Book 1 - Foundations of Risk Management

Chapter 1 –
• Three lines of defense
• Expected Loss calculation = EAD * PD * LGD

Chapter 2 –
• Risk Appetite has to be less than Risk capacity (know this thing)

Chapter 3 –
LO 3.c: Assess the role and responsibilities of the board of directors in risk governance
LO 3.f: Assess the role and responsibilities of a firm’s audit committee.

Chapter 4 –
LO 4.c: Evaluate the role of credit derivatives in the 2007-2009 financial crisis and explain changes in the credit derivative market that
occurred as a result of the crisis
Role of SPV

Chapter 5 –
CAPM undervalued vs overvalued
All Ratios are very important
Expected return on stock.
Chapter 6 –
• Multi factor model calculation using formula
• Fama French Model (highly likely to show up on exam)

Chapter 7 –
• Pls find Questions below for this chapter

Chapter 8 –
• Pls find Questions below for this chapter
• Risk culture topic is crucial for this

Chapter 9 –
• LTCM and MGRM Case Study
• London Whale

Chapter 10
• Central Bank intervention in Financial Crisis and pls read the entire chapter for this (Small reading yet imp)

Chapter 11-
• Pls find Questions below for this
Book 3 - Financial Markets & Products
Chapter 1 -
• Conflicts of Interests between investment banking and commercial banking
• Investment Banking fee arrangements.

Chapter 2 -
• breakeven premium payment – Pls check GARP question only
• Insurance ratios
• Longevity and Mortality Risk

Chapter 3 -
• Computing NAV,
• Hedge Funds returns for investors and fund both (very imp)

Chapter 4 -10 Futures and Forwards ( pls find few typical questions below for these chapters )
• Arbitrage opportunities
• netting calculation
• impact of central clearing
• initial margin and variation margin calculation

Chapter 11 –
• exchange rate drivers
• currency Appreciation/ depreciation (simple yet asked on exam)
• Cash Carry Arbitrage
• which option spread strategies used based on example.
Chapter 13 – Properties Of Options
• Understand the Upper and Lower Bounds (Calculations can show up with dividends and without dividends), Synthetic replication using put call parity

Chapter 14 –
• which option spread strategies used based on example. Finding the strategy and their payoffs.

Chapter 15 – exotic options

• Gap Options, Barrier and Lookback Options

Chapter 16 – Interest Rates

• Forward Rates Cal, please do FRA from GARP only, OIS Rate, Duraion and Modified Duration, Convexity and Modified Convexity ( Pls see GARP end of chapter
examples for this )

Chapter 18 – MBS
• Dollar Roll (Don’t forget abt accrued interest in this question)
• TBA Market and Specified Pool
• SMM and CPR ( Check Full Mock 3 there is one question on this using a different formula)

Chapter 19
• Cheapest to deliver bonds
• Duration Hedging last Learning objective
• Quotation on Bonds/ Clean and dirty Price/ Yield Curve Shapes

Chapter 20-
• Calculations can come for Swaps – specifically for currency swaps
Book 4 – VRM
Chapter 1
• Expected Shortfall Calculation
• Var Using those 3 Approaches that we have in curriculum

Chapter 2 –
• Var for Non Linear Derivative(very imp)

Chapter 3 –
• Why Fat Tails and their reason
• EWMA and GARCH (more than 2 questions can come)
• Updating Correlations

Chapter 4 –
• LO 50.c: Define and use the hazard rate to calculate the unconditional default probability of a credit asset.
• compare the through-the-cycle and point-in-time internal ratings approaches.
• Expected Loss Calculation

Chapter 5 – Country Risk

• sovereign risk with currency printing option
• LO 51.b: Evaluate composite measures of risk that incorporate all major types of country risk.
• Characteristics of sovereign credit spreads and sovereign credit default swaps (CDS)
Chapter 6- Credit Risk
• LO 52.e: Estimate the mean and standard deviation of credit losses assuming a binomial distribution.
• Vasicek Model, don’t focus on Vasicel model formula, rather know how to Cal Unexpected Loss formula.
• Eulers Theorem

Chapter 7- Ops Risk

operational risk regulatory capital, Power law and how a loss distribution is derived from an appropriate loss frequency distribution and loss severity
distribution using Monte Carlo simulation

Chapter 8 – Stress Testing (pls find questions below for this)

Chapter 9 –
Replicating Portfolios (those 2 variations included in Revision notes) and Clean and dirty price

Chapter 10 – Interest Rates

• Par Rates Calculation and Value of Bond Cal using Par Rates
• LO 56.e: Interpret the relationship between spot, forward, and par rates.
• Describe overnight indexed swaps (OIS) and distinguish OIS rates from LIBOR swap rates.
• Yield Curve Shapes and trading strategies

Principal component analysis 32.call option price calculation 33.BSM calculation 2 calculation 34.theta gamma vega and rho given which one to be used
Chapter 11 – Bond Yields
• Explain the relationship between spot rates and YTM, Japanese Yields BOND RETURN DECOMPOSITION

Chapter 12 – DVO1
• DVO1 cal and hedging using dvo01
• Duration + Convexity Hedging (using both)
• Barbell Portolfio

Chapter 13 – Modelling Non Parallel Term Structure

• PCA and LO 59.d: Define, calculate, and interpret key rate 01 and key rate duration.

Chapter 14/15 – Binomial Trees/BSM

• Expect Calculations for both Binomial and BSM

Chapter 16 – Greeks
• Hedging using both Delta + Gamma
• Portfolio Insurance
Book 2 - Quants
1.joint probability and Bayes theorem (typical questions are below, pls do that)
kurtosis
hypothesis created which one to reject-(find questions below)
properties of ols
F-Test6
Multicollinearity7.
white noise
Jarque bera test
pseudo random generator mixed with bootstraping and monte carlo approach
Machine Learning 15th Chapter is imp – pls find those questions in Full Mock 3
VRM – STRESS TESTING
Which of the following statements is most likely incorrect regarding the key elements of effective governance and controls over stress
testing?

