.
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III. To fit either distribution (GDP or GEV), we need to specify both a scale and a tail
parameter, but there are no known methods for estimating these parameters with
historical data.
IV. EVT estimates are uncertain and attach with relatively wide confidence intervals due
to their (mostly) asymptotic nature and paucity of data.
Which of Fred’s criticisms is valid?
A. None are valid.
B. Only II and III
C. Only IV
D. All are valid
25. A hedge fund is considering taking positions in various tranches of a collateralized debt
obligation (CDO). The fund’s chief economist predicts that the default probability will
decrease significantly and that the default correlation will increase. Based on this
prediction, which of the following is a good strategy to pursue?
A. Buy the senior tranche and buy the equity tranche.
B. Buy the senior tranche and sell the equity tranche.
C. Sell the senior tranche and sell the equity tranche.
D. Sell the senior tranche and buy the equity tranche.
26. The annual returns of two assets, X(i) and Y(i), are shown below for the five years from
2010 to 2013. The returns have been sorted with respect to X(i); for example, in 2010 X(i)
returned 1.0% which ranked 3rd among its annual returns and in the same year Y(i)
st
returned -3.3% which ranked 1 among its annual returns (ranking is from worst to best).
The final two columns compute the number of concordant pairs, which is six, and the
number of discordant pairs, which is four.
Assigned
Ranked
Year (same year)
Return of
Return of
X(i)
Y(i)
2013 -8.8% 0.8%
2011 -5.1% -1.5%
2010 1.0% -3.3%
2014 4.7% 6.2%
2012 9.6% 4.0%
The Pearson correlation coefficient, taken from the actual return pairs – for example, (X, Y)
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= (-8.8%, 0.8%) – is 0.5490. But we are interested instead in a rank correlation. Which is
nearest to the Kendall’s tau?
A. -0.15
B. 0.20
C. 0.50
D. 0.67
27. About the Gaussian copula utilized for financial applications, Meissner says each is true
except which is not?
A. The Gaussian copula has low tail dependence which is a weakness because
dependencies (including correlations) increase in a crisis.
B. The Gaussian copula is difficult to calibrate to market prices; for example, it is difficult
to calibrate CDO tranches with a single correlation model.
C. The Gaussian copula is principally static and consequently allows only limited risk
management; i.e., there is no stochastic process for the critical underlying variables’
default intensity and default correlation.
D. The Gaussian copula is limited to market risk applications because it requires (n*n)
pairwise correlation parameters, which is natural to a covariance matrix, but in credit
risk there is no theoretical way to assume these values when they are pairwise
default correlations.
28. Small Bank is attempting to transition to the new Basel III standards. Specifically, they are
wondering if their liquidity and funding ratios meet the updated requirements as specified
by the Basel Committee. Given the following information, what is the bank’s net stable
funding ratio?
 High-quality liquidity assets $300
 Marketable securities $125
 Required amount of stable funding $250
 Cash inflows over the next 30 days $214
 Net cash outflows over the next 30 days $285
 Long-Term economic capital $500
 Available amount of stable funding $255
A. 89%
B. 98%
C. 102%
D. 196%
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29. Which of the following statements regarding frictions in the securitization of subprime
mortgages is correct?
A. The arranger will typically have an information advantage over the originator with
regard to the quality of the loans securitized.
B. The originator will typically have an information advantage over the arranger, which
can create an incentive for the originator to collaborate with the borrower in filing
false loan applications.
C. The major credit rating agencies are paid by investors for their rating service of
mortgage-backed securities, and this creates a potential conflict of interest.
D. The use of escrow accounts for insurance and tax payments eliminates the risk of
foreclosure.
30. With respect to the risk-free rate, LIBOR, and the overnight indexed swap (OIS) rate,
consider the following five statements:
I. Among derivatives traders and market participants, the most common assumption for
the risk-free rate is U.S. Treasury bills, notes and bonds.
II. Following the credit crisis, banks have abandoned LIBOR as the risk-free rate for
non-collateralized transactions.
III. An overnight indexed swap (OIS) is a swap where a fixed rate (i.e., the OIS rate) for
a period (e.g., one month, three months) is exchanged for the geometric average of
the overnight rates (e.g., Federal Funds rate in the U.S.) during the period.
