Final FRM® Exam Preparation tips
It is essential to have a final preparation study plan for the last... Read More
Valuation and risk models are among the 4 four broad topics tested in FRM Part I. GARP aims to test a candidate’s understanding of valuation techniques and risk models using these topics. 30% of questions in FRM Part I exams originate from these topics, and this can be up to 30 out of 100 exam questions. The Learning Outcomes provided for this section by GARP are computational and non-computational. These are well-balanced in all 16 chapters to be studied in this section. Non-computational LOs usually contain tricky questions as compared to computational LOs.
Some of the points covered in the 16 topics are:
Let us review the contents of the 16 topics and what GARP tests from each.
To determine the suitable risk measure, you must base your assumption on the shape of the primary return distribution. Mean-variance only relates to elliptical distributions such as normal distribution. For non-elliptical distributions, its risk measures are calculated using VaR. However, this measure is unpredictable because it does not approximate the losses incurred.
A better way to estimate risk is using Expected Shortfall. This is because it satisfies all the qualities of a consistent risk measure and has less restrictive presumptions.
For this chapter, the exam might test on:
This chapter focuses on the risk evaluation techniques for linear and non-linear derivatives. GARP examines your understanding of the various methods of calculating VaR and Estimated Shortfall under the following techniques:
This includes the advantages, disadvantages, and basal assumptions of these techniques.
GARP might also test on extended VaR approaches, commonly used when correctly measuring risk for complex derivatives and scenarios. Questions on the following methods may appear in relation to extended VaR techniques:
To understand plausible risk exposure, an accurate estimation of volatility is vital. A normal distribution can be utilized to assess asset value. However, deviations from reality are a common occurrence. Risk managers are frequently challenged by such deviations when measuring volatility and VaR. GARP aims to test your understanding of the following concepts in FRM Part 1 exams:
Credit ratings provide valuable insight into both individual and company investments. Objectively, there is a significant correlation between ratings and subsequent defaults. Therefore most rating organizations use qualitative and quantitative approaches when determining external ratings.
From this chapter, you are needed to demonstrate your understanding of the following concepts:
Sovereign risk frequently varies across countries. Aspects such as a country’s political hazard, legal hazard, or position in the economic market influence the overall risk an investor might face. Rating companies also assess sovereign risks and rating transitions.
GARP might examine your capacity to:
The investment strategy for a financial institution holds a lot of assets. Therefore, you must analyze the expected and unexpected losses from the investment strategy.
During the examination, GARP might test your ability to:
This is the direct or indirect loss arising from insufficient or failed internal processes, external risks, people, and the system. This chapter elaborates on the types of operational risk and bank business lines that must be considered when calculating operational risk capital.
Stress testing aims to anticipate extreme events with a low possibility of occurrence but a profound effect if they do. An organization is required to have a sufficient amount of liquid assets and capital to endure these events. You might come across questions on the following areas on the exam day:
The relationship between VaR and ES is paramount to stress testing. Stressed risk metrics have merits and demerits corresponding to traditional risk measures.
The chapter outlines the foundations of bond valuation. The value of a bond is equivalent to the current value of its cash flows discounted to the suitable periodic time needed to return. Coupon bonds are priced according to discount factors. This is used to gauge whether the bond trades below or above par.
The law of one price states that securities matching future cash flows should trade at the same price.
The future and the present value of an investment are directly impacted by how you compound interest rates. The areas examinable from this topic are:
The different types of rates relevant to debt devices
The relationship between the rates and the influence they have on bond valuations
Yield curves. What causes the flattening and steepening of the curve and the tactics used in these scenarios?
Bond yields and spreads and reinvestment of a coupon are essential in finding the overall return. Using yield to maturity as an indicator of actual returns upon maturity may not be reliable for coupon bonds. If the market goes down, an investor receiving coupon payments is vulnerable to the risk that these cashflows will get reinvested at a rate lower than the initially guaranteed yield. The exams test the calculation and interpretation of YTM(Yield to maturity) and different elements of bond returns.
These are the various ways to determine and secure risk for fixed-income securities. The primary concepts covered in this chapter are:
DV01 and duration can evaluate price volatility but fail to grasp the curvature of the bond yield and price relationship.
This section discusses the term structure of interest by separating it into many regions and assumptions on how the rate of each region changes. Critical rate analysis deduces a portfolio’s exposure to changes in key rates. It is simple and is based on the assumption that rates value in the region of the critical rate selected. The forward-bucket method, however, uses information from a more significant collection of rates, especially those factored into the forward rate curve. The exam tests your knowledge of the following:
This topic is about the Binomial model for valuing options on the stock. It also introduces the Black-Scholes-Merton model. In the exam, GARP tests your ability to:
This option pricing model is based on the assumption that stock prices follow a lognormal distribution. It also discusses how volatility can be measured using the BSM model and current option pricing. The GARP tests your ability to:
Factors affecting the level of risk related to an option position are:
The relationship between the value of a position involving options and the value of the underlying assets.
This is an overview of what to expect from valuation and risk models topics in FRM part I. Are you ready to start studying for your FRM part I? Explore the FRM study options available with AnalaystPrep to ensure you master these concepts adequately for your final exam.
It is essential to have a final preparation study plan for the last... Read More
Financial professionals who want advancements in their career always find it difficult to... Read More