A) Proper governance and controls are especially important for stress tests that are qualitative in nature and where stress tests
require a very small number of assumptions.
B) Effective governance and controls are critical to ensuring that stress tests are conducted appropriately and are subject to adequate
oversight.
C) Key elements of effective governance and controls over stress testing include the governance structure, policies and procedures,
documentation, validation and independent review, and internal audit.
D) Institutions should aim for oversight that is tailored to the complexity and characteristics of the specific institution

Solution : A
Proper governance and controls are especially important for stress tests that are highly technical in nature and where stress tests
require a large number of assumptions or create uncertainties in estimating stressed events and conditions.
VRM – STRESS TESTING
The role of the internal audit in stress testing governance and control is an important component of an institution's
governance and controls. Which of the following statements is most likely incorrect regarding the internal audit's role?
The internal audit:

A) should verify that stress tests are conducted thoroughly and as intended, and that the staff in charge of these
activities possesses the necessary expertise and adheres to the appropriate policies and procedures.
B) is intended to assess the integrity and reliability of an institution’s policies and procedures, including those pertaining
to stress tests.
C) should review the procedures pertaining to the documentation, review, and approval of stress tests.
D) should be dependent on other departments with sufficient knowledge and technical expertise when conducting their reviews.

Solution : D
Auditors should be independent with sucient knowledge and technical expertise to conduct their reviews..
VRM – STRESS TESTING
Regarding the responsibilities of the board of directors and senior management in stress testing activities, which of the
following statements most likely pertains specially to senior management? Senior management:

A) has oversight for an organization’s key strategies and decisions and is responsible and accountable for the entire
organization.
B) should establish robust policies and procedures to ensure compliance with stress testing these activities, reviewing
and coordinating stress test activities, and remedying any issues.
C) members should be critical of stress tests by actively challenging assumptions.
D) should be sufficiently knowledgeable about the organization’s stress testing activities to ask informed questions

Solution : B
Senior management is accountable to the board and is responsible for the satisfactory implementation of the stress testing activities
authorized by the board. This entails establishing robust policies and procedures to ensure compliance with these activities, reviewing
and coordinating stress test activities, and remedying any issues. The remaining statements are responsibilities of the board.
VRM – STRESS TESTING
Assume that the value at risk (VAR) over a 1-day time horizon for an $80 million equity portfolio at the 95 percent
confidence level is calculated to be $792,000. Which of the following is a drawback to this VAR calculation?

A) The measure is backward looking.

B) The interpretation of the VAR measure would be different for a fixed-income portfolio.
C) The actual loss in a time of extreme market stress could be much greater than $792,000.
D) Increasing the time period used in the calculation will increase the VAR.

Solution : C
One of the main drawbacks to VAR is that it fails to incorporate the loss that may occur beyond the 95% condence level, such as the loss
that may occur with an extreme market event. This drawback of VAR is the reason stress testing is necessary. Note that increasing the
time period resulting in an increase in VAR would not be considered a drawback; the fact that VAR is expressed in dollars means the
interpretation would the same for a xedincome portfolio and that VAR is a forward-looking measure, not a backward-looking measure
VRM – STRESS TESTING
Which of the following most accurately describes the relationship between computing internal capital requirements using
a stress testing approach versus a value at risk (VAR) capital strength approach? Stress testing approaches:

A) should never be used since they are based entirely on subjective inputs.
B) can never be combined with VAR approaches because they are based on different probability distributions.
C) are substitutes for VAR approaches since they better measure the entire spectrum of potential outcomes.
D) complement VAR approaches since they account for scenarios that may not be properly considered in VAR
approaches.

Solution : D
Since VAR often relies on common probability distributions, it may not properly capture extreme, but possible, events. Stress testing
involves evaluating the eects that these events would have on the institution and then establishing capital requirement based on the
ndings. The two approaches are natural complements
VRM – STRESS TESTING
According to the Principles for sound stress testing practices and supervision by BIS, when is stress testing especially
important?

A. When new regulations such as Basel III or Dodd-Frank are introduced and implemented
B. During periods of expansion or long periods of benign economic and financial conditions
C. During a corporate transaction such as a merger, especially if key executive roles are changing
D. Immediately after a market crisis because the standard models will be less useful when systemic input assumptions
are depressed

Solution : B
During periods of expansion or long periods of benign economic and financial conditions
VRM – STRESS TESTING
When developing a stress testing program, according to BIS, each of the following elements or component is essential
EXCEPT which is not?

A. Reverse stress test

B. System-side interactions and feedback effects
C. Rigorously estimated ex ante probabilities of stress events based on statistical relationships
D. Imaginative and forward-looking scenarios informed by the judgment of experts across the organization

Solution : C
False. BIS: "The financial crisis has shown that estimating ex ante the probabilities of stress events is problematic. The statistical
relationships used to derive the probability tend to break down in stressed conditions. In this respect, the crisis has underscored the
importance of giving appropriate weight to expert judgment in defining relevant scenarios with a forward looking perspective."
VRM – STRESS TESTING
Each of the following statements is true about stress testing EXCEPT which is false?

A. Stress testing is a non-statistical risk measure that may employ scenario analysis as one approach
B. An acceptable proxy for stress testing is to generate value at risk (VaR) with a series of progressively increasing
confidence levels; e.g., 99.0%, 99.50%, 99.75%, 99.90%, and 99.99%
C. While backtesting validates model parameter(s) using a large number of actual, historical observations; stress testing
on the other hand uses a small number of extreme movements in market variables
D. Unlike value at risk (VaR) which indicates neither the magnitude nor shape of extreme losses beyond the VaR
threshold, stress testing DOES attempt to characterize the magnitude/shape of the extreme loss tail

Solution : B
False, or at least it is not necessarily true that high levels of VaR confidence are good proxies for stress testing. VaR might be based on
historical observations that do not anticipate (or imagine) discontinuous shifts. Related, this is also false for the same reason that choice
(D) is true
VRM – STRESS TESTING
Which of the following statements in relation to effective governance over a bank's stress-testing activities are correct?
I. Stress testing should be carried out over long-term horizons because adverse conditions take longer to develop.
II. Stress testing should consider the potential for capital and liquidity problems to arise simultaneously or exacerbate one another.
III. Stress testing should be conducted at relevant levels in a bank, including business line, portfolio and risk type, as well as on an
enterprise-wide basis.
IV. When conducting an enterprise-wide stress test, a bank should ensure that business lines and risk areas use the same
assumptions for the chosen scenario.

A. I and IV only
B. II and III only
C. II, III, and IV only
D. I, II, III, and IV
Solution : C
II, III, and IV only
I is incorrect because stress testing should be conducted over various relevant time horizons to adequately capture the risks faced by
the bank.
VRM – STRESS TESTING
Which of the following statements correctly describe a bank's stress-testing policies and documentation that are
consistent with effective stress-testing governance?
I. A bank should ensure that its stress tests are documented appropriately.
II. Stress-testing policies should specify the frequency and priority with which stress-testing activities should be carried out.
III. Stress-testing policies should provide transparency to third parties for their understanding of a bank's stress-testing activities.
IV. When a bank uses stress tests from a vendor, there is no obligation for the vendor to provide documentation of the vendor's
approach because this information is proprietary to the vendor.