IV. Three-month LIBOR rate is normally higher than the three-month OIS rate because
there more risk in making a single three-month loan to a creditworthy bank than a
series of overnight loans to creditworthy banks.
V. LIBOR is the rate of interest at which AA-rated banks borrow for periods up to 12
months from other banks.
According to Hull, which of the above statements is (are) true?
A. None are true.
B. I and II only are true.
C. III, IV and V are true.
D. All are true.
31. Computing VaR on a Portfolio containing a very large number of positions can be
simplified by mapping these positions to a smaller number of elementary risk factors.
Which of the following mappings would be adequate?
A. USD/EUR forward contracts are mapped on the USD/JPY spot exchange rate.
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B. Each position in a corporate bond portfolio is mapped on the bond with the closest
maturity among a set of government bonds.
C. Government bonds paying regular coupons are mapped on zero-coupon government
bonds.
D. A position in the stock market index is mapped on a position in a stock within that
index.
32. Griffin Riehl is a risk manager at Bluegrass Bank and Trust, a small, independent
commercial bank in Kentucky. Riehl has recently read the Basel Committee on Banking
Supervision’s recommendations for sound operational management and would like to put
several controls in place. He would like to start with the three lines of defense suggested
by the committee. Which of the following is not one of the three common “lines of
defense” suggested by the Basel Committee for operational risk governance?
A. Business line management.
B. Board of directors and senior management risk training programs.
C. Creating an independent operational risk management function in the bank.
D. Conducting independent reviews of operational risks and risk management
operations.
33. Using the Vasicek model, assume a current short-term rate of 6.2% and an annual
volatility of the interest rate process of 2.5%. Also assume that the long-run
mean-reverting level is 13.2% with a speed of adjustment of 0.4. Within a binomial
interest rate tree, what are the upper and lower node rates after the first month?
Upper Node Lower Node
A. 6.67% 5.71%
B. 6.67% 6.24%
C. 7.16% 6.24%
D. 7.16% 5.71%
34. A 2-year credit default swap (CDS) specifying physical delivery defaults at the end of two
years. If the reference asset is a $200 million, 8.0% ABC corporate bond, and the CDS
spread is 125 basis points, the buyer of the CDS will:
A. Receive payments of 800 basis points for the next two years.
B. Receive a payment of $167.5 million.
C. Deliver the bond and receive a payment of $200 million
D. Continue to receive payments of 675 basis points for the next two years.
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35. A trader observes a quote for Stock DUY, and the midpoint of its current best bid and best
ask prices is CAD 45. DUY has an estimated daily return volatility of 0.38% and average
bid-ask spread of CAD 0.1. Using the constant spread approach on a 20,000 share
position and assuming the returns of DUY are normally distributed, what is closest to the
estimated liquidity-adjusted, 1-day 95% VaR?
A. CAD 1,600
B. CAD 5,600
C. CAD 6,600
D. CAD 7,600
36. Model risk is the risk associated with trying to capture an observed phenomenon using a
financial model. Models, by their very construction, are flawed instruments and cannot
possibly capture the full scope of factors necessary to explain the dynamic relationships
we observe. It is better to ask oneself what is wrong with the model rather than glossing
over potential errors in construction. Important sources of model risk include incorrect
model specifications, incorrect model application, implementation risk, incorrect
calibration, programming errors, and data problems. Which of the following statements is
correct regarding sources of model risk?
A. An example of incorrect model application would be if a model assumes a binomial
distribution, whereas a normal distribution represents a more accurate underlying
stochastic process.
B. Multiple users of the capital asset pricing model (CAPM) may incorporate different
measures of beta. This is an example of incorrect model specification.
C. Use of outdated model input parameters measured with error or based upon
inappropriate sample periods is an example of incorrect model application.
D. Using the standard bond valuation model to value mortgage-backed securities is an
example of incorrect model application.
37. Jason Connor, FRM, is a hedge fund manager who is explaining implied volatility for
currency options to junior analysts. Which of the following statements best completes his
explanation?
A. There is a greater chance of extreme price movements than predicted by a
lognormal distribution.
