FRM

PART I

FULL LENGTH TEST - 3

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FRM Part I Full Length Test - 3

Question 1

Volatility of total returns is most accurately described as:

A) relative risk.
B) directional risk.
C) absolute risk.
D) non-directional risk.

Question 2

Unexpected volatility in an asset is called:

A) surprise.
B) biased expectations.
C) risk.
D) asset price instability.

Question 3

A derivative contract:
A) has an infinite life.
B) derives its value from an underlying security.
C) is issued to raise capital.
D) is a non-zero-sum game.

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Question 4

The capital market line results from combining the efficient frontier with a risk-free asset. Given the
availability of risky assets and a risk-free asset, the best combinations of risk and return are represented
by:
A) the efficient frontier of risky assets.
B) combinations of the market portfolio and risk-free borrowing or lending.
C) combinations of the minimum variance portfolio of risky assets and the risk-free asset.
D) combinations of the market portfolio and minimum variance portfolio of risky assets.

Question 5

An analyst collected the following data for three possible investments.

Price Today Forecasted Price* Dividend Beta

Stock
Alpha

25

31

1.6

Omega

105

110

1.2

Lambda

10

10.80

0.5

*Forecasted Price = expected price one year from today.

The expected return on the market is 12% and the risk-free rate is 4%.
Part 1)
According to the security market line (SML), which of the three securities is correctly priced?
A) Lambda.
B) Alpha.
C) Omega.
D) None of the securities are correctly priced.

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Part 2)
Which of the three securities identified by Williams would plot on the capital market line(CML)?
A) Alpha.
B) Omega.
C) Lambda.
D) None of the securities would plot on the CML.

Question 6

The Treynor and Sharpe ratios will:

A) give identical rankings when the assets have identical standard deviations.
B)

give identical rankings when the same minimum acceptable return is chosen for the
calculations.

C) always provide identical rankings.

D) give identical rankings when the assets have identical correlations with the market.

Question 7

Jensens alpha for a portfolio measures the:

A) funds return in excess of the required rate of return given the systematic risk of the portfolio.
B)

funds return in excess of the required rate of return given the unsystematic risk of the
portfolio.

C) difference between a funds return and the market return.

D) difference between the funds Sharpe ratio and Treynor measure.

Question 8

For a given portfolio, the expected return is 12% with a standard deviation of 22%. The beta of the
portfolio is 1.1. The expected return of the market is 10% with a standard deviation of 20%. The risk-free
rate is 4%. The Sharpe measure of the portfolio is:
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A) 20.00.
B) 0.36.
C) 7.27.
D) 0.10.
Question 9
All of the following affect the role of operational risk management in preventing large trading losses EXCEPT:

A) the breadth of responsibilities and power given to traders.

B) the degree of supervision and oversight.
C) marked-to-market losses.
D) multiple approvals for large trades by senior management.
Question 10

Which of the following choices is an example of operational risk in the collapse of Barings?
A) Failure to supervise the actions of its trader.
B) The Nikkei collapsed due to an earthquake.
C) Much of a companys assets were in illiquid derivative products.
D) The default of Japanese industrial firms.
Question 11

Which of the following factors contributed to the collapse of Barings Bank?

A) A maturity mismatch between the hedging instrument and the risk being hedged.
B) Basis risk.
C) A trader having authority in the settlement process.
D) Japanese financial reporting requirements.

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Question 12

When an analyst makes an investment recommendation, which of the following statements must be
disclosed to clients?
A) The firm is a market maker in the stock of the recommended company.
B) An employee of the firm holds a directorship with the recommended company.
C) The analyst's Father-in-law has a material ownership in the security.
D) All of these statements must be disclosed to clients.

Question 13

A dummy variable would best be used to measure the effect of which of the following?
I.
II.
III.
IV.

The difference in implied volatility from one day to the next.

The difference in realized volatility from one day to the next.
The volatility of a stock on Mondays compared to that of other days.
Changes in a stocks volatility on option expiration dates compared to other dates.
A) II and III only.
B) I and III only.
C) I and II only.
D) III and IV only.

Question 14

If the probability of both a new Wal-Mart and a new Wendys being built next month is 68% and the
probability of a new Wal-Mart being built is 85%, what is the probability of a new Wendys being built if a
new Wal-Mart is built?
A) 0.80.
B) 0.70.
C) 0.60.
D) 0.85.