II and III only

II and IV only
I, II, and III only
I, III, and IV only

Solution : C
IV is incorrect because the bank should ensure that appropriate documentation of the vendor's approach is available so that the stress
test can be reviewed and approved by the bank
VRM – STRESS TESTING
All of the following statements in relation to the practical implementation of enterprise-wide stress tests are correct except for:

A. Stress tests tend to focus on a few scenarios whereas VaR measures usually use a large number of scenarios.
B. Stress tests tend to take a “market” view of loss estimates whereas VaR measures usually take an accounting view of losses.
C. Stress-test scenarios are often ad hoc and conditional whereas VaR measures are typically based on unconditional scenarios.
D. Stress tests do not tend to focus on the cardinal probabilities associated with scenarios whereas cardinal probabilities feature
prominently in the use of VaR models.

Solution : B
Stress tests tend to take an accounting view of losses whereas VaR measures (including economic capital) usually take a market view.
VRM – STRESS TESTING
Carlos asks Esteban about the applications of stress testing combined with VaR. All of the following about stress testing are correct
except:
A. Stress testing can expose weaknesses in risk management policies.
B. Stress testing complements VaR approaches since stress testing estimates the magnitude while VaR estimates the probability of an
event. S
C. tress testing can substitute VaR since they better measure the entire spectrum of potential outcomes.
D. Stress testing can help managers allocate capital within a firm.

Solution : C
Stress testing can substitute for VaR since it can better measure the entire spectrum of potential outcomes. Uses of stress testing
include exposing weakness in risk management policies and allocating capital. Stress testing can be combined with VaR because they
are perfect complements of each other. Stress testing can identify the magnitude while VaR can estimate the probability.
VRM – STRESS TESTING
Which of the following weaknesses were identified in stress-testing scenarios used by banks prior to the 2008 financial crisis?

I. Hypothetical stress tests generally applied moderate shocks.

II. Extreme hypothetical scenarios were often regarded as implausible by the board and senior management.
III. Stress tests based on historical scenarios did not capture risks in new products that were at the center of the crisis.
IV. Historically based stress tests underestimated the severity levels and duration of stress that was experienced in the financial crisis.

A. I and II only
B. III and IV only
C. II, III, and IV only
D. I, II, III, and IV

Solution : D
It was difficult for risk managers to persuade senior management to consider the more extreme scenarios.
FOUNDATIONS : GARP CODE OF CONDUCT
Will Lambert, FRM, is a financial risk analyst for Oshore Investments. He is preparing a purchase recommendation on Burch
Corporation. According to the GARP Code of Conduct, which of the following statements about disclosure of conicts is most correct?
Lambert would have to disclose that:

A. his wife owns 2,000 shares of Burch Corporation

B. all of these choices require disclosure
C. he has a material beneficial ownership of Burch Corporation through a family trust
D. Oshore is an OTC market maker for Burch Corporation’s stock

Solution :
B.
According to Standard 2.2, GARP Members shall make full and fair disclosure of all matters that could reasonably be expected to impair
independence and objectivity or interfere with respective duties to their employer, clients, and prospective clients.
FOUNDATIONS : GARP CODE OF CONDUCT
Charmaine Townsend, FRM, has been managing a growth portfolio for her clients using a screening process that identifies companies
that have high earnings growth rates. Townsend has decided that, because she thinks the economy might turn volatile, she is going to
adopt a value strategy using a screening process that identifies companies that have low price earnings multiples. Townsend will violate
the GARP Code of Conduct if she makes this change in her investment process without:

A. promptly notifying her clients of the change

B. getting written permission from her clients in advance of the change.
C. getting prompt written acknowledgment of the change from her clients within a reasonable time after the change was made
D. notifying her supervisor before she makes the change

Solution :
A.
GARP Members shall make full and fair disclosure of all matters that could reasonably be expected to impair independence and
objectivity or interfere with respective duties to their employer, clients, and prospective clients
FOUNDATIONS : GARP CODE OF CONDUCT
Which of the following statements is a correct description of the responsibility of GARP members with respect to professional integrity
and ethical conduct under the GARP Code of Conduct?

A. Members must not use confidential information for personal benefit.

B. Members shall exercise reasonable judgment in the provision of risk services while maintaining independence of thought and
direction.
C. Members shall make full and fair disclosure of all matters that could reasonably be expected to impair their independence and
objectivity.
D. Members shall be familiar with current generally accepted risk management practices and shall clearly indicate any departure from
their use.

Solution :
B.
This is a correct description of the responsibility of GARP members with respect to professional integrity and ethical conduct under the
GARP Code of Conduct.
FOUNDATIONS : RDARR
Which of the following is typically not a role that supervisors play in the monitoring and implementation of risk data aggregation and
reporting practices?

A. Periodically review and evaluate a bank’s compliance with the principles for effective risk data aggregation and reporting.
B. Have and use the appropriate tools and resources to require effective and timely remedial action by a bank to address deficiencies
in its risk data aggregation capabilities and risk reporting.
C. Cooperate with relevant supervisors in other jurisdictions regarding the supervision and review of the principles for effective risk
data aggregation and reporting, and the implementation of any remedial action if necessary.
D. Rating of their firms’ current performance on achieving compliance with the RDARR principles and reporting these rating to the Risk
Data Network (RDN)

Solution :
D.
The Risk Data Network (RDN) periodically releases progress reports on implementation of the BCBS 239 principles. In these reports,
supervisors rate firms’ current performance on achieving compliance with the RDARR principles. However, the raring and reporting to
RDN is not part of the principles. Hence this answer is true.
FOUNDATIONS : RDARR
Which of the following is typically not a benefit of having effective risk data aggregation and reporting, when implementing the BCBS
guidelines?

A. Enhancement of tactical and strategic decision making

B. Reduction of the chance of losses and improvement of risk adjusted returns
C. Easier adherence to regulatory standards regarding data quality assessment
D. The creation of the CDO position within the firm

Solution :
D.
BCBS 239 was a major driver in the rise of the chief data officer (CDO) function. The CDO is typically responsible for standardizing a
firm’s approach to data management. However, having a CDO is not a requirement to having effective risk data aggregation and
reporting and, obviously, there other ways to implement an effective aggregation and reporting structure to yield its benefits. Hence,
this answer is true.
FOUNDATIONS : RDARR
Which of the following is typically not true when describing governance principles related to risk data aggregation and risk reporting
(RDARR) practices?

