{"id":11112,"date":"2023-06-13T14:32:06","date_gmt":"2023-06-13T14:32:06","guid":{"rendered":"https:\/\/analystprep.com\/blog\/?p=11112"},"modified":"2026-03-06T12:39:27","modified_gmt":"2026-03-06T12:39:27","slug":"frm-part-i-topics-in-valuation-and-risk-models","status":"publish","type":"post","link":"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/","title":{"rendered":"FRM Part I: Topics in Valuation and Risk Models"},"content":{"rendered":"\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"FAQPage\",\n  \"mainEntity\": [\n    {\n      \"@type\": \"Question\",\n      \"name\": \"What are valuation and risk models in FRM?\",\n      \"acceptedAnswer\": {\n        \"@type\": \"Answer\",\n        \"text\": \"Valuation and risk models refer to the methods used to estimate the value of financial instruments and to assess the risk associated with them. In FRM Part I, this includes understanding pricing models, risk measurement tools, and the theoretical frameworks used in financial analysis.\"\n      }\n    },\n    {\n      \"@type\": \"Question\",\n      \"name\": \"Which topics are covered under valuation and risk models in FRM Part I?\",\n      \"acceptedAnswer\": {\n        \"@type\": \"Answer\",\n        \"text\": \"The main topics include bond valuation and yield measures, valuation of forwards, futures, swaps, and options, value at risk (VaR), Greeks and option sensitivities, interest rate models, and risk-adjusted performance measurement.\"\n      }\n    },\n    {\n      \"@type\": \"Question\",\n      \"name\": \"How to prepare for valuation and risk models in the FRM exam?\",\n      \"acceptedAnswer\": {\n        \"@type\": \"Answer\",\n        \"text\": \"Start by mastering key formulas and concepts through your study materials. Then, reinforce your knowledge with practice questions, particularly on pricing, duration, convexity, and VaR. Use mock exams and performance analytics to focus on weak areas.\"\n      }\n    },\n    {\n      \"@type\": \"Question\",\n      \"name\": \"Is valuation and risk models a difficult topic in FRM Part I?\",\n      \"acceptedAnswer\": {\n        \"@type\": \"Answer\",\n        \"text\": \"Yes, it\u2019s considered one of the more technical sections, requiring a solid grasp of math and financial theory. However, consistent practice and conceptual clarity can make it manageable even for candidates without a quant background.\"\n      }\n    },\n    {\n      \"@type\": \"Question\",\n      \"name\": \"What is the weight of valuation and risk models in FRM Part I?\",\n      \"acceptedAnswer\": {\n        \"@type\": \"Answer\",\n        \"text\": \"As per GARP\u2019s latest curriculum, valuation and risk models account for 30% of the total FRM Part I exam weight, making it one of the most heavily tested areas.\"\n      }\n    },\n    {\n      \"@type\": \"Question\",\n      \"name\": \"Are formulas provided during the FRM exam?\",\n      \"acceptedAnswer\": {\n        \"@type\": \"Answer\",\n        \"text\": \"No, candidates must memorize key formulas. This includes bond valuation, Black-Scholes, binomial option pricing, and VaR calculations. Flashcards and formula sheets are helpful for review.\"\n      }\n    },\n    {\n      \"@type\": \"Question\",\n      \"name\": \"Where can I find practice questions for valuation and risk models?\",\n      \"acceptedAnswer\": {\n        \"@type\": \"Answer\",\n        \"text\": \"You can access topic-specific FRM Part I practice questions at AnalystPrep. The platform offers quizzes, full-length mock exams, and detailed solutions tailored to the 2024 FRM curriculum.\"\n      }\n    }\n  ]\n}\n<\/script>\n\n\n\n<p>Valuation and risk models are two of the four main topics tested in FRM Part I. GARP (Global Association of Risk Professionals) focuses on a candidate\u2019s understanding of these concepts through various questions. 30% of the FRM Part I exam questions come from these topics. This means up to 30 out of 100 exam questions will be about valuation techniques and risk models.<\/p>\n\n\n\n<p>The Learning Outcomes (LOs) for this section, provided by GARP, include both computational and non-computational aspects. These LOs are spread across 16 chapters, ensuring a well-balanced approach to the material. While computational LOs involve calculations and formula applications, non-computational LOs often contain tricky questions that require deeper understanding and critical thinking. Preparing thoroughly for both types is crucial to doing well on this exam.<\/p>\n\n\n\n<p>Some of the points covered in the 16 topics are:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Value at Risk (VaR)<\/li>\n\n\n\n<li>Expected Shortfall (ES)<\/li>\n\n\n\n<li>Estimation of volatility and correlation<\/li>\n\n\n\n<li>Economic and regulatory capital<\/li>\n\n\n\n<li>Stress testing and scenario analysis<\/li>\n\n\n\n<li>Option valuation<\/li>\n\n\n\n<li>Fixed Income Valuation<\/li>\n\n\n\n<li>Hedging<\/li>\n\n\n\n<li>Country and sovereign risk models and management<\/li>\n\n\n\n<li>External and internal credit ratings<\/li>\n\n\n\n<li>Expected and unexpected losses<\/li>\n\n\n\n<li>Operational risk<\/li>\n<\/ul>\n\n\n\n<p>Let us review the contents of the 16 topics and what GARP tests from each.