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18Nov/090

FRM(30) Risk Mgt. & Investment Mgt.

Risk management  and investment management will account
for 10% of this year’s FRM exam. The topics in this area are
reflective of the enormous growth and potential risks of hedge
funds. Other major subjects covered include performance analysis,
risk budgeting, and portfolio theory. The material is a mix of both
highly technical and easy-to-read qualitative material.
  • Know the various measures for measures for calculating
    portfolio VAR including diversified VAR and undiversified VAR.
  • Be familiar with the computation of incremental VAR and
    component VAR. Incremental VAR is the change in VAR given an
    addition to the portfolio. Component VAR is used to calculate the
    change in portfolio VAR from deleting a position.
  • Know that using VAR as a risk budgeting technique is becoming
    more popular than using historical measures of risk. Investors are
    relying more on VAR because of increased globalization, complexity,
    and dynamics of the investment industry.
  • Memorize the formulas for expected return and the variance of a
    two-asset portfolio. A question asking you to calculate the
    variance could give you the correlation or covariance between two
    assets. Know the relationship between the correlation and
    covariance.
  • Learn the concepts of beta, the security market line, the CAPM,
    and how they are related to the expected rate of return.
  • Memorize the formula for the CAPM.
  • Be familiar with the forms of market efficiency.
  • Know how to calculate and interpret the Treynor measure, Sharpe
    measure, Jensen’s alpha, tracking error, the information ratio, and
    the Sortino ratio. Memorizing some relatively simple formulas is in
    order here.
  • Know the difference between returns-based and portfolio-based
    style analysis.
  • Be able to calculate the three components of active systematic
    returns.
  • Be able to compare and contrast mutual funds and hedge funds.
    Hedge funds have been growing at a higher rate recently; however,
    this growth will likely slow with changes in regulation.
  • Know the two methods used to replicate hedge fund returns(i.e.,
    how hedge fund portfolios are "cloned"). The two methods are
    fix-weight and rolling-window clones.
  • Reading "Individual Hedge Fund Strategies" is a great way to
    learn about the various styles of hedge funds in the marketplace.
    If asked about a specific type of hedge fund, be able to describe
    general performance and risk characteristics about that style.
  • Selecting a hedge fund manager involves strategy/sector
    selection, individual manager selection, manager due diligence, and
    ongoing risk management. Be familiar with the main considerations
    in each of these areas.
  • Know how style drift for a hedge fund differs from style drift
    for traditional long-only investments and be aware of the potential
    red flags for style drift.
  • Know the various forms of risk for a fund of hedge funds. A
    fund of hedge funds is exposed to risks at both the investment and
    portfolio levels.
  • The issue of hedge fund transparency is a hot topic in the
    marketplace.
  • Know when transparency is and is not appropriate for a fund,
    and know the four main attributes of transparency.
  • Know that the best way to present hedge fund returns is to
    compare the overall performance of the fund with the performance of
    the underlying risk premium returns. Also, be familiar with
    attributes of a good hedge fund index and the problems associated
    with hedge fund indices.
  • Be cognizant of the recommendations set forth by the
    President’s Working Group on Financial Markets(PWG). PWG has
    provided recommendations for investors, fiduciaries, supervisors,
    and key creditors and counterparties regarding private pool of
    capital.
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18Nov/090

frm（29）Operational&Integrated Risk Mgt.