A. Effective risk data governance is achieved by implementing policies that set “out a clear delineation of roles, incentive schemes, and
responsibilities for risk data management.”
B. Ineffective risk governance is “a lack of structured policies and frameworks to consistently assess and report risk data activities to
the board and senior management.”
C. A board should design, build, and maintain data architecture and IT infrastructure which fully supports its risk data aggregation
capabilities and risk reporting practices not only in normal times but also during times of stress or crisis.
D. The board has an important governance role related to RDARR.

Solution :
C.
Although data architecture and IT infrastructure should be designed, built and maintained, this is not a task the board should
undertake. Moreover, this principle is not related to governance but to effective data architecture and IT infrastructure. Hence this
answer is true.
FOUNDATIONS : RDARR
All of the following statements correctly describe a characteristic of effective risk reporting practices according to the Basel Committee's
Principles for Effective Risk Data Aggregation and Risk Reporting except for:

A. Risk management reports should cover all material risk areas within the organization.
B. Risk management reports should include an appropriate balance between risk data, analysis and interpretation, and qualitative
explanations.
C. Risk management reports should be accurate and precise to ensure that top management can rely confidently on the aggregated
data to make critical decisions about risk.
D. Top management should set the frequency of risk management report production and distribution such that it is appropriate for
normal market conditions as well as during times of stress or crisis.

Solution :
D.
Principle 10 (Frequency) recommends that the frequency of reports should be increased during times of stress or crisis.
FOUNDATIONS : RDARR
Which of the Basel Committee's Principles for Effective Risk Data Aggregation and Risk Reporting recommends that a bank's risk data
aggregation capabilities and risk reporting practices be fully documented and independently validated?

A. Principle 1—Governance
B. Principle 3—Accuracy and Integrity
C. Principle 4—Completeness
D. Principle 8—Comprehensiveness

Solution :
A.
Principle 1 recommends that a bank's risk data aggregation capabilities and risk reporting practices should be subject to strong
governance arrangements.
FOUNDATIONS : RDARR
All of the following recommendations in relation to Principle 2 (Data Architecture and IT Infrastructure) of the Basel Committee's
Principles for Effective Risk Data Aggregation and Risk Reporting are true except for:

A. A bank should establish integrated data taxonomies and architecture across the bank.
B. Roles and responsibilities should be established as they relate to the ownership and quality of risk data and information for both
business and IT functions.
C. Risk data aggregation capabilities and risk reporting practices should be given direct consideration as part of a bank's business
continuity planning processes.
D. A bank's data architecture and IT infrastructure should support its risk data aggregation capabilities and risk reporting practices in
normal times while allowing expert judgment to be applied in times of stress or crisis.

Solution :
D.
A bank's data architecture and IT infrastructure should support its risk data aggregation capabilities and risk reporting practices in
normal times as well as during times of stress or crisis.
FOUNDATIONS : RDARR
Which of the following is NOT required by Principle 3(Accuracy and Integrity) of the Basel Committee on Banking Supervision?

A) Controls applied to risk data should be as robust as those surrounding accounting data.
B) Data should be reconciled with other bank data, including accounting data, to ensure its accuracy.
C) The production of aggregate risk information should be delayed to ensure its accuracy.
D) Banks monitor the accuracy of risk data and establish plans to correct poor data quality.

Solution :
C.
Principle 3 of the Basel Committee on Banking Supervision requires banks to generate accurate and reliable risk data, with effective
controls in place for manual processes and data reconciled with other bank data.

Option A is correct because Principle 3 explicitly states that controls applied to risk data should be as robust as those surrounding
accounting data.
Option B is correct because data reconciliation with other bank data is required to ensure accuracy.
Option D is correct because banks are expected to monitor and correct poor data quality.
FOUNDATIONS : RDARR
A bank has just discovered a large potential credit risk exposure to a corporate borrower, and their risk management team needs to
produce an aggregated risk report for this critical risk. The bank has established specific frequency requirements for risk management
reporting, but the risk data aggregation system is experiencing technical difficulties. What should the bank do to meet the requirement
of timely risk data aggregation in this scenario?

A) Wait for the technical difficulties to be resolved before producing the risk report.
B) Produce the risk report as soon as possible, even if it means manually aggregating the data.
C) Delay the production of the risk report until the technical difficulties are resolved, but notify bank supervisors about the delay.
D) Produce the risk report using outdated data, rather than delay the production of the report.

Solution :
B.
Principle 5 requires that risk data aggregation should be timely and meet all requirements for risk management reporting, particularly
in stress/crisis situations for critical risks. In this scenario, the bank has a critical risk exposure and needs to produce an aggregated risk
report as soon as possible. While technical difficulties may cause delays in automated risk data aggregation, the bank should utilize
manual processes to produce the report in a timely manner.
Waiting for the technical difficulties to be resolved (option A) or delaying the production of the risk report (option C) could lead to
regulatory non-compliance, and producing the report using outdated data (option D) would not meet the accuracy and integrity
principles.
Suppose that the return on seven different mutual funds are independent from each other. An analyst believes that each fund has a
60% probability of achieving a positive return in any one week. The probability that at least two funds will produce a positive return in
any one week is closest to:

A. 85.8%.
B. 98.1%. "At least" means that the outcome can be
equal to or greater than a certain number.
C. 99.6%.
D. 99.8%

Solution :Chapter 1 : Fundamentals of probability

B.
An analyst on the fixed-income trading desk observed that the number of defaults per year in the bond portfolio follows a Poisson
process. The average number of defaults is four per year. Assuming defaults are independent, what is the probability that there is at
most one default next year?

A 6.58%
B 7.33% "At most" means that the outcome can be
equal to or less than a certain number.
C 9.16%
D 25.00%

Solution :Chapter 1 : Fundamentals of probability

C.
An analyst is examining a portfolio that consists of 2,500 subprime mortgages and 800 prime mortgages. Of the subprime mortgages,
500 are late on their payments. Of the prime mortgages, 64 are late on their payments. If the analyst randomly selects a mortgage from
the portfolio and it is currently late on its payments, what is the probability that it is a subprime mortgage?

A 60%
B 67%
C 75%
D 89%

Solution :Chapter 1 : Fundamentals of probability

D.
An analyst determines that there is a 40% probability that a company's earnings per share (EPS) will increase. If the company's EPS
increases, there is a 75% probability that the company's stock price will rise and a 25% probability that the price will fall. If the
company's EPS decreases, there is a 20% probability that the company's stock price will rise and an 80% probability that the price will
fall. Given that the company's stock price has risen, the probability that the company's EPS has increased is closest to:

A. 30%
B. 42%
C. 71%
D. 95%

Solution :Chapter 1 : Fundamentals of probability

C.
A portfolio manager is analyzing the risk-adjusted performance of one of his client's portfolios with a sample of 30 monthly returns. The monthly returns
are independent and identically distributed. The mean monthly return of this sample of monthly returns is 1.5% and the sample standard deviation is
2.5%. The related t-table values (one-tailed probabilities) are shown below.