<\/p>\n\n\n\n<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_80 counter-hierarchy ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">Table of Contents<\/p>\n<span class=\"ez-toc-title-toggle\"><a href=\"#\" class=\"ez-toc-pull-right ez-toc-btn ez-toc-btn-xs ez-toc-btn-default ez-toc-toggle\" aria-label=\"Toggle Table of Content\"><span class=\"ez-toc-js-icon-con\"><span class=\"\"><span class=\"eztoc-hide\" style=\"display:none;\">Toggle<\/span><span class=\"ez-toc-icon-toggle-span\"><svg style=\"fill: #999;color:#999\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" class=\"list-377408\" width=\"20px\" height=\"20px\" viewBox=\"0 0 24 24\" fill=\"none\"><path d=\"M6 6H4v2h2V6zm14 0H8v2h12V6zM4 11h2v2H4v-2zm16 0H8v2h12v-2zM4 16h2v2H4v-2zm16 0H8v2h12v-2z\" fill=\"currentColor\"><\/path><\/svg><svg style=\"fill: #999;color:#999\" class=\"arrow-unsorted-368013\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" width=\"10px\" height=\"10px\" viewBox=\"0 0 24 24\" version=\"1.2\" baseProfile=\"tiny\"><path d=\"M18.2 9.3l-6.2-6.3-6.2 6.3c-.2.2-.3.4-.3.7s.1.5.3.7c.2.2.4.3.7.3h11c.3 0 .5-.1.7-.3.2-.2.3-.5.3-.7s-.1-.5-.3-.7zM5.8 14.7l6.2 6.3 6.2-6.3c.2-.2.3-.5.3-.7s-.1-.5-.3-.7c-.2-.2-.4-.3-.7-.3h-11c-.3 0-.5.1-.7.3-.2.2-.3.5-.3.7s.1.5.3.7z\"\/><\/svg><\/span><\/span><\/span><\/a><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#Measures_of_Financial_Risk\" >Measures of Financial Risk<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#Calculating_and_Applying_VaR\" >Calculating and Applying VaR<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#Measuring_and_Monitoring_Volatility\" >Measuring and Monitoring Volatility<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#External_and_Internal_Credit_Ratings\" >External and Internal Credit Ratings<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-5\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#Country_Risk_Determinants_Measures_and_Implications\" >Country Risk: Determinants, Measures, and Implications<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-6\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#Measuring_Credit_Risk\" >Measuring Credit Risk<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-7\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#Operational_Risk\" >Operational Risk<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-8\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#Stress_Testing\" >Stress Testing<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-9\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#Pricing_Conventions_Discounting_and_Arbitrage\" >Pricing Conventions, Discounting, and Arbitrage<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-10\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#Interest_Rates\" >Interest Rates<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-11\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#Bond_Yields_and_Return_Calculations\" >Bond Yields and Return Calculations<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-12\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#Applying_Duration_Convexity_and_DV01\" >Applying Duration, Convexity, and DV01<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-13\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#Modeling_Non-Parallel_Term_Structure_Shifts_and_Hedging\" >Modeling Non-Parallel Term Structure Shifts and Hedging<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-14\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#Binomial_Trees\" >Binomial Trees<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-15\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#The_Black-Scholes-Merton_Model\" >The Black-Scholes-Merton Model<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-16\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#Option_Sensitivity_Measures_%E2%80%9CThe_Greeks%E2%80%9D\" >Option Sensitivity Measures: \u201cThe Greeks\u201d<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-17\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#FAQs_FRM_Part_I_%E2%80%93_Valuation_and_Risk_Models\" >FAQs: FRM Part I \u2013 Valuation and Risk Models<\/a><ul class='ez-toc-list-level-4' ><li class='ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-18\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#1_What_are_valuation_and_risk_models_in_FRM\" >1. What are valuation and risk models in FRM?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-19\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#2_Which_topics_are_covered_under_valuation_and_risk_models_in_FRM_Part_I\" >2. Which topics are covered under valuation and risk models in FRM Part I?