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Question 15

A sample covariance for the common stock of the Earth Company and the S&P 500 is 9.50. Which of
the following statements regarding the estimated covariance of the two variables is most accurate?

A)

The relationship between the two variables is not easily predicted by the calculated
covariance.

B) The two variables will have a slight tendency to move together.

C) The two variables will have a strong tendency to move in opposite directions.
D)

The relationship between the two variables is highly predictable given the calculated
covariance.

Question 16

The annual returns for a portfolio are normally distributed with an expected value of 50 million and a
standard deviation of 25 million. What is the probability that the value of the portfolio one year from
today will be between 91.13 million and 108.25 million?
A) 0.025.
B) 0.075.
C) 0.090.
D) 0.040.
Question 17

Which of the following is the correct sequence of events for testing a hypothesis?

A)

State the hypothesis, select the level of significance, formulate the decision rule, compute the
test statistic, and make a decision.

B)

State the hypothesis, formulate the decision rule, select the level of significance, compute the
test statistic, and make a decision.

C)

State the hypothesis, select the level of significance, compute the test statistic, formulate the
decision rule, and make a decision.

D)

State the hypothesis, formulate the decision rule, compute the test statistic, select the level of
significance, and make a decision.

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Question 18

If n is very large and p is small, the Poisson distribution may be used to approximate the binomial
distribution with:
A) =np(1-p).
B) =n/p.
C) =np.
D) =np.

Question 19

A normal distribution can be completely described by its:

A) skewness and kurtosis.
B) mean and mode.
C) mean and variance.
D) standard deviation.
Question 20

In the scatter plot below, the correlation between the return on stock A and the market index is:

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A) negative.
B) zero.
C) positive.
D) not discernable using the scatter plot.
Question 21

An analyst is regressing fund returns against the return on the Wilshire 5000 to determine whether beta is
equal to 1.0. The analyst is trying to determine whether the number of observations should be increased.
Which of the following is a reason why the test will have higher power if the number of observations is
increased? The:
A) estimate of beta will be farther away from 1.0.
B) mean squared error of the regression will be lower.
C) constant of the regression will be closer to zero.
D) standard error of the regression will be lower.
Question 22

A researcher runs a regression using 100 observations and two independent variables. The researcher
will test each coefficient for being significantly different from zero. Since the sample size is large, the
researcher will use the Z-values +/- 1.96 to conduct a two-tail test. The estimates of the slope coefficients
B1 and B2 are 4.94 and -1.02. Their respective standard errors are 0.082 and 1.67. Which, if either, of the
two hypotheses H0: B1 = 0 and H0: B2 = 0 can be rejected using the given critical Z-statistic?
A) H0: B1 = 0 but not H0: B2 = 0.
B) H0: B2 = 0 but not H0: B1 = 0.
C) Neither H0: B1 = 0 and H0: B2 = 0.
D) Both H0: B1 = 0 and H0: B2 = 0.
Question 23

When using an EWMA model to estimate portfolio volatility, the method used to estimate the portfolio
covariance matrix should be the:

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A) historical method.
B) GARCH(1,1).
C) EWMA method.
D) hypergeometric method.
Question 24

The VaR measure obtained from simulating data based on assumptions concerning the return
distributions is called:
A) Monte Carlo VaR.
B) Prospective VaR.
C) Stochastic VaR.
D) Kurtotic VaR.
Question 25
An error-correction model of interest-rate dynamics allows for the dynamics between short and long rates to be:

A) affected by a common factor.

B) short-lived.
C) affected by differential factors.
D) stochastic.
Question 26
The practice of adjusting the margin balance in a futures account for the daily change in the futures price is called:

A) settling up.
B) the daily call.
C) marking to market.
D) a margin call.

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Question 27

A call option gives the holder:

A) the right to sell at a specific price.
B) the right to buy at a specific price.
C) an obligation to buy at a certain price.
D) an obligation to sell at a certain price.

Question 28

The highest price a dealer is willing to pay to purchase a security is the:

A) offer price.
B) strike price.
C) exercise price.
D) bid price.

Question 29

Which of the following statements regarding margin in futures accounts is FALSE?

A) Margin is usually 10% of the contract value for futures contracts.
B) Margin must be deposited before a trade can be made.
C) Margin is resettled daily.
D) With futures margin, there is no loan of funds.

Question 30

Which of the following statements about closing a futures position through delivery is most accurate?

