2016
FRM EXAM REVIEW
COVERS
ALL TOPICS
IN PART I
FRMPART I
FORMULA SHEETS
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Cover design: Loewy Design
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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
2 2016 Wiley
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
2016 Wiley 3
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
4 2016 Wiley
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)
6 2016 Wiley
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 )
2016 Wiley 7
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
8 2016 Wiley
Miller, Chapter 6
Miller, Chapter 6
P(Information|Event) P(Event)
P(Event |Information) =
P(Information)
2016 Wiley 9
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
2016 Wiley 11
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)
2016 Wiley 13
Stock, Chapter 6
Stock, Chapter 6
2
Var (Slope) =
( x x )2
MSR RSS/k
F -stat = =
MSE SSE/[n (k + 1)]
14 2016 Wiley
Stock, Chapter 7
Stock, Chapter 7
n 1
Adjusted R 2 = R 2 = 1 (1 R )
2
n k 1
2016 Wiley 15
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
16 2016 Wiley
Hull, Chapter 23
Hull, Chapter 23
2n = VL + U n21 + 2n 1
2n = + U n21 + 2n 1
b0
xt =
1 b1
2016 Wiley 17
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 ]
2016 Wiley 19
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
2016 Wiley 21
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
2016 Wiley 23
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
2016 Wiley 25
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
2016 Wiley 27
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
2016 Wiley 29
Valuation and Risk Models (VRM)
Allen, Chapter 3
Allen, Chapter 3
PortfolioVaR = VaR underlying
2016 Wiley 31
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)
2016 Wiley 33
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
34 2016 Wiley
Hull, Chapter 19
Hull, Chapter 19
Change in option price
Delta =
Change in underlying price
2016 Wiley 35
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
36 2016 Wiley
Tuckman, Chapter 2
Tuckman, Chapter 2
1
d (t ) =
r (t ) 2 t
(1 + )
2
2016 Wiley 37
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
2016 Wiley 39
Tuckman, Chapter 5
Tuckman, Chapter 5
1 P
DV 01k =
10, 000 y k
1 P
Dk =
P y k
40 2016 Wiley
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
2016 Wiley 41
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