B. Arbitrage opportunities clearly exist.
C. The implied volatility of currency options is expected to increase in the near future.
D. There are no arbitrage opportunities unless the implied volatility versus strike price
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represents a skewness that is referred to as a smirk rather than a smile.
38. Assume three counterparties (A, B and C) are entered into bilateral derivative trades with
the following net current replacement values: replacement value for A with respect to B =
$10 million (i.e., if closed out immediately, B would owe $10 million to A); replacement
value for B with respect to C = $10 million; replacement value for C with respect to A =
$10 million. If these positions were immediately novated to central counterparty with
multilateral netting, which of the following is implied?
A. Counterparty exposures among A, B and C are each eliminated to zero; but each will
have a $10 million exposure to the central counterparty.
B. Counterparty exposures among A, B and C are each eliminated to zero; and each
will have zero exposure to the central counterparty.
C. Counterparty exposures among A, B and C are, in total, reduced from $30 million to
$10 million; and the central counterparty assumes $20 million in exposure.
D. The total exposure is not reduced from $30 million; it is effectively transferred to the
central counterparty.
39. An analyst is backtesting a daily holding period VaR model using a 97.5% confidence
level over a 255-day period and is using a 3.84 test statistic. The following table shows
the calculated values of a log-likelihood ratio (LR) at a 97.5% confidence level.
Number of Exceptions
1 2 3 4 5 6 7 8 9 10 11 12
7.16 4.19 2.27 1.04 0.33 0.02 0.06 0.39 0.98 1.81 2.84 4.06
Based on the above information, which of the following statements accurately describes
the VaR model that is being backtested?
A. If the number of exceptions is more than 3, we would not reject the model.
B. If the number of exceptions is more than 2 and less than 12, we may commit a Type
II error.
C. If the number of exceptions is less than 2, we would accept the hypothesis that the
model is correct.
D. If the number of exceptions is less than 2, we may commit a Type II error.
40. Canzone International Bank carries $3.0 billion in Level 1 assets plus $2.0 billion in Level
2A assets. With respect to expected cash outflows over the next 30 days, the bank carries
"less stable" deposits (liabilities) of $80.0 billion with an average run-off rate (factor) of
10%; expected cash inflows are $10.0 billion. Please note per Basel III:
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 Level 1 assets can comprise an unlimited share of the pool and are not subject to a
haircut under the LCR

 A 15% haircut is applied to the current market value of each Level 2A asset held in
the stock of HQLA
 Level 2 assets (comprising Level 2A assets and any Level 2B assets permitted by the
supervisor) can be included in the stock of HQLA, subject to the requirement that
they comprise no more than 40% of the overall stock after haircuts have been
applied
 Definition: Total net cash outflows over the next 30 calendar days = Total expected
cash outflow - Min{total expected cash inflows; 75% of total expected cash outflows}
Which is nearest to Canzone's liquidity coverage ratio (LCR)?
A. 87.5%
B. 136.5%
C. 235.0%
D. 360.0%
41. Using the Merton model, calculate the current value of a firm’s equity and debt given that
the current value of the firm is $100 million, the principal amount due in five years on the
zero-coupon bond is $100 million, the annual interest rate is 10%, and the volatility of the
firm is 20%.
A. $100 million in debt and $0 in equity.

B. $60.65 million in debt and $39.35 million in equity.
C. $58.38 million in debt and $41.62 million in equity.
D. $32.59 million in debt and $67.41 million in equity.
42. Peter, the municipal bond analyst observes that in recent years there have occurred only
about 6.0 U.S. municipal defaults per year. If he makes the highly simplifying assumption
that 6.0 defaults per year is the average in a Poisson process (distribution), what is the
probability that the next municipal default will occur within one month?
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A. 8.42%
B. 17.00%
C. 39.35%
D. 60.65%
43. An investor has sold default protection on the most senior tranche of a CDO. If the default
correlation between assets held in the CDO decreases sharply, assuming everything else
is unchanged, the investor’s position:
A. Will gain significant value, since the probability of exercising the protection falls.
B. Will lose significant value, since the protection will gain value.
C. Will neither gain nor lose value, since only expected default losses matter and
correlation does not affect expected default losses.
D. Can either increase or decrease, depending on the pricing model used and the
market conditions.