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A) Delivery is also known as exchange for physicals (EFP).

B) Delivery can occur through the clearinghouse or by private party negotiation.
C)

Depending on the wording of the contract, a trader may close a contract by either delivering
the goods to a designated location or by making a cash settlement of any gains or losses.

D)

Although the popularity of physical delivery has decreased over time, delivery by cash
settlement remains the most popular method of closing a futures position.

Question 31

To equitize the cash portion of assets under management, a portfolio manager enters into a long futures
position on the S&P 500 index with a multiplier of 250. The cash position is $15 million which at the
current futures value of 1,000, requires the manager to be long 60 contracts. If the current initial margin is
$12,500 per contract, and the current maintenance margin is $10,000 per contract, what variation margin
does the portfolio manager have to advance if the futures contract value falls to 995 at the end of the first
day of the position being placed?
A) $0.
B) $30,000.
C) $300,000.
D) $75,000.

Question 32

Which of the following is a definition of basis risk? Basis risk is the uncertainty about the difference
between the:
A) current spot price and the current futures price.
B) spot price and the futures price at the time the hedge is removed.
C) current spot price and the spot price over the hedging horizon.
D) current spot price and the spot price at the time the hedge is removed.

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Question 33

Which of the following is closest to the correct value for the basis associated with a spot position valued
at $15 per unit and a futures contract with a value of $18 per unit?
A) $3.0.
B) $5.0.
C) $3.0.
D) $2.0.

Question 34

Craig Fullen is a portfolio manager with a $25,000,000 value portfolio with a beta of 0.75 relative to the
S&P 500. Fullen is concerned the market will fall, and wants to hedge the risk to his portfolio using S&P
500 futures contracts. If the current value of the S&P 500 is 1,050, what action should Fullen take to
hedge his portfolio?
A) Sell 95 futures contracts.
B) Buy 95 futures contracts.
C) Sell 119 futures contracts.
D) Sell 71 futures contracts.

Question 35

A 12-year, 6 percent, option-free bond is currently trading at par. The bond has a duration of 8.38 years
and a convexity of 91.93. Your estimate of the percent price change (PPC) associated with a 100 basis
point decrease in yield is closest to:
A) 8.84 percent increase.
B) 7.92 percent increase.
C) 8.84 percent decrease.
D) 7.92 percent decrease.

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Question 36

The effective annual yield (EAY) of a loan with a quoted rate of 8%, compounded quarterly is equivalent
to the EAY of a loan with a continuously compounded quoted rate of:
A) 7.92%.
B) 8.16%.
C) 8.08%.
D) 8.24%.

Question 37

A Treasury bill, with 45 days until maturity, has an effective annual yield of 12.50%. The bill's holding
period yield is closest to:
A) 1.57%.
B) 12.50%.
C) 1.54%.
D) 1.46%.

Question 38

Using the continuous time forward pricing model, what is the no-arbitrage price of a 9-month forward
contract if the interest rate is 2.4 percent and the spot price of the asset is $1,650?
A) $1,664.
B) $1,689.
C) $1,621.
D) $1,680.

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Question 39

The dirty, or full, price of a bond:

A) equals the present value of all cash flows, plus accrued interest.
B) applies if an issuer has defaulted.
C) is paid when a security trades ex-coupon.
D) is usually less than the clean price.

Question 40

Because there are a large number of available Treasury bonds (T-bonds) available for delivery on the
futures market, which of the following defines the price received by the short position of the futures
contract?
A) Conversion factor.
B) Wild card option.
C) Chicago Board of Trade (CBOT) factor.
D) Market yield option.

Question 41

John Jordan manages a bond portfolio valued at $11.2 million, which has a duration of five years. To
hedge against an increase in interest rates, he wishes to employ interest-rate futures. The deliverable on
the current futures contract has a duration of seven years, and the futures contract is trading at 97.5. To
hedge the position, Jordan must:
A) buy 82 contracts.
B) sell 82 contracts.
C) sell 54 contracts.
D) buy 54 contracts.

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Question 42

The credit risks to the fixed-rate payer in a swap:

A) increase when floating rates are below the swap rate.
B) are greatest at the inception of the swap.
C) are greatest just prior to maturity.
D) increase when floating rates rise above the swap rate.

