Exam Feedback FRM Part 2 (May 2015) Exam Feedback

[M.A.]

Was the question what is the VaR allocation of each manager or the capital allocation of each manager so that total VaR of 3 portfolios should not exceed 100 -> the VaR budget? Because if the latter, then 100/(0.1*2.33)=429 (which was answer D) and then 429/3=143, which was answer B (I think). Or I may be talking nonsense..

I think we both fall into the same mistake by considering the 10% as the portfolio std whilst we need to calculate the portfolio std sqrt of 10^2 +10%^2.

This is a problem with FRM questions they are asking about too many things some with many tricks in one questions

 

[JDGutzmann]

Was the question what is the VaR allocation of each manager or the capital allocation of each manager so that total VaR of 3 portfolios should not exceed 100 -> the VaR budget? Because if the latter, then 100/(0.1*2.33)=429 (which was answer D) and then 429/3=143, which was answer B (I think). Or I may be talking nonsense..

Hello, I assumed that the question asked for the amount of ACTUAL capital to be invested, not RISK capital (i.e. money in $, not VaR in $). Therefore, the relationship between the possible answers and the 100 VaR limit isn't as simple. I tried to calculate it as follows (recklessly adapting the formula for two-asset VaR):

var_portfolio == z * SQRT ( 3 * capital² * sigma² )
100 = 2.326 * SQRT ( 3 * capital² * 0.01)
--> solve for capital = 248

In regard to the EL question with the 3 different bonds, I also found the AAA to have the highest EL, because it had the longest maturity and it wasn't mentioned to be only a 1-year EL (in my mind).

 

[Salonica]

Does anyone remember the question in which there were number of exceptions given at 95% and 99% C.I. In the options we were asked to reject a particular hypothesis based on these figures. Anyone knows the answer to this??

I think the answer was to reject at 95% level as abs(33-5%*1000)/sqrt(5%*95%*1000)>1.96. I unbelievably managed to get that wrong.

 

[vsism]

I think the answer was to reject at 95% level as abs(33-5%*1000)/sqrt(5%*95%*1000)>1.96. I unbelievably managed to get that wrong.

I think correct answer should be to reject at 99% C.I. There were given 11 exceptions. And 1% of 1000 is 10. Whereas in 95% C.I maximum exceptions could be 50 (5 % of 1000) whereas the given was 33. So, I thought it was in acceptable range. I am not sure though. I may be wrong.

 

[Salonica]

Hello, I assumed that the question asked for the amount of ACTUAL capital to be invested, not RISK capital (i.e. money in $, not VaR in $). Therefore, the relationship between the possible answers and the 100 VaR limit isn't as simple. I tried to calculate it as follows (recklessly adapting the formula for two-asset VaR):

var_portfolio == z * SQRT ( 3 * capital² * sigma² )
100 = 2.326 * SQRT ( 3 * capital² * 0.01)
--> solve for capital = 248

In regard to the EL question with the 3 different bonds, I also found the AAA to have the highest EL, because it had the longest maturity and it wasn't mentioned to be only a 1-year EL (in my mind).

Agreed, 248 is the correct answer.

 

[Goldfish3]

If the objectives of the question are choosing Trenyor ratio >0.1 AND lowest marginal VaR,
you should calculate Trenyor ratio by using index Beta but use Portfolio Beta in finding the lowest marginal VaR

If the question refers to minimizing Marginal VaR as long as Trenyor > 0.1
you should find the highest Trenyor ratio in order to maximize your return AND Trenyor ratio > 0.1 to minimize the Marginal VaR

The question was find the lowest mvar with treynor ratio greater than 0.1. So yes this will be lowest porfolio beta out of the 3 (because only asset A treynor was less than 0.1) whose treynor ratio come out to be greater than 0.1. I think it was asset B or C. Cant remember Exactly.

 

[Goldfish3]

I think correct answer should be to reject at 99% C.I. There were given 11 exceptions. And 1% of 1000 is 10. Whereas in 95% C.I maximum exceptions could be 50 (5 % of 1000) whereas the given was 33. So, I thought it was in acceptable range. I am not sure though. I may be wrong.

I sort of used this reasoning and chose the answer that said reject the 99% with 95% confidence.

 

[erko25]

Im not 100% sure, but i thought the whole budget was 100 Mio. And from the answers only one was below that. The others were 140 Mio. and above. So i choose the one below the total budget, because of no correlation, the seperate VaRs must be lower than portfolio VaR.