The 95% confidence interval for the mean monthly return is closest to:
A. [0.5666%, 2.4334%].
B. [0.5680%, 2.4320%].
C. [0.7245%, 2.2755%].
D. [0.7254%, 2.2746%].

Solution :Chapter 6 : Hypothesis Testing

A.
Consider the regression results from the regression of Y against X for 50 observations:
Y = 0.78 + 1.2 X
The standard error of the estimate is 0.40 and the standard error of the coefficient is 0.45.
Which of the following reports the correct value of the t-statistic for the slope and correctly evaluates its statistical significance with 95 percent
confidence?

A) t = 3.000; slope is significantly different from zero.

B) t = 2.667; slope is significantly different from zero.
C) t = 1.789; slope is not significantly different from zero.
D) t = 1.200; slope not significantly different from zero.

Solution :Chapter 6 : Hypothesis Testing

B.
The test statistic is t = (1.2 − 0) / 0.45 = 2.667. The critical t-values for 48 degrees of freedom are ± 2.011. Therefore, the slope is
different from zero.
A bank entered into a 4-year tenor plain vanilla swap exactly three years ago from today. The agreements of the swap are to pay 6.5
percent annually, based on annual compounding with a 30/360 day-count convention, fixed rate on a $50 million notional, and receive
1-year London Interbank Offered Rate (LIBOR). The continuously compounded LIBOR for 1-year obligations is currently 5.75 percent.
The 1-year LIBOR at the beginning of the period was 6.25 percent. The value of the swap is closest to:

A) −$270,000.
B) −$257,020.
C) $110,000.
D) $800,522

Solution :Chapter 20 : Swaps

A.
The value of the fixed-rate component of the swap is ($50 × 1.065)e (−0.0575) = $50.27M. The value of the floating-rate component of
the swap is its par value of $50M since we are currently at an annual settlement date. Hence, the value of the swap to this counterparty
is approximately $50M − $50.27M = −$270,000.
Suppose that some time ago a U.S. company entered into a currency swap in which it pays 4% per annum in AUD and receives 3% per
annum in USD. The principal amounts are AUD 135 million and USD 100 million. There are two years remaining on the swap and the
current exchange rate is AUD 1.40 to USD 1. The current term structure of interest rates is flat in Australia and the United States, with
the Australian rate being 5% per annum and the U.S. rate being 2% per annum, both rates on a continuous compounded basis. The
value of the currency swap to the company using the two-bond methodology is closest to:

A. –USD 3,993,900.
B. +USD 3,993,900.
C. –USD 7,490,600.
D. +USD 7,490,600

Solution :Chapter 20 : Swaps

D.
When dealing with Treasury bond futures, locating the cheapest-to-deliver bond is a critical decision. When yields are fairly low (below
6%), as they are at present, which of the following types of bonds tend to be the cheapest-to- deliver?

A) High-coupon, long maturity.

B) Zero-coupon, long maturity.
C) Low-coupon, long maturity.
D) High-coupon, short maturity.

Solution :Chapter 19 : Interest rate futures

D.
When yields are < 6%, high coupon and short maturity bonds are CTD
Sally, a human resources specialist for a major international bank has been asked to develop compensation schemes for the bank's
executives that would be aligned with the long-term interest of shareholders and other stakeholders of the bank. Which of the
following compensation schemes is she most likely to propose?

A. Guaranteed cash bonuses

B. Bonuses in the form of call options on the company's shares
C. Bonuses in the form of shares in the company if short-term profit targets are achieved
D. Bonuses combining call options on the company's shares and bonds issued by the company

Solution :Chapter 3: Corporate Governance

D.

This compensation scheme allows executives to benefit from the upside potential of the call options but also bear the risk of downside
on their bonds. Forms of compensation that align with long-term interests are those that deliver compensation over longer periods of
time and aren't paid out in cash over shorter periods of time. The intent here is to keep bonuses from being like a call option on the
banks’ balance sheet where big bets can be paid and bonuses earned but have no consequences for the longer-term costs. The
combination of options and debt is a remedy to align those interests.
Which of the following most likely indicates the maximum fee an investor should pay a portfolio manager?

A. Sharpe ratio
B. Jensen's alpha
C. Treynor ratio
D. Sortino ratio

Solution :Chapter 5: Modern Portfolio Theory (MPT) and the Capital Asset Pricing Model (CAPM)
B.

Jensen's alpha equals the difference between the portfolio's actual return and the required return (as predicted by the CAPM) based on
the asset's systematic risk. An investor should not pay the portfolio manager a fee greater than the portfolio's Jensen's alpha, as such a
fee would take the portfolio's net return lower than the risk of a passively managed portfolio.
The reporting structure for the chief risk officer of an organization should ideally be achieved through a:

A. Solid-line reporting relationship between the chief risk officer and the chief executive officer.
B. Solid-line reporting relationship between the chief risk officer and the chief financial officer.
C. Solid-line reporting relationship between the chief risk officer and the chief financial officer and a dotted-line reporting relationship
between the chief risk officer and the chief executive officer.
D. Solid-line reporting relationship between the chief risk officer and the chief executive officer and a dotted-line reporting
relationship between the chief risk officer and the board of directors.

Solution :Chapter 3 : Corporate Governance (PLEASE REMEMBER THIS RELATIONSHIP) It is very important
D.

The dotted line may be converted into a solid line so that the CRO can go directly to the board in extreme circumstances without fear of
losing his/her job. The importance of the CRO role is rooted in the independence of the job and “solid-line” reporting means a direct
reporting. No matter how you see it on the exam, just remember the answer that preserves as much independence in the CRO role is
the right one.
All of the following statements in relation to risk-adjusted performance measurement are true except for:

A. The slope of the capital market line is equal to its Sharpe ratio.
B. The Jensen measure can be used to rank portfolios with the same beta.
C. The Jensen measure and Treynor ratio can be used to evaluate the performance of well-diversified portfolios.
D. When evaluating the performance of portfolios that contain significant amounts of unsystematic risk, the Sharpe and Treynor ratios
should be used.

Solution :Chapter 5: Modern Portfolio Theory (MPT) and the Capital Asset Pricing Model (CAPM)
D.

The Treynor ratio should only be used for well-diversified portfolios.

Which of the following scenarios best illustrates systemic risk?