44. Asu Walia is a senior analyst working for a sell side company preparing research reports
on the mining sector. Walia noted that one of the companies he follows recently increased
risk to the firm’s assets, which he expects will benefit equity holders to the detriment of
debt holders. Which of the following concepts best describes the scenario in Walia’s
analysis?
A. Coordination failures.
B. Adverse selection.
C. Risk shifting.
D. Principal-agent problem.
45. A credit risk manager for a bank is looking to mitigate counterparty credit risk exposure to
ZTM, an A-rated firm. Currently the bank has the following derivatives contracts with ZTM:
Contract Contract Value (HKD)
A 40,000,000
B 60,000,000
C 28,000,000
D 2,000,000
With the information provided, what is the most appropriate credit risk mitigation
technique in this case?
A. Implement a netting scheme.
B. Use credit triggers.
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C. Sell credit default swaps on ZTM.

D. Increase collateral.
46. During the recent credit crisis, subprime mortgages received pressure from upward
movements in interest rates, along with the impossibility for most of these borrowers to
refinance. As a result, many subprime borrowers allowed their reduced value homes to be
taken over by the lender. All of the following statements describe the effect subprime
actions had on mortgage-backed security portfolios except:
A. Repayment issues in lower tranches impacted confidence in higher tranches.
B. There was a fire sale of securitized debt.
C. Panic among MBS investors led to a flight to safer assets.
D. The defaults in the lower tranches were high but did not affect senior tranche
investors.
47. Given the information below, what is the liquidity-adjusted VaR at the 95% confidence
level?
Current stock price $200
Stock price standard deviation 3.0%
Bid-ask spread mean 1.0%
Bid-ask spread standard deviation 0.5%
Spread confidence parameter 1.96
A. $11.73.
B. $11.88.
C. $13.59.
D. $13.74.
48. Consider a three-tier securitization structure with the following assumptions:

 The loans in the collateral pool and the liabilities are assumed to have a maturity of 5
years.
 Assets consist of 100 identical loans with par value of $1 million each, priced at par,
paying a fixed 8.5% (i.e., 350 bps over LIBOR flat at 5%).
 Senior debt (senior bonds) of $85 million paying a coupon of LIBOR + 50 bps.
 Mezzanine debt (junior bonds) of $10 million paying a coupon of LIBOR + 500 bps
 The scenario assumes a default rate of 10% per annum.
 The money market rate is 5%
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Under this high-default scenario, which of the following statements is true?
A. There is never a year in which either the junior or senior bonds are paid their full
interest.
B. Both bond holders (senior and junior) realize all of their interest payments in the first
four years, but neither recover their entire obligation in the fifth year (i.e., shortfall for
both bond holders).
C. Junior bond holder suffer interest payment shortfalls and a principal shortfall, but
senior bond holders receive all of their interest and experience no principal shortfall.
D. Both bond holders realize all of their interest payments, in full, and get back the
entirety of their principal.
49. The RAROC is 15%, the risk-free rate is 3%, the market return is 16%, and the equity
beta is 1.50. What is the adjusted RAROC (ARAROC), and should the project be
accepted?
A. The ARAROC is 8.0%, and the project should be rejected.
B. The ARAROC is 8.0%, and the project should be accepted.
C. The ARAROC is 12.0%, and the project should be rejected.
D. The ARAROC is 12.0%, and the project should be accepted.
50. In October 2007, the Basel Committee released guidelines for treating incremental default
risk in the trading book. Later, in light of the global financial crisis (GFC), the Committee
expanded the scope of the capital charge into the more encompassing incremental risk
charge (IRC). Which of the following was most nearly the motivation for the expanded
coverage of the IRC?
A. Losses due to idiosyncratic factors, not systematic factors, including basis risk and
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event risk.
B. Unanticipated losses during a period of stress.
C. Losses in the trading book not necessarily due to default but due to credit migrations,
widening spreads and/or loss of liquidity.
D. Losses on securitized products due to operational risk including legal and contract
risk.