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-20\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#3_How_to_prepare_for_valuation_and_risk_models_in_the_FRM_exam\" >3. How to prepare for valuation and risk models in the FRM exam?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-21\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#4_Is_valuation_and_risk_models_a_difficult_topic_in_FRM_Part_I\" >4. Is valuation and risk models a difficult topic in FRM Part I?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-22\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#5_What_is_the_weight_of_valuation_and_risk_models_in_FRM_Part_I\" >5. What is the weight of valuation and risk models in FRM Part I?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-23\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#6_Are_formulas_provided_during_the_FRM_exam\" >6. Are formulas provided during the FRM exam?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-24\" href=\"https:\/\/analystprep.com\/blog\/frm-part-i-topics-in-valuation-and-risk-models\/#7_Where_can_I_find_practice_questions_for_valuation_and_risk_models\" >7. Where can I find practice questions for valuation and risk models?<\/a><\/li><\/ul><\/li><\/ul><\/li><\/ul><\/nav><\/div>\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Measures_of_Financial_Risk\"><\/span><strong>Measures of Financial Risk<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>When determining the appropriate risk measure, it&#8217;s important to consider the shape of the primary return distribution. Mean-variance analysis is only relevant for elliptical distributions, such as the normal distribution. For non-elliptical distributions, risk measures are calculated using Value at Risk (VaR). However, VaR can be unpredictable as it does not accurately estimate potential losses.<\/p>\n\n\n\n<p>A more reliable method for estimating risk is Expected Shortfall (ES). ES is preferred because it meets all the criteria of a consistent risk measure and has fewer restrictive assumptions, providing a more accurate assessment of potential risks.<\/p>\n\n\n\n<p>For this chapter, the exam might test on:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Calculating the VaR<\/li>\n\n\n\n<li>Expected Shortfall methodology<\/li>\n\n\n\n<li>Properties of a coherent risk measure<\/li>\n<\/ul>\n\n\n\n<div style=\"text-align:center; margin:18px 0;\">\n<a href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" rel=\"noopener noreferrer\" style=\"display:inline-flex; align-items:center; justify-content:center; padding:10px 18px; border:2px solid #1e5bd8; color:#1e5bd8; background:#f5f7fb; border-radius:9999px; text-decoration:none; font-weight:600; white-space:nowrap;\">\nPractice VaR and Expected Shortfall calculations for FRM\n<\/a>\n<\/div>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Calculating_and_Applying_VaR\"><\/span><strong>Calculating and Applying VaR<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>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:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Historical simulation technique<\/li>\n\n\n\n<li>Delta-normal technique<\/li>\n\n\n\n<li>Full re-valuation technique<\/li>\n<\/ul>\n\n\n\n<p>This includes the advantages, disadvantages, and basal assumptions of these techniques.<\/p>\n\n\n\n<p>GARP might also test on extended VaR approaches, commonly used when correctly measuring risk for complex derivatives and scenarios.&nbsp; Questions on the following methods may appear in relation to extended VaR techniques:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Structured Monte Carlo<\/li>\n\n\n\n<li>Stress testing<\/li>\n\n\n\n<li>Worst-case scenario analysis<\/li>\n<\/ul>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Measuring_and_Monitoring_Volatility\"><\/span><strong>Measuring and Monitoring Volatility<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>To understand plausible risk exposure, an accurate estimation of volatility is vital. A <a href=\"https:\/\/analystprep.com\/cfa-level-1-exam\/quantitative-methods\/normal-distribution\/\">normal distribution<\/a> 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:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Challenges associated with volatility estimation and alternative methods that can be used to determine VaR(parametric and non-parametric)<\/li>\n\n\n\n<li>The pros and cons of these methods<\/li>\n\n\n\n<li>The fundamental assumptions associated with these methods<\/li>\n\n\n\n<li>Why deviations from normality emerge<\/li>\n\n\n\n<li>The tendency of volatility to revert its mean<\/li>\n\n\n\n<li>Approximating volatility using the exponentially weighted moving average and generalized autoregressive conditional heteroskedasticity models.<\/li>\n<\/ul>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"External_and_Internal_Credit_Ratings\"><\/span><strong>External and Internal Credit Ratings<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>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.