A. The difficulty experienced by a company in refinancing its bank loans at maturity

B. A change in consumer sentiment, which leads to reduced demand for the firm's key products
C. The potential for the failure of one bank to threaten the stability of other banks and the overall financial system
D. An error by an options trader when pricing OTC call options, which leads to a significant loss for the trader's firm

Solution :Chapter 10: Anatomy of the Great Financial Crisis

C.

The interdependencies among financial institutions will exacerbate systemic risk when there is a financial crisis. Here's a mnemonic to
help you remember which is which. Systematic risk is the risk to a specific “system” or a specific security. Systemic risk is the risk to the
entire “system.” These are very similar but very different concepts..
Which of the following statements related to the global impact of the 2007–2008 financial crisis on the real economy is least likely to be
true?

A. There was an overall decrease in bank loan supply.

B. There was an overall increase in the demand for bank credit.
C. Firms on average reduced capital expenditures and dividend payments.
D. Banks that were financed to a larger extent by short-term debt exhibited a greater reduction in syndicated lending.

Solution :Chapter 10: Anatomy of the Great Financial Crisis

B.
There was an overall decrease in the demand for bank credit, which is consistent with the global recession which followed the financial
crisis.
Which of the following is typically not a benefit of having effective risk data aggregation and reporting, when implementing the BCBS
guidelines?

A. Enhancement of tactical and strategic decision making

B. Reduction of the chance of losses and improvement of risk adjusted returns
C. Easier adherence to regulatory standards regarding data quality assessment
D. The creation of the CDO(chief data officer) position within the firm

Solution :Chapter 7: Principles for Effective Data Aggregation and Risk Reporting
D.
BCBS 239 was a major driver in the rise of the chief data officer (CDO) function. The CDO is typically responsible for standardizing a
firm’s approach to data management. However, having a CDO is not a requirement to having effective risk data aggregation and
reporting and, obviously, there other ways to implement an effective aggregation and reporting structure to yield its benefits. Hence,
this answer is true.
The main vulnerability of the U.S. financial system that amplified the initial shocks that led to the financial crisis of 2007–2008 was
related to disruptions in the:

A. Shadow banking system in the U.S. money market

B. U.S. long-term debt markets.
C. U.S. short-term debt markets.
D. Losses on U.S. subprime mortgages.

Solution :Chapter 10: Anatomy of the Great Financial Crisis

C
Disruptions in the U.S. short-term debt markets, mostly due to repos and commercial paper, amplified the losses in the subprime
market. I think this is one of the more important distinctions with this section of the exam: how similar triggers and vulnerabilities are
and which is which. We generally consider losses on subprime one of the key triggers. Think of a vulnerability as something that
amplifies the initial triggers and it will seem easier.
Which of the following is typically not a role that supervisors play in the monitoring and implementation of risk data aggregation and
reporting practices?

A. Periodically review and evaluate a bank’s compliance with the principles for effective risk data aggregation and reporting.
B. Have and use the appropriate tools and resources to require effective and timely remedial action by a bank to address deficiencies
in its risk data aggregation capabilities and risk reporting.
C. Cooperate with relevant supervisors in other jurisdictions regarding the supervision and review of the principles for effective risk
data aggregation and reporting, and the implementation of any remedial action if necessary. R
D. ating of their firms’ current performance on achieving compliance with the RDARR principles and reporting these rating to the Risk
Data Network (RDN

Solution : Chapter 7: Principles for Effective Data Aggregation and Risk Reporting)
D
The Risk Data Network (RDN) periodically releases progress reports on implementation of the BCBS 239 principles. In these reports,
supervisors rate firms’ current performance on achieving compliance with the RDARR principles. However, the raring and reporting to
RDN is not part of the principles. Hence this answer is true.
Assume that you are concerned only with systematic risk. Which of the following would be the best measure to use to rank order funds
with different betas based on their risk-return relationship with the market portfolio?

A. Treynor ratio
B. Sharpe ratio
C. Jensen's alpha
D. Sortino ratio

Solution : Modern Portfolio Theory (MPT) and the Capital Asset Pricing Model (CAPM)
A
The least important antecedent to the financial crisis of 2007–2008 was the acceleration of:

A. Consumer debt.
B. External government debt.
C. Domestic government debt.
D. Debt of financial institutions

Solution : Chapter 10: Anatomy of the Great Financial Crisis

A
Consumer debt. The buildup of government debt (both external and domestic) and debt of financial intermediaries were the most
important antecedents to the financial crisis of 2007–2008. It might be better to think of this “debt” as leverage. Most of the debt was
not in the form of new issuance but rather generous repo haircuts on assets that banks could put back into the marketplace..
What is the responsibility of the board of directors in stress testing governance?

A) Actively challenge stress test assumptions and ensure policies are followed
B) Conduct stress tests to evaluate risks and update them regularly
C) Review and approve stress test procedures and report results to senior management
D) Develop robust policies and procedures for stress-testing activities

Solution : Stress Testing

A
Actively challenge stress test assumptions and ensure policies are followed.

Option B is the responsibility of senior management,

Option C is the responsibility of senior management reporting to the board,
Option D is the responsibility of senior management developing policies and procedures.
Which of the following is the rationale for using stress testing as a risk management tool?

A) To evaluate an entity's performance in normal market conditions

B) To measure the probability of low-impact events
C) To prepare for high-impact events with high probability of occurrence
D) To estimate expected shortfall (ES) alone

Solution : Stress Testing

C
To prepare for high-impact events with high probability of occurrence.
A is incorrect because stress testing is not specifically designed to evaluate an entity's performance in normal market conditions.
Rather, it focuses on extreme events with low probability of occurrence but high impact.

B is incorrect because stress testing is not focused on measuring the probability of low-impact events. Instead, it aims to identify and
evaluate high-impact events that may occur in the future.

D is incorrect because stress testing is not used to estimate expected shortfall (ES) alone. It is often used in conjunction with other risk
management tools such as VaR and ES to provide a more comprehensive view of risk across an enterprise.
1) An analyst determines that there is a 40% probability that a company's earnings per share (EPS) will increase. If the
company's EPS increases, there is a 75% probability that the company's stock price will rise and a 25% probability that the
price will fall. If the company's EPS decreases, there is a 20% probability that the company's stock price will rise and an
80% probability that the price will fall. Given that the company's stock price has risen, the probability that the company's
EPS has increased is closest to:
A. 30%
B. 42%
C. 71%
D. 95%

Solution : BANKS
C
What pricing strategy should the investment bank choose for underwriting the issue of 20 million shares at a current
share price of USD 24?