Agree, spent too much time on this question as well. 100m was total VAR budget not p-lio value. It took me a few min to realize that the question was asking for p-lio value allocation based on the data given not VAR allocation. 1) calculate p-lio VAR % 2) calc total p-lio value VAR = QxZxV 3) pro-rate based on the data given. Don;t remember the number, but I got first or second choice.

 

[hamu4ok]

This question only asks categorization and action to prevent from happening
Even if profit is made, it still needs to be categorized in operational risk database as operational risk gain event
Near miss is a scenario losses are made but a bank is able to recover the loss (excluding recoveries from insurance)

I see.

btw do you remember one question about scoring model. Which can help during the process: SVM, merton, Area under the Curve or ROC?

As for scoring model, I chose SVM.

 

[hamu4ok]

I sort of used this reasoning and chose the answer that said reject the 99% with 95% confidence.

I used binominal approximation as x-pT/Sqr (1-p)pT to get 0,32... for 99%

 

[hamu4ok]

Who remebers the qestions about RAROC after sensitivity test? I chose a 25% increase in operating expenses will decrease RAROC.

 

[xenatr]

I think correct answer should be to reject at 99% C.I. There were given 11 exceptions. And 1% of 1000 is 10. Whereas in 95% C.I maximum exceptions could be 50 (5 % of 1000) whereas the given was 33. So, I thought it was in acceptable range. I am not sure though. I may be wrong.

The question includes the following information
A. 33 exceptions in 95% VaR
B. 11 exceptions in 99% VaR
C. Sample = 1000 days

Critical value of 95% VaR = (33-1000*0.05)/sq root(1000*0.95*0.05) = -2.46
Critical value of 99% VaR = (11-1000*0.01)/sq root(1000*0.99*0.01) = 0.3178
Critical Value of 99% confidence level = +- 2.56
To reject, absolute value of test statistics must be greater than absolute value of critical value at 99%
* This is a two tailed test

Choice
A. Statistics of 95% VaR = 0.3178
B. Statistics of 99% VaR = 0.3178
C. Reject 95% VaR at 99% confidence level
D. Reject 99% VaR at 99% confidence level

 

[BTO]

Who remebers the qestions about RAROC after sensitivity test? I chose a 25% increase in operating expenses will decrease RAROC.

I think the answer is if cost of deposit increases to 3%.

 

[BTO]

The question includes the following information
A. 33 exceptions in 95% VaR
B. 11 exceptions in 99% VaR
C. Sample = 1000 days

Critical value of 95% VaR = (33-1000*0.05)/sq root(1000*0.95*0.05) = -2.46
Critical value of 99% VaR = (11-1000*0.01)/sq root(1000*0.99*0.01) = 0.3178
Critical Value of 99% confidence level = +- 2.56
To reject, absolute value of test statistics must be greater than absolute value of critical value at 99%
* This is a two tailed test

Choice
A. Statistics of 95% VaR = 0.3178
B. Statistics of 99% VaR = 0.3178
C. Reject 95% VaR at 99% confidence level
D. Reject 99% VaR at 99% confidence level

I got this wrong probably due to laziness. Just couldn't be bothered to calculate it out.

Unfortunately don't agree with your answer
If you are to allocate $100 million VaR limit among 3 managers with UNCORRELATED portfolios, the VaR Limit on each manager should be
Sq root (VaR ^2 + VaR ^ 2 + VaR ^2 ) = 100
VaR Limit on each manager must be < 100

You could be right but I think question was about portfolio size and not individual VaR. To be honest I am beginning to forget the details of some of the questions.

 

[JDGutzmann]

In regard to the RAROC-question, I chose the one that increased the funding costs, because following the calculation it was the only one that would lower the RAROC below 10%.

For the Backtesting-question I couldn't find any reasons to reject the hypotheses, since both Alphas were less than 1.96 or 2.58, respectively (intuitively, 11 out of 10 and 33 out of 50 expected hits seemed fine to me). I therefore chose one of the other two (can't remember excactly).

Johannes

 

[xenatr]

In regard to the RAROC-question, I chose the one that increased the funding costs, because following the calculation it was the only one that would lower the RAROC below 10%.

For the Backtesting-question I couldn't find any reasons to reject the hypotheses, since both Alphas were less than 1.96 or 2.58, respectively (intuitively, 11 out of 10 and 33 out of 50 expected hits seemed fine to me). I therefore chose one of the other two (can't remember excactly).