Operational and integrated risk management, as well as legal
issues, will account for 25% of the exam questions. Modeling
operational risk is an important concept here in addition to Basel
II. Expect to see questions on operational and liquidity risk case
studies as well as numerous questions from the Basel
readings.
  • The Bank of International Settlement(BIS) defines operational
    risk as the risk of losses due to inadequate or failed pocesses,
    persons, and systems that are unable to protect a firm from outside
    events. This definition focuses on the impact of operational
    losses.
  • Be familiar with the methodologies for measuring operational
    risk and calculating capital charges, The approaches include basic
    indicator, standadized, and advanced measurement.
  • There are two categories used to describe operational losses.
    Low frequency, high severity(LFHS) risks are the greatest area of
    concern for operational risk managers because there is little data
    available to study such risks, and their cost to the firm
    could be catastrophic. Expect a test question in some form
    regarding this concept.
  • Distinguish between top-down and bottom-up operational risk
    models and know the strengths and weaknesses of each approach. You
    should also know examples of operational risk models for each
    approach.
  • Know the characteristics of catastrophe options and catastrophe
    bonds.
  • Be familiar with the general structure of loss distribution
    approach(LDA) models and understand the application of frequency
    and severity distributions when modeling losses.
  • Have a general understanding of the types of distributions that
    are used to model operational risk severity with LDA models.
  • Know the two risks of implementing technological
    innovations.
  • Know the difference between economies of scale and economies of
    scope.
  • Daylight overdraft risk is a significant risk for the banking
    system. Know this concept.
  • Model risk is the risk associated with using financial models
    to simulate complex relationships. It may arise from incorrect
    model application, implementation risk, calibration errors,
    programming errors, and data problems. Managers can protect against
    model risk by employing reality checks of the model.
  • Know that under an EMH framework, the best way to manager model
    risk is to find a better model. Under a non-EMH framework, the
    focus is on how current pricing methodologies will change in the
    future.
  • Read and be familiar with the various case studies presented,
    including Metallgesellschaft, Sumitomo, Barings, and Long-Term
    Capital Management. Lessons from history are important, and as a
    potential certified Financial Risk Manager, GARP will test your
    knowledge of the factors that caused the enormous losses in these
    cases, hoping that your knowledge will prevent history from
    repeating itself. Be able to cite examples of risk controls that
    could have been in place to stop these disasters from
    occurring.
  • Be familiar with the various ways corporations can manage risk
    through the use of an Enterprise Risk Management(ERM) process. ERM
    can be used to better carry out a company’s strategic plan, gain a
    competitive advantage, and create shareholder value.
  • The formula for the RAROC of a loan is one of the few equations
    in this section that you need to memorize. You should also know the
    formula for adjusted RAROC(ARAROC), which overcomes the deficiency
    in RAROC of assuming the probability of default is constant.
  • Know that liquidity risk is comprised of funding risk and
    market liquidity risk. Alternatives to measuring liquidity risk
    include: liquidity gap and liquidity risk
    elasticity.
  • Be aware that VAR can be adjusted for liquidity risk(LVAR) by
    incorporating the impact of the bid-ask spread.
  • Review the recommendations and guiding principles of the
    Counterparty Risk Management Policy Group II report. Understand
    that it was drafted with the goal of promoting global financial
    stability. Do not memorize all the recommendations, but rather
    focus on the big picture concepts for each category and recognize
    that much of the material addressed is related to other areas of
    the FRM curriculum.
  • Be familiar with the four primary justifications for the
    existence of banking regulation. They include:
    protect bank depositor from a loss in bankruptcy, provide stability
    for transactions, avoid domino effects on the banking system, and
    maintain stability in the economy.
  • The new Basel Capital Accord is very important. Questions about
    Basel are the closest to a "sure thing" there is for the FRM exam.
    Read the Basel material more than once to make sure you understand
    the big picture of the Accord’s purpose, as well as the many
    details in this material that may show up as test questions.
  • Be able to define what is included in tier 1, tier 2, and tier
    3 capital. Ways you could see this material tested on the exam
    include giving you a balance sheet and asking you to calculate one
    of the forms of capital, or asking you which asset mix would best
    satisfy Basel’s rules regarding the capital used to satisfy capital
    requirements.
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18Nov/090

frm(28) credit risk

08年FRM考试Credit Risk Mgt.考点解析

Topics in the credit risk area will account for 25% of the
questions on the exam. Credit risk topics are divided into four
sections: measuring credit risk, counterparty
risks, manage credit risk, and securitization. There is renewed
emphasis this year on being able to calculate expected loss and
unexpected loss as well as the application of credit
derivative.
  • Know how to compute the cumulative default probability over a
    multiyear period given the marginal default probability for each
    year. Be able to do this computation in both directions. The
    computation could be turned around if you were given a 1-year
    cumulative default  probability and asked to solve for the
    quarterly marginal default probability.
  • Note that if the rates on the corporate bond and Treasury bond
    are equivalent, the implied probability of repayment is 100%.
    Therefore, since corporate bond rates exceed Treasury bond rates,
    realistic implied probabilities of repayment will be less than
    100%.
  • When calculating the probability of default, be sure to use
    debt securities of the same maturity. Mismatching maturities will
    give incorrect implied probabilities. Also, if p equals
    the implied probability of repayment, then 1-p equals the
    implied probability of default. Know how to make adjustments on a
    quarterly, semmiannual, or annual basis.
  • Memorize the fomula for the contractually promised gross return
    on a loan. Remember that this is a promised return, which is
    potentially different from the actual or realized return.
  • Sovereign risk is the risk that a foreign government may
    default on a loan. There are five key variables that measure the
    probability of a foreign government rescheduling its debt payments;
    focus on the interpretation of these variables. Review the example
    for a multiyear restructuring agreement(MYRA).
  • Memorize the formulas for expected loss and unexpected loss and
    be able to apply these concepts to a portfolio setting.
  • Understanding the relationship between commitments and
    outstandings is vital toward correctly computing adjusted exposure
    which is utilized in the calculation of expected and unexpected
    loss.
  • Know the difference between current, potential, and peak
    exposure for a derivative contract. Current and potential exposures
    are both essential for properly assessing credit risk.
  • Know the difference between right-way and wrong-way exposures
    and be able to cite examples of each.
  • The various forms of credit risk mitigants are important. Make
    sure you are familiar with terminology such as credit triggers,
    netting agreements, and liquidity puts.
  • A credit valuation adjustment(CVA) adjusts payments to reflect
    changes in credit risk changes relative to the counterparties in
    derivative transactions.
  • Understand the difference between the mean loss rate and the
    risk-neutral mean loss rate. The risk-neutral mean loss is an
    artificially higher loss rate that makes an investor indifferent
    between buying a risky security and a risk-free security with the
    same expected payoff. The risk-neutral mean loss rate is a key
    input to many credit risk pricing applications.
  • Know the difference between managing the risks of a derivatives
    portfolio and managing the risks associated with traditional bank
    lending. Derivatives contracts have features that allow the fim to
    offset risks between counterparties or with a single
    counterparty(netting). Understand the various strategies used to
    offset these risks.
  • Be familiar with purposes of external and internal ratings and
    know the process that is conducted to arrive at a particular
    rating.
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18Nov/090