A) Firm commitment at USD 20

B) Best efforts with a charge of 40 cents per share sold regardless of price
C) Firm commitment at USD 24
D) Best efforts with a charge of 20 cents per share sold regardless of price

Solution : BANKS
A
Firm commitment at USD 20 coz u r earning good spread of 24 – 20 = 4 dollars per share.
The bids and bidders in a Dutch auction to sell 20,000 shares are as follows: At what price are the shares sold? How many shares does
each bidder get?

A) 80
B) 84
C) 86
D) 85

Solution :
B.
19,000 shares can be sold for 85 or more. 23,000 shares can be sold for 84 or more. Shares are therefore sold for 84. Bidders C, D, and
G get the shares they have bid for. Bidder F gets 1,000 of the 4,000 shares it has bid for
Which of the following is not a conflict of interest in a banking context

A. The investment banker is struggling to sell new shares for a client. They may ask the bank's brokers to encourage
clients to buy and purchase the shares for their discretionary accounts
B. An investment banker advising a client on a potential acquisition might gather confidential information about the
target company from the commercial banking arm of the bank, which is also a client of the bank.
C. An investment bank seeking business from a company might ask researchers from the brokerage end of the bank to
recommend buying the company's stock to please its management.
D. A bank's commercial banking arm could recommend that a client with a high-risk loan seek independent advice from
another bank regarding the possibility of replacing the loan with a bond issue

Solution:
D
A bank's commercial banking arm may suggest that a high-risk loan be replaced with a bond issue handled by the bank's investment
banking arm. This transfer of debt to less informed investors may increase the bank's profitability, but poses a potential risk for the
investors.
Two of the key risks facing insurance companies are moral hazard and adverse selection. Three of the following examples
are illustrations of moral hazard, but one is an example of adverse selection. Which is the example of adverse selection?

A. An individual buys health insurance and consequently decreases their demand for maintaining good health.
B. A cell phone owner buys a "total equipment protection" insurance plan and, consequently, becomes more careless
with the phone
C. Because it is backed by a government-sponsored deposit insurance plan, a bank is less worried about losing
depositors and consequently it takes on more risks
D. A health insurance company is mandated by government to offer the same price (premium cost) to all new customers
so that it cannot increase the relative price of riskier customers and consequently it attracts more high-risk customers

Solution:
D
This is an example of adverse selection, but (A), (B) and (C) are examples of moral hazard
How does financial guarantee, capital requirements, or regulation differ between insurance companies and banks in the United States
or the EU?

A. Unlike the United States, insurance companies are centrally regulated and have remained largely unchanged since the 1970s with
the same rule applying to all EU member states. The original rule system, Solvency I, implied that with a capital base of 10%, life
insurance companies have a 95% chance of survival.
B. In the United States, banks are regulated at the state level and insurance companies have a central, federal regulator. However,
state insurance regulators can set capital requirements higher than the federally set minimum capital requirement.
C. In the EU, insurance companies are centrally regulated, but in the United States, they are decentrally regulated. Furthermore,
while each state in the United States can set its own capital requirements, the EU is working on Solvency II that assigns capital
based on a wider range of risks than Solvency I.
D. In the United States, when a life insurance company goes insolvent, its policies are often taken over by other insurance companies
and there is a guaranty fund that is partially paid by the Federal Deposit Insurance Corporation to protect those insurance
companies that take over the failed company's policies.

Solution:
C
Basically everything you don't want to know is in the wrong answer choices. In the United States, insurance companies have decentral
regulation and in the EU it is central. For the first answer choice, the Solvency I capital requirement in the EU is 4%, not 10%, of policy
provisions as a capital base. For the second answer choice, the relationship between banks and insurance companies is reversed and in
the last answer choice, while it is true that other insurance companies take over those policies, it is not true that the FDIC (notice I
didn't include the better-known acronym in the answer choice; expect GARP to do the same) offers guaranties to those insurance
companies. FDIC is a banking guaranty, not an insurance company guaranty.
An actuarial analyst is calculating the premium on a $200,000 term life insurance policy for a man aged 80 using the mortality table
below. The man is in average health and requires term insurance lasting two years. Assume that insurance premiums are paid at the
beginning of each year and that payouts occur midway through the year.

If the interest rate is 3% per year with semi-annual compounding, the breakeven annual premium payment is closest to:

A. $12,370.
B. $12,760.
C. $12,980.
D. $13,380.

Solution:
B
America's Best Fund (Class A) is an open-ended mutual fund with 1.20 million shares outstanding. Currently, it is 10 am U.S. eastern
standard time (EST) in the morning and the fund owns the following:
$9.30 million in large cap equities,
$1.0 million in short-term U.S. Treasury bills;, and
$500,000 in cash Which of the following statements is TRUE?

A. The fund's net asset value (NAV) is about $7.75 per share
B. If the fund reinvests dividends earned on the equities, the fund's investors are not taxed on these reinvested dividends
C. An immediate order to buy shares, at 10 am, can specify the total dollar amount but will know neither the exact NAV nor exact
number of shares purchased
D. Unless and until the fund issues additional shares in a secondary offering or initiates a share buyback, the number of shares
outstanding will remain fixed at 1.20 million

Solution:
C.
In regard to false A and D, the fund's NAV is about ($9.30 + 0.50 + 1.0)/1.20 mm = $9.00 but it will fluctuate throughout the day. For
Option B, investors usually pay taxes.
In regard to various hedge fund strategies, each of the following statements is generally true EXCEPT which statement is false?

A. A Distressed Securities hedge fund investor is more likely to earn an illiquidity risk premium than a typical Global
Macro manager
B. A Merger Arbitrage hedge fund investors should have a lower correlation to the broad equity markets than a typical
Long/Short Equity manager
C. Although prior to 2009, hedge fund returns lagged the S&P 500, since 2009 hedge funds have outperformed the S&P
500
D. Most of the performance returns are voluntary and those funds that perform poorly or shut down either don't report
or remain in the sample size without performance data.

Solution:
C
All are True, except C
Prior to 2009, hedge fund returns generally beat the S&P 500, but since 2009 hedge funds have generally lagged behind
the S&P 500
Suppose a private equity firm charges a standard 2 plus 20% incentive fee structure for an investment with a 60% probability of making
a 25% return and a 40% probability of losing 10%. What is the expected payoff for fees?