<\/p>\n\n\n\n<p>From this chapter, you are needed to demonstrate your understanding of the following concepts:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Solving a default probability table and a rating transition matrix<\/li>\n\n\n\n<li>Value of the hazard rate and the recovery rate and how they relate to expected losses<\/li>\n\n\n\n<li>How external and internal credit ratings are proven<\/li>\n<\/ul>\n\n\n\n<p>Want to test your knowledge of valuation and risk models?<br>Get access to hundreds of <a href=\"https:\/\/analystprep.com\/cfa-level-1-practice-questions\/\">FRM Part I practice questions<\/a> covering this exact topic.<br><\/p>\n\n\n\n<p><a>Start practicing with AnalystPrep<\/a><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Country_Risk_Determinants_Measures_and_Implications\"><\/span><strong>Country Risk: Determinants, Measures, and Implications<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Sovereign risk frequently varies across countries. Aspects such as a country\u2019s 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.&nbsp;<\/p>\n\n\n\n<p>GARP might examine your capacity to:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Analyze and differentiate the benefits of sovereign debt ratings and sovereign default risk spread<\/li>\n\n\n\n<li>Identify the origins of sovereign risk and illustrate the outcomes of both local and foreign currency defaults<\/li>\n<\/ul>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Measuring_Credit_Risk\"><\/span><strong>Measuring Credit Risk<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>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.&nbsp;<\/p>\n\n\n\n<p>During the examination, GARP might test your ability to:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Compute each asset&#8217;s expected loss, unexpected loss, and risk contributions in the investment strategy.<\/li>\n\n\n\n<li>Calculate risk under Basel II<\/li>\n\n\n\n<li>Evaluate credit losses using different ways<\/li>\n\n\n\n<li>Model credit risk using the Gaussian Copula model, the Vasicek model, the credit metrics model, and Euler\u2019s theorem. This includes comprehending the principal rationale and drawbacks of using these methods.<\/li>\n<\/ul>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Operational_Risk\"><\/span><strong>Operational Risk<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>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<strong>.<\/strong><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Stress_Testing\"><\/span><strong>Stress Testing<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>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:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Your understanding of the scenarios and how they are chosen.<\/li>\n\n\n\n<li>How models are regulated<\/li>\n\n\n\n<li>The basal stress testing principle for banks<\/li>\n<\/ul>\n\n\n\n<p>The relationship between VaR and ES is paramount to stress testing. Stressed risk metrics have merits and demerits corresponding to traditional risk measures.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Pricing_Conventions_Discounting_and_Arbitrage\"><\/span><strong>Pricing Conventions, Discounting, and Arbitrage<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>The chapter outlines the foundations of bond valuation. A bond&#8217;s value 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, which are used to gauge whether the bond trades below or above par.&nbsp;<\/p>\n\n\n\n<p>The law of one price states that securities matching future cash flows should trade at the same price.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Interest_Rates\"><\/span><strong>Interest Rates<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>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:<\/p>\n\n\n\n<p>The different types of rates relevant to debt devices<\/p>\n\n\n\n<p>The relationship between the rates and the influence they have on bond valuations<\/p>\n\n\n\n<p>Yield curves. What causes the flattening and steepening of the curve and the tactics used in these scenarios?<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Bond_Yields_and_Return_Calculations\"><\/span><strong>Bond Yields and Return Calculations<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>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.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Applying_Duration_Convexity_and_DV01\"><\/span><strong>Applying Duration, Convexity, and DV01<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>These are the various ways to determine and secure risk for fixed-income securities. The primary concepts covered in this chapter are:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>DV01 &#8211; This is the measure of how much the price of a bond shifts in response to a one basis point change in yield.<\/li>\n\n\n\n<li>Duration &#8211; The change in a bond\u2019s value resulting from a small parallel change in rates can be measured by effective duration.