frm（27）sovereign risk

sovereign risk
Sovereign risk is the risk of a government becoming unwilling
or unable to meet its loan obligations, or reneging on loans it
guarantees.[5]
The existence of sovereign risk means that creditors should take a
two-stage decision process when deciding to lend to a firm based in
a foreign country. Firstly one should consider the sovereign risk
quality of the country and then consider the firm’s credit
quality.[6]
Five macroeconomic variables that affect the probability of
sovereign debt rescheduling are:
[7]
  • Debt
    service ratio    （债务/出口）DSR+
  • Import ratio （进口系数）IR+
  • Investment ratio （投资系数）INVR_OR+
  • Variance of export revenue （出口波动）VAREX+
  • Domestic money supply growth （国内货币增长）MG+
The probability of rescheduling is an increasing function of
debt service ratio, import ratio, variance of export revenue and
domestic money supply growth. Frenkel, Karmann and Scholtens also
argue that the likelihood of rescheduling is a decreasing function
of investment ratio due to future economic productivity gains.
Saunders argues that rescheduling can become more likely if the
investment ratio rises as the foreign country could become less
dependent on its external creditors and so be less concerned about
receiving credit from these countries/investors.[8]
problems with CRA model
1 time or forecasting problem
2population group that are too broad
3 political risk factors
4diversification effect of a portfolio
5assessing the incentives to reschedule
Debt-for-Equity Swaps
In a debt-for-equity swap, a company’s creditors
generally agree to cancel some or all of the debt in
exchange for
equity in the company.
Debt for equity deals often occur when large companies run
into serious financial trouble, and often result in these companies
being taken over by their principal creditors. This is because both
the debt and the remaining assets in these companies are so large
that there is no advantage for the creditors to drive the company
into bankruptcy. Instead the creditors prefer to take control of
the business as a going
concern. As a consequence, the original shareholders’ stake in
the company is generally significantly diluted in these deals and
may be entirely eliminated, as is typical in a
Chapter 11 bankruptcy.
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18Nov/090

frm(26) Credit Risk individual loan Risk

Contractually promised gross loan return

Per Saunders, we need five assumptions:
  • Base lending rate plus
    margin: likely the bank’s cost of
    capital plus a profit margin. Note this pricing already
    includes     expected losses (EL) on the loan. The promised
    return is greater than the expected return due to default risk; the
    expected losses due to default risk are priced into a component of
    the margin.
  • Origination fee
  • Compensation balance (a.k.a., offsetting
    balance): held by bank
  • Reserve requirement: This is a
    determined by regulators. Reserve requirements are one of central
    banks’ tools for influencing the demand for liquidity.
    Varies by country and, within country, often by complex rules
    pertaining to type/size of deposits. Could be 0%, 2%, 5%, 10%.
For example, assume:
  • 8% base lending rate (BR) + 2% margin (m) = 10% loan rate
  • Origination fee (f): 0.125% (one-eight of one
    point)
  • Compensation balance (b): 10%
  • Reserve requirement (R): 5%
Then the contractually promised gross loan return is given
by:
Note the impact of the denominator is to lever up the return.
If the compensating balance is zero, then the promised gross loan
return in this case is simply 10.125% (base rate + margin +
fees).
Assessing Defult Probabilities
there are lots of model about this theory
1 qualitative based models
2 quantiatitive credit scoring model
3linear discriminant analysis model
Marginal Default Probabilities and cumulative default
probability
1-p=1-(1+i)/(1+k)
Cp=1-(p1*p2*…)
p2(1+c1)=(1+f1）
这一章其实还是有不少题目的，写了几套题，总是算不对，应该是自己好没有理解吧。
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