51. In regard to collateralization, each of the following is true except which is false?
A. The valuation agent is the party calling for delivery or return of collateral and thus
must handle all calculations; i.e., calculation of credit exposure, market value of
posted collateral, uncollateralized exposure, and the delivery or return amount
B. A counterparty who posts a dividend-paying asset as collateral (i.e., the "giver" of
collateral) forfeits all dividends as the receiver immediately becomes the economic
owner of the collateral
C. The threshold represents an amount of uncollateralized exposure: If an exposure is
above the threshold, only the incremental exposure will be collateralized
D. An independent is effectively a negative threshold and is typically held as a cushion
against “gap risk;” i.e., the risk that a transaction's market value may gap
substantially and quickly
52. Which of the following measures are most likely to be used by a securitized product
backed by student loans?
A. Single monthly mortality (SMM), constant prepayment rate (CPR), and Public
Securities Association (PSA).
B. Loss curves and absolute prepayment speed (APS).
C. Weighted average life (WAL), weighted average maturity (WAM), and weighted
average coupon (WAC).
D. Debt service coverage ratio (DSCR) and monthly payment rate (MPR).
53. Which of the following subprime characteristics provide direct protection for senior
tranches?
A. Subordination, excess spread, and shifting interest.
B. Subordination, prepayments, and shifting interest.
C. Overcollateralization, excess spread, and timing of losses.
D. Overcollateralization, excess spread, and prepayments.
54. A firm is experiencing financial difficulties. Using a contingent claims approach, which of
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the following best describes the valuation of their senior and subordinated debt?
A. Both the senior debt and subordinated debt have positive exposures to debt maturity,
firm volatility, and interest rates (i.e., the debt value increases as these factors
increase).
B. The senior debt has negative exposures to debt maturity, firm volatility, and interest
rates (i.e., the senior debt value decreases as these factors increase). The
subordinated debt has positive exposures to debt maturity, firm volatility, and interest
rates (i.e., the subordinated debt value increases as these factors increase).
C. The senior debt has positive exposures to debt maturity, firm volatility, and interest
rates (i.e., the senior debt value increases as these factors increase). The
subordinated debt has negative exposures to debt maturity, firm volatility, and
interest rates (i.e., the subordinated debt value decreases as these factors increase).
D. Both the senior debt and subordinated debt have negative exposures to debt
maturity, firm volatility, and interest rates (i.e., the debt value decreases as these
factors increase).
55. A money management firm has USD 33 billion in assets. The risk manager computes the
daily VaR at various confidence levels as follows:
Confidence Level VaR (USD)
95.0% 503,700,000
95.5% 511,550,000
96.0% 520,000,000
96.5% 542,750,000
97.0% 562,250,000
97.5% 581,750,000
98.0% 605,150,000
98.5% 636,350,000
99.0% 677,300,000
99.5% 740,350,000
What is the closest estimate of the daily expected shortfall at the 96.5% confidence level?
A. USD 543 million
B. USD 588 million
C. USD 621 million
D. USD 740 million
56. Consider a $100.0 million Portfolio (P) which holds the following two positions:
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 Asset A has a value of $50.0 million (50% weight) with volatility of 13.0% per annum;
and the beta of Asset A with respect to the portfolio, beta (A, P), equals 0.520.
 Asset B has a value of $50.0 million (50% weight) with volatility of 26.0% per annum;
and the beta of Asset B with respect to the portfolio, beta (B, P), equals 1.480.
 The correlation between asset returns, rho, is 0.30. The correlation between Asset A
and the portfolio, rho (A, P), is equal to 0.647. The correlation between Asset B and
the portfolio, rho (B, P), is equal to 0.9213.
 As the portfolio volatility is 16.18%, the 95.0% portfolio VaR = $26.6 million (returns
are normally distributed)
Which is nearest to the component VaR of Asset B?
A. $10.8 million
B. $16.5 million
C. $19.7 million
D. $21.4 million
57. A bank uses the standardized approach to determine their capital charge for operational
risk under Basel II (or Basel III). The bank has three business lines and each business
line contributes one-third toward the total gross income. For a given total gross income,
which business mix will produce the largest capital charge?