Johannes

Information given in the question
A. 800 million loan with 2.5% interest cost
B. Operating expense = 14million
C. Economic Capital of 100million with 3.5% return
D. Expected loss = 6 million
E. Revenue = 50 million
F. The analyst calcuates the RAROC correctly at 13.5% currently
* Ignore unexpected loss

Answer= interest cost increases to certain level

The most tricky one is the economic capital is increased to 125 million. If it is increased, the revenue generated from the economic capital will increase as well and this results in a return higher than the threshold of 10%

 

[robin3301]

I still remember two questions
1. the difference between discounted by CDS and risk free rate
2. why OIS rate is a better proxy for risk free rate

 

[Ryan S]

Some general questions I remember that may not have been mentioned yet here:

• Asking question regarding payment vs close-out netting and the difference
• 3 question set on XYZ's SPE of mortgage bonds, one question was the most pressing concerns regarding the consulting companies proposals for the SPE…
• Choosing between "Gamma" and "Theta" companies based upon balance sheets as the better counterparty, i.e. longer duration assets, shorter duration liabilities, less non-USD exposure, and something else were answer choices
• Repo with Hedge Fund question – some answers included special rate b/w General and Special, I chose an increase in bond price will reduce the HF’s exposure
• Question on Exposure of $9ook with a $1m threshold and $250k mta, exposure increases to $1.2m, and the outcome. I did not like this question as I thought this should trigger a $1.2m margin call, but that was not an answer. I chose increase $300k but the answer may have been zero.
• Question on Cybersecurity and the next step after discovering some sort of issue (forget exact details)

 

[xenatr]

I still remember two questions
1. the difference between discounted by CDS and risk free rate
2. why OIS rate is a better proxy for risk free rate

I guess you are talking about using either CDS spread or bond yield to derive risk neutral probability
Subject to availability bias..., i chose CDS isolates default risk premium

Some general questions I remember that may not have been mentioned yet here:

• Asking question regarding payment vs close-out netting and the difference
• 3 question set on XYZ's SPE of mortgage bonds, one question was the most pressing concerns regarding the consulting companies proposals for the SPE…
• Choosing between "Gamma" and "Theta" companies based upon balance sheets as the better counterparty, i.e. longer duration assets, shorter duration liabilities, less non-USD exposure, and something else were answer choices
• Repo with Hedge Fund question – some answers included special rate b/w General and Special, I chose an increase in bond price will reduce the HF’s exposure
• Question on Exposure of $9ook with a $1m threshold and $250k mta, exposure increases to $1.2m, and the outcome. I did not like this question as I thought this should trigger a $1.2m margin call, but that was not an answer. I chose increase $300k but the answer may have been zero.
• Question on Cybersecurity and the next step after discovering some sort of issue (forget exact details)

Payment netting will reduce the settlement risk and closeout netting will reduce pre settlement risk that is the counterparty risk. Under central clearing, netting will transfer the risk to outsiders, that is redistributing the risk instead mitigating the risk from a holistic perspective.

SPE only know 2
XYZ's most valid concern was the line of credit will negate the bankruptcy remote status (don't remember the exact wording)
For the question of reducing default risk of underlying via buying CDS, the concern is the protection seller's credit worthiness and default correlation between the underlying and the protection seller

Increase in bond price will reduce hedge fund's exposure since it is holding the bond as a collateral
General rate is in general equal or higher than the special rate

Collateral amount is zero given the exposure must be higher the combined figures of threshold and minimum transfer amount

Cybersecurity risk question is related to framework function, Protect
The answer is increase staff's awareness and offer trainings

Add 2 more
An entity longs a bond and buys CDS
Market risk does not change, operational risk increases and credit risk decreases

Traditional vs Bootstrapping Historical Simulation
The latter is in general more accurate than the former...this is empirically supported

NO idea about which bank the firm should choose in taking cross currency swap position.

 

[M.A.]

Information given in the question
A. 800 million loan with 2.5% interest cost
B. Operating expense = 14million
C. Economic Capital of 100million with 3.5% return
D. Expected loss = 6 million
E. Revenue = 50 million
F. The analyst calcuates the RAROC correctly at 13.5% currently
* Ignore unexpected loss

Answer= interest cost increases to certain level

The most tricky one is the economic capital is increased to 125 million. If it is increased, the revenue generated from the economic capital will increase as well and this results in a return higher than the threshold of 10%

The answer was if interest increased from 2.5%. To 3 % as this will increase the expenses by 4 m leading to reducing RAROC to less than 10%.