A. 9.00%
B. 8.50%.
C. 10.11%.
D. 9.38%.

Solution:
D.
The private equity firm could potentially earn fees of 14% [2% (flat fee) + 0.20 × 63% (incentive fee on return above the 2% flat fee)].
The expected payoff for fees then becomes 9.38% computed as follows: (0.60 × 14%) + (0.40 × 2%) = 9.38%
Suppose that a U.S. bank uses $30 million of its funds today to make a 1-year risk-free loan in UK pounds yielding 4% when the
exchange rate is $1.50/pound. At the same time, it enters into a 1-year forward contract to sell the expected principal and interest from
the pound loan for dollars at today's forward rate of $1.48/pound. The bank's hedged return on the UK loan in dollar terms is closest to:

A. –1.3%.
B. +2.6%.
C. +4.0%.
D. +5.3%.

Solution:
B
An investor enters into a short forward contract to sell 100,000 Euros for US dollars at an exchange rate of $1.40 US dollars per Euro.
How much does the investor gain or lose if the exchange rate at the end of the contract is $1.20?

A. Loss of USD $20,000

B. Loss of EUR €20,000
C. Gain of USD $20,000
D. Gain of EUR €20,000

Solution:
C
Gain of USD $20,000. The investor is obligated to sell Euros for $1.40 when they are worth $1.20. The gain is (1.40 - 1.20)*100,000 =
$20,000
In the post-2008 move to centralized clearing, unique risks arise from the mandatory central counterparty (CCP) clearing of OTC
derivatives. Which of the following is not one of the risks the CCP can create or amplify?

A. The loss of initial margin a clearing member posts because of the failure of another member
B. The central clearing party replaces the banks as the “too big to fail” link within the financial system.
C. Increased risk of moral hazard if a central bank, or several central banks, are forced to bail out a failed central clearing party
D. The potential for an increased shock amplifier as multiple clearing members try to raise capital to meet the obligations of a failed
member

Solution:
A
The first answer is actually a problem the CCP solves rather than creates. All other answer choices are risks that the CCPs create and can
be remembered for the exam. It is also important to remember that the central clearing party will not use their own capital until the
very last moment before failure. A CCP will use the initial margin of a member to meet their obligations, will use the pledge collateral of
other members to make parties whole, and only lastly use their own economic capital to prevent failure. The amount of capital is so
high within a CCP that the assumption remains that counterparty risk is zero because, ultimately, the CCP has, in theory, the capital to
make the members to the failed party whole
Which of the following statements correctly describe the operation of a central counterparty (CCP) in the OTC derivatives market?
I. The CCP has no net market risk but takes on counterparty risk.
II. The initial margin set by the CCP depends primarily on the credit quality of the market participant posting it.
III. In the event of a default by a CCP member, the CCP will typically close out the defaulting member's positions at market value.
IV. The default losses that a CCP member incurs are not directly related to the transactions that the member has entered into with the
defaulting member.

A. I and III only

B. I and IV only
C. I, II, and IV only
D. II, III, and IV only

Solution:
B
II is incorrect because the initial margin set by the CCP does not depend primarily on the credit quality of the market participant posting
it. III is incorrect because the CCP will typically auction the defaulting member's positions among the other CCP members instead of
closing out the positions
Which of the following statements in relation to the impact of central clearing on the broader financial markets are correct?
I. The use of central counterparties (CCPs) leads to more stable financial markets.
II. The use of CCPs can potentially stifle innovation in financial markets.
III. The mechanisms used by CCPs protect CCP counterparties at the expense of other creditors.
IV. The use of CCPs can potentially increase or decrease systemic risk of the financial system.

A. I and IV only
B. II and III only
C. II, III, and IV only
D. I, II, III, and IV

Solution:
C
I is incorrect because the use of CCPs does not necessarily enhance financial market stability.
A company enters into a futures contract to buy 10,000 units of an asset for USD 50 per unit in two years. At the end of the first year,
the futures price is USD 45. At the end of the second year, the futures price is USD 52. The contract is closed out during the third year
when the futures price is USD 54. What is the accounting for the profit or losses from the trade each year if the company (a) uses hedge
accounting and (b) does not use hedge accounting?
Which of the following is TRUE about a wheat futures contract?

A. The long can stall but must eventually take delivery of wheat
B. The short can deliver futures on any day of the contract delivery month
C. The exchange defines the underlying asset (quality), contract size, delivery months and delivery arrangements
D. If the contract was entered into between “Investor A” (long wheat) and “Investor B” (short wheat), then eventual physical delivery
must be to the original Investor A

Solution:
C
The exchange defines the underlying asset (quality), contract size, delivery months and delivery arrangements.
A crude oil refiner intends to buy 50,000 barrels of WTI Crude oil in one months’ time. It intends to hedge the purchase using Brent
Crude futures contracts, having determined that the correlation between the change in the spot price of WTI Crude and the change in
the price of the Brent Crude futures contract is 0.75. The standard deviation of the change in the spot price of WTI Crude is 0.15 per
month and the standard deviation in the price of the Brent Crude futures contract is 0.12 per month. If one Brent Crude futures
contract is for 1,000 barrels, the optimal number of futures contracts to hedge the refiner's intended purchase of WTI Crude oil is
closest to:

A. 30 contracts.
B. 47 contracts.
C. 53 contracts.
D. 83 contracts.

Solution:
B
The chief risk officer of your firm has asked you to decide between buying a futures contract on an exchange and buying a forward
contract directly in the OTC Space with the firm's best client. Both have the identical terms. You find that the forward price is higher
than the futures price. What single factor acting alone would be a realistic explanation for this price difference?

A. The asset is strongly negatively correlated with interest rates.

B. The futures contract is more liquid and easier to clear.
C. The forward contract counterparty has a higher default probability.
D. The convenience yield on the forward contract is less than on the futures contract.

Solution:
A
Forward contracts do not have a daily settlement feature and this is the reason for the convexity impact on eurodollar futures. The
futures contract has a “free” option on the potential to earn the risk-free rate of return on the mark-to-mark movement of the futures
price. This free option impact—also called the convexity impact—is closely related to both volatility of the futures and how closely
negatively correlated with interest rates the underlying asset is. If the futures contract moves higher in price, and you are long the
future (hence have an overnight gain), that gain will be invested at lower rates.
Suppose that a stock index is at 6,850 today. The average annualized dividend yield on the index is 3.2% and the risk-free rate of
interest is 1.5% per annum (both rates expressed on a continuously compounded basis). A three-month futures contract on the stock
index is trading at 6,835. Which of the following statements correctly describes the arbitrage opportunity from taking a position in one
stock index futures contract?

A. An arbitrage profit of approximately 14.05 could be realized by taking a long position in the futures contract.
B. An arbitrage profit of approximately 14.05 could be realized by taking a short position in the futures contract.
C. An arbitrage profit of approximately 44.17 could be realized by taking a long position in the futures contract.
D. An arbitrage profit of approximately 44.17 could be realized by taking a short position in the futures contract

Solution:
B