A. Corporate finance, trading and sales, payment and settlement
B. Retail banking, retail brokerage, and asset management
C. Commercial banking, agency services, asset management
D. Retail banking, commercial banking, and payment and settlement
58. Public Employee Retirement Fund (PERF) has $600 million in assets and $600 million in
liabilities, for a current surplus of zero. The annual expected return on assets is 8.0% with
18.0% volatility per annum; the annual expected return on liabilities is 6.0% with 14.0%
volatility per annum. Both are normally distributed. The correlation between assets and
liabilities is 0.60. What is the 95% absolute surplus at risk (absolute SaR); i.e., the worst
expected shortfall, or loss relative to current surplus of zero, with 95% confidence?
A. $12.0 million
B. $85.6 million
C. $133.6 million
D. $194.0 million
59. The interest rate tree below shows the true process for a one-year interest rate. The
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current one-year spot rate is 7.0%. Next year, investors expect the one-year rate to either
increase to 10.0% or drop to 4.0%, with equal probability of an increase or drop. In the
subsequent year (Year 2), investors similarly expect the future one-year rate to again
either increase or decrease by +/- 3%, with equal likelihood. Graphically, as follows:
Before the inclusion of a risk premium, assuming the above interest rate tree the true and
known process, the price of a $1,000 par two-year zero-coupon bond would be $874.13;
i.e., this price is the expected discounted value under annual compounding. However, let
us modify this and instead assume that investors are risk-averse: they would prefer a
certain 7.0% return to an expected 7.0% return with volatility. Consequently, let us
assume investors require (charge) a risk premium of 90 basis points. Compared to the
risk-neutral price of $874.13, what is the change in price due to the introduction of the risk
premium?
A. Increase bond price by $14.58
B. Increase bond price by $7.30
C. Decrease bond price by $7.30
D. Decrease bond price by $14.58
60. Consider a 1-year maturity zero-coupon bond with a face value of USD 1,000,000 and a
0% recovery rate issued by Company A. The bond is currently trading at 80% of face
value. Assuming the excess spread only captures credit risk and that the risk-free rate is
5% per annum, the risk-neutral 1-year probability of default on Company A is closest to
which of the following?
A. 2%
B. 14%
C. 16%
D. 20%
61. Which of the following statements about correlation and copula are correct?
I. Copula enables the structures of correlation between variables to be calculated
separately from their marginal distributions.
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II. Transformation of variables does not change their correlation structure.

III. Correlation can be a useful measure of the relationship between variables drawn
from a distribution without a defined variance.
IV. Correlation is a good measure of dependence when the measured variables are
distributed as multivariate elliptical.
A. I and IV only
B. II, III and IV only
C. I and III only
D. II and IV only
62. Major Investments is an asset management firm with USD 25 billion under management.
It owns 20% of the stock of a company. Major Investment’s risk manager is concerned
that, in the event the entire position needs to be sold, it size would affect the market price.
His estimate of the price elasticity of demand is -0.5. What is the increase in Major
Investments’ Value-at-Risk estimate for this position if a liquidity adjustment is made?
A. 4%
B. 10%
C. 15%
D. 20%
63. The Merton model and the Moody’s KMV use different approaches to determine the
probability of default. Which of the following is consistent with Moody’s KMV model?
A. The distance to default is 1.96, so there is a 2.5% probability of default.
B. The distance to default is 1.96, so there is a 5.0% probability of default.
C. The historical frequency of default for corporate bonds has been 6%. Updating this
with Altman’s Z-score analysis would provide a probability of default that is
somewhat different than 6%.
D. The distance to default is 1.96 and, historically, 1.2% of firms with this
characterization have defaulted, so there is a 1.2% probability of default.
64. You are quantitative analyst at an insurance company. Given some large losses incurred
by the company recently, your boss is interested in determining the expected number of
extreme losses per year. As well, your boss is quite certain that the company is now more
likely to experience an extreme event than before. Based on the information provided by
your boss, to model the frequency and severity of extreme events, which of the following
distributions would be most appropriate to use?
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Frequency Severity
A. Poisson distribution Frechet distribution
B. Poisson distribution Gumbel distribution
C. Weibull distribution Frechet distribution
D. Weibull distribution Gumbel distribution
65. The CEO of Merlion Holdings, a large diversified conglomerate, is keen to enhance
shareholder value using an enterprise risk management framework. You are asked to
assist senior management to quantify and manage the risk-return tradeoff for the entire
firm. Specifically, the CEO wants to know which risks to retain and which risks to lay off
and how to decentralize the risk-return trade-off decisions within the company. Which of
the following statements is/are correct?