<\/li>\n<\/ul>\n\n\n\n<p>DV01 and duration can evaluate price volatility but fail to grasp the curvature of the bond yield and price relationship.<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Convexity &#8211; This captures the impacts of the price-yield relationship.<\/li>\n\n\n\n<li>The exams test your ability to draw comparisons and calculate DV01, duration, and convexity.<\/li>\n<\/ul>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Modeling_Non-Parallel_Term_Structure_Shifts_and_Hedging\"><\/span><strong>Modeling Non-Parallel Term Structure Shifts and Hedging<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>In this section, we explore the term structure of interest rates by dividing it into multiple segments and making assumptions about how the rate in each segment changes. Critical rate analysis is a straightforward approach that evaluates a portfolio\u2019s exposure to changes in specific key rates. It operates on the assumption that rate changes are concentrated around the selected key rate.<\/p>\n\n\n\n<p>On the other hand, the forward-bucket method incorporates information from a broader range of rates, particularly those included in the forward rate curve. This method provides a more comprehensive analysis by considering a wider set of rate changes.<\/p>\n\n\n\n<p> The exam tests your knowledge of the following:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Applying critical rate shift analysis<\/li>\n\n\n\n<li>Key rate 01 and critical rate duration<\/li>\n\n\n\n<li>The calculations relating to hedging position given a particular key rate exposure profile<\/li>\n<\/ul>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Binomial_Trees\"><\/span><strong>Binomial Trees<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>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:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Calculate the value of a European or American option using a one-step or two-step binomial model.<\/li>\n\n\n\n<li>Use delta concepts to compte hedging.<\/li>\n\n\n\n<li>Modify the binomial model and lengthen it past modeling for individual, non-dividend-paying stock.<\/li>\n<\/ul>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"The_Black-Scholes-Merton_Model\"><\/span><strong>The Black-Scholes-Merton Model<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>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:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Calculate the value of a call and put the option using the BSM model.<\/li>\n\n\n\n<li>Factor in dividends, currencies, and futures into the model when required.<\/li>\n\n\n\n<li>Compute the put-call parity.<\/li>\n<\/ul>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Option_Sensitivity_Measures_%E2%80%9CThe_Greeks%E2%80%9D\"><\/span><strong>Option Sensitivity Measures: \u201cThe Greeks\u201d<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Factors affecting the level of risk related to an option position are:<\/p>\n\n\n\n<p>The relationship between the value of a position involving options and the value of the underlying assets.<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Time until expiration.<\/li>\n\n\n\n<li>Asset value volatility.<\/li>\n\n\n\n<li>Risk-free rate.<\/li>\n\n\n\n<li>The metrics that capture the outcomes of these factors are called Greeks because of their names; delta, theta, gamma, vega, and rho.<\/li>\n<\/ul>\n\n\n\n<p>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 <a href=\"https:\/\/analystprep.com\/shop\/frm-part-1-complete-course-by-analystprep\/\">FRM study options<\/a> available with AnalaystPrep to ensure you master these concepts adequately for your final exam.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"FAQs_FRM_Part_I_%E2%80%93_Valuation_and_Risk_Models\"><\/span>FAQs: FRM Part I \u2013 Valuation and Risk Models<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<h4 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"1_What_are_valuation_and_risk_models_in_FRM\"><\/span><strong>1. What are valuation and risk models in FRM?<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h4>\n\n\n\n<p>Valuation and risk models refer to the methods used to estimate the value of financial instruments and to assess the risk associated with them. In FRM Part I, this includes understanding pricing models, risk measurement tools, and the theoretical frameworks used in financial analysis.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h4 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"2_Which_topics_are_covered_under_valuation_and_risk_models_in_FRM_Part_I\"><\/span><strong>2. Which topics are covered under valuation and risk models in FRM Part I?