I. Management should retain strategic and business risks in which the company has a
comparative advantage but diversify risks that can be hedged inexpensively through
the capital markets.
II. When proposing new projects, business unit managers must evaluate all major risks
in the context of the marginal impact of the project on the firm’s total risk.
A. Statement I only.
B. Statement II only.
C. Both statements are correct.
D. Both statements are incorrect.
66. Suppose a portfolio has a value of $1,000,000 with 50 independent credit positions. Each
of the credits has a default probability of 2% and a recovery rate of 0%. The credit
portfolio has a default correlation equal to 0. The number of defaults is binomially
distributed and the 95th percentile of the number of defaults is 3. What is the credit value
at risk at the 95% confidence level for this credit portfolio?
A. $20,000
B. $40,000
C. $60,000
D. $980,000
67. Each of the following is true about the foundation/advanced internal ratings-based (IRB)
approach to credit risk in Basel II and Basel III, except:
A. The risk weight function estimates a 99.9% confident one-year horizon credit
value-at-risk.
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B. The capital charge intends to cover unexpected losses and not expected losses with
UL = WCL – EL
C. The risk weight function includes PD, LGD, EAD and asset correlations but does not
include a maturity adjustment.
D. Asset correlations are included in the risk weight function but cannot be specified by
the banks’ own internal estimates.
68. Which of the following statements is incorrect regarding volatility smiles?

A. Currency options exhibit volatility smiles because the at-the-money options have
higher implied volatility than away-from-the-money options.
B. Volatility frowns result when jumps occur in asset prices.
C. Equity options exhibit a volatility smirk because low strike price options have greater
implied volatility.
D. Relative to currency traders, it appears that equity traders’ expectations of extreme
price movements are more asymmetric.
69. Consider the following exposure profile:
Given the expected exposure (EE), then each of the following is therefore plausible,
except which is not true?
A. Line A is the effective expected exposure (effective EE) which is the non-decreasing
EE.
B. Line A, only because the EE is unimodal (with one peak), is also the maximum
potential future exposure (maximum PFE).
C. Line B is the expected positive exposure (EPE), often called the "loan equivalent,"
and is a single number because it is the average of the expected exposures over the
time horizon.
D. Line C is the effective expected positive exposure (EEPE), and is a single number
26-30
because it is the average of the effective EE.
70. A recently published article on issues with value at risk (VaR) estimates included the
following statements.
Statement 1: Differences in the use of confidence intervals and time horizon can cause
significant variability in VaR estimates as there is lack of uniformity in practice.
Statement 2: Standardization of confidence interval and time horizon would eliminate
most of the variability in VaR estimates.
The article’s statements are most likely correct with regard to:
A. Statement 1 only.
B. Statement 2 only.
C. Both statements.
D. Neither statement.
71. Sarah Williams, a risk manager at a mid-size bank in Chicago, has decided that,
according to the Basel Committee’s guidelines, it would be better to choose a distribution
for loss frequency data and another for loss severity data. With respect to severity,
Williams should choose a distribution that is most sensitive to:
A. The tail of the distribution
B. The body of the distribution
C. The assumptions of the distribution
D. The second moment of the distribution
72. The Chief Risk Officer of your bank has put you in charge of operational risk management.
As a first step, you collect internal data to estimate the frequency and severity of
operational-risk-related losses. The table below summarizes your findings:
Frequency Distribution Severity Distribution
Number of Occurrences Probability Loss (USD) Probability
0 0.6 1,000 0.5
1 0.3 100,000 0.4
2 0.1 1,000,000 0.1

Based on this information, what is your estimate of the expected loss due to operational
risk?
A. USD 20,000
B. USD 70,250
C. USD 130,600
27-30
D. USD 140,500
73. In recent year, large dealer banks financed significant fractions of their assets using
short-term, often overnight, repurchase (repo) agreements in which creditors held bank
securities as collateral against default losses. The table below shows the quarter-end
financing of four broker-dealer banks. All values are in USD billions.