<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h4>\n\n\n\n<p>The main topics include:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Bond valuation and yield measures<\/li>\n\n\n\n<li>Valuation of forwards, futures, swaps, and options<\/li>\n\n\n\n<li>Value at Risk (VaR)<\/li>\n\n\n\n<li>Greeks and option sensitivities<\/li>\n\n\n\n<li>Interest rate models<\/li>\n\n\n\n<li>Risk-adjusted performance measurement<\/li>\n<\/ul>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h4 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"3_How_to_prepare_for_valuation_and_risk_models_in_the_FRM_exam\"><\/span><strong>3. How to prepare for valuation and risk models in the FRM exam?<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h4>\n\n\n\n<p>Start by mastering key formulas and concepts through your study materials. Then, reinforce your knowledge with practice questions, particularly on pricing, duration, convexity, and VaR. Use mock exams and performance analytics to focus on weak areas.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h4 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"4_Is_valuation_and_risk_models_a_difficult_topic_in_FRM_Part_I\"><\/span><strong>4. Is valuation and risk models a difficult topic in FRM Part I?<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h4>\n\n\n\n<p>Yes, it\u2019s considered one of the more technical sections, requiring a solid grasp of math and financial theory. However, consistent practice and conceptual clarity can make it manageable even for candidates without a quant background.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h4 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"5_What_is_the_weight_of_valuation_and_risk_models_in_FRM_Part_I\"><\/span><strong>5. What is the weight of valuation and risk models in FRM Part I?<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h4>\n\n\n\n<p>As per GARP\u2019s latest curriculum, valuation and risk models account for <strong>30%<\/strong> of the total FRM Part I exam weight, making it one of the most heavily tested areas.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h4 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"6_Are_formulas_provided_during_the_FRM_exam\"><\/span><strong>6. Are formulas provided during the FRM exam?<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h4>\n\n\n\n<p>No, candidates must memorize key formulas. This includes bond valuation, Black-Scholes, binomial option pricing, and VaR calculations. Flashcards and formula sheets are helpful for review.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h4 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"7_Where_can_I_find_practice_questions_for_valuation_and_risk_models\"><\/span><strong>7. Where can I find practice questions for valuation and risk models?<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h4>\n\n\n\n<p>You can access topic-specific FRM Part I practice questions at AnalystPrep. The platform offers quizzes, full-length mock exams, and detailed solutions tailored to the 2024 FRM curriculum.<\/p>\n\n\n\n<p> <a>Access AnalystPrep\u2019s <\/a><a href=\"https:\/\/analystprep.com\/cfa-level-1-practice-questions\/\">FRM Part I practice<\/a><a> questions<\/a><\/p>\n\n\n\n<div style=\"text-align:center; margin:32px 0 10px;\">\n\n<a href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" rel=\"noopener noreferrer\" style=\"display:inline-flex; align-items:center; justify-content:center; padding:12px 24px; border-radius:9999px; background:#1e5bd8; color:#ffffff; font-weight:700; text-decoration:none;\">\nStart Free Trial \u2192\n<\/a>\n\n<p style=\"margin-top:12px; font-size:16px; line-height:1.5;\">\nStrengthen your risk management skills by solving FRM exam-style questions on Value at Risk (VaR), Expected Shortfall (ES), and coherent risk measures.\n<\/p>\n\n<\/div>\n","protected":false},"excerpt":{"rendered":"<p>Valuation and risk models are two of the four main topics tested in FRM Part I. GARP (Global Association of Risk Professionals) focuses on a candidate\u2019s understanding of these concepts through various questions. 30% of the FRM Part I exam&#8230;<\/p>\n","protected":false},"author":2,"featured_media":11113,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[71],"tags":[],"class_list":["post-11112","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-frm","blog-post","animate"],"acf":[],"post_mailing_queue_ids":[],"_links":{"self":[{"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/posts\/11112","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/comments?post=11112"}],"version-history":[{"count":11,"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/posts\/11112\/revisions"}],"predecessor-version":[{"id":14274,"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/posts\/11112\/revisions\/14274"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/media\/11113"}],"wp:attachment":[{"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/media?parent=11112"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/categories?post=11112"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/analystprep.com\/blog\/wp-json\/wp\/v2\/tags?post=11112"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}