Bank A Bank B Bank C Bank D
Financial Instruments Owned 823 629 723 382
Pledged as collateral 272 289 380 155

In the event that repo creditors become nervous about a bank’s solvency, which bank is
least vulnerable to a liquidity crisis?
A. Bank A
B. Bank B
C. Bank C
D. Bank D
74. Given the following information, what is the percent of contribution to VaR from asset A?
There are two asses in a portfolio: A and B
Asset A marginal VaR: 0.05687
Asset A value: $7,000,000
Asset B marginal VaR: 0.17741
Asset B value: $4,000,000
A. 64.06%
B. 24.27%
C. 35.94%
D. 63.64%
75. Which of the following statements about risk management in the pension fund industry is
correct?
A. A pension plan’s total VaR is equal to the sum of its policy-mix VaR and
active-management VaR.
B. Pension fund risk analysis does not consider performance relative to a benchmark.
C. In most defined-benefit pension plans, if liabilities exceed assets, the shortfall does
not create a risk for the plan sponsor.
D. From the plan sponsor’s perspective, nominal pension obligations are similar to a
short position in a long term bond.
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76. Each of the following was both a deficiency and omission of Basel II but is, at the same
time, explicitly addressed by new requirement in Basel III except for:
A. Basel II did not formally include liquidity risk, but Basel III explicitly covers liquidity
risk.
B. Basel II could arguably create a procyclical effect, but Basel III explicitly adds a buffer
to address this.
C. Basel II did not require external credit ratings, but Basel III seeks to increase the
reliance on external ratings.
D. Basel II allowed many banks to show strong risk-based regulatory capital ratios
despite high on- and off-balance sheet leverage; Basel III adds a simple leverage
ratio to act as a backstop to the risk-based capital ratio.
77. A risk team in the investment banking subsidiary of a bank holding company is setting up
a Monte Carlo simulation methodology to estimate the subsidiary’s aggregate loss
distribution. Which of the following loss severity and loss frequency distribution pairs is
the most appropriate to use?
A. Binomial distribution for severity, lognormal distribution for frequency.
B. Binomial distribution for frequency, normal distribution for severity.
C. Poisson distribution for severity, normal distribution for frequency.
D. Poisson distribution for frequency, lognormal distribution for severity.
78. A major regional bank has determined that a counterparty has a constant default
probability of 5.5% per year. What is the probability of this counterparty defaulting in the
fourth year?
A. 4.39%
B. 4.64%
C. 4.91%
D. 5.50%
79. Suppose a stock price is currently $50.00 while the risk-free rate is 3.0% per annum. For
a series of options with a three month (0.25 years) maturity, the implied volatility is
calculated at various strike prices, as below
Stock Price, S(0) $50.00
Riskfree rate 3.0%
Maturity (years) 0.250
Strike Call Put Implied Volatility
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$42.00 $9.02 $0.70 36.6%
$44.00 $8.32 $1.99 47.9%
$46.00 $7.64 ? 54.5%
$48.00 $7.05 $4.69 59.7%
$50.00 $6.50 $6.13 63.8%
$52.00 $5.31 $6.92 60.2%
$54.00 $4.17 $7.77 56.3%
$56.00 $3.09 $8.68 51.8%
$58.00 $1.69 $9.26 42.1%
A. The market price (trades) of the put is $3.30 and this is lower than the BSM
model-based price which assumes an (ATM) volatility of 63.8%
B. The market price (trades) of the put is $3.30 and this is higher than the BSM
C. The market price (trades) of the put is $4.13 and this is lower than the BSM
D. The market price (trades) of the put is $4.13 and this is equal to the BSM
80. A bank wants to estimate its total capital charge using the least sophisticated set of Basel
II approaches (i.e., SA for credit and market risk, BIA for operational risk). With respect to
its Standardized Approach (SA) to Market Risk, the bank has already determined that its
market risk charge is $40 million. With respect to its Basic Indicator Approach (BIA) to
operational risk, the bank’s three-year average annual gross income was $80 million per
year. With respect to its Standardized Approach (SA) to Credit Risk, the bank’s credit
assets (aka, credit exposures) total $650 million with a weighted-average risk weight of
75%. Which is nearest to the bank’s total capital charge?
A. $43.16 million
B. $72.80 million
C. $91 million
D. $104million
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