Question 43

A forward rate agreement (FRA):

A) is risk-free when based on the Treasury bill rate.
B) can be used to hedge the interest rate exposure of a floating-rate loan.
C) is priced in dollars.
D) is settled by making a loan at the contract rate.

Question 44

The success of the currency swap markets has been explained by which of the following?
A) Reduced counterparty risk arguments.
B) Efficient exchange rate pricing arguments.
C) Comparative advantage arguments.
D) Floating interest rate risk arguments.

Question 45

Which of the following best explains put-call parity?

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A)

No arbitrage requires that using any three of the four instruments (stock, call, put, bond) the
fourth can be synthetically replicated.

B) A stock can be replicated using any call option, put option and bond.
C) A stock can be replicated using any at the money call and put options and a bond.
No arbitrage requires that only the underlying stock can be synthetically replicated using at the
D) money call and put options and a zero coupon bond with a face value equal to the strike price
of the options.
Question 46

Ronald Franklin, CFA, has recently been promoted to junior portfolio manager for a large equity portfolio
at Davidson-Sherman (DS), a large multinational investment-banking firm. He is specifically responsible
for the development of a new investment strategy that DS wants all equity portfolio managers to
implement. Upper management at DS has instructed its portfolio managers to begin overlaying option
strategies on all equity portfolios. The relatively poor performance of many of their equity portfolios has
been the main factor behind this decision. Prior to this new mandate, DS portfolio managers had been
allowed to use options at their own discretion, and the results were somewhat inconsistent. Some
portfolio managers were not comfortable with the most basic concepts of option valuation and their
expected return profiles, and simply did not utilize options at all. Upper management of DS wants Franklin
to develop an option strategy that would be applicable to all DS portfolios regardless of their underlying
investment composition. Management views this new implementation of option strategies as an
opportunity to either add value or reduce the risk of the portfolio.
Franklin gained experience with basic options strategies at his previous job. As an exercise, he decides to
review the fundamentals of option valuation using a simple example. Franklin recognizes that the
behavior of an option's value is dependent on many variables and decides to spend some time closely
analyzing this behavior. His analysis has resulted in the information shown in Exhibits 1 and 2 for
European style options.
Exhibit 1: Input for European Options
Stock Price (S)

100

Strike Price (X)

100

Interest Rate (r)

0.07

Dividend Yield (q)

0.00

Time to Maturity (years) (t)

1.00

Volatility (Std. Dev.)(Sigma)

0.20

Black-Scholes Put Option Value $4.7809

Exhibit 2: European Option Sensitivities
Sensitivity

Call

Put

Delta

0.6736

-0.3264

Gamma

0.0180

0.0180

Theta

-3.9797

2.5470

Vega

36.0527

36.0527

Rho

55.8230

-37.4164

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Part 1)
Using the information in Exhibit 1, Franklin wants to compute the value of the corresponding European
call option. Which of the following is the closest to Franklin's answer?
A) $11.54.
B) $4.78.
C) $5.55.
D) $12.07.
Part 2)
Franklin is interested in the sensitivity of the European call option to changes in the volatility of the
underlying equity's returns. What happens to the value of the call option if the volatility of the underlying
equity's returns decreases?
The call option value:
A) decreases.
B) increases.
C) stays the same.
D) increases or decreases.

Question 47

The buyer of a straddle on a stock is most likely to benefit:

A) if the volatility of the underlying assets price decreases.
B) if the volatility of the underlying assets price increases.
C) if the position expires worthless.
D) under all conditions because the straddle is guaranteed a risk-free rate of return.

Question 48

A covered call position is:

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A) the purchase of a share of stock with a simultaneous sale of a call on that stock.
B) the simultaneous purchase of the call and the underlying asset.
C) the purchase of a share of stock with a simultaneous sale of a put on that stock.
D) the short sale of a stock with a simultaneous sale of a call on that stock.
Question 49
Assume that the current price of a stock is $100. A call option on that stock with an exercise price of $97 costs $7. A
call option on the stock with the same expiration and an exercise price of $103 costs $3. Using these options what is
the profit for a long bull spread if the stock price at expiration of the options is equal to $110?
A) -$2.
B) $0.
C) $6.
D) $2.

Question 50

Any rational quoted price for a financial instrument should:

A) provide an opportunity for investors to make a profit.
B) provide no opportunity for arbitrage.
C) be low enough for most investors to afford.
D) be always increasing.

Question 51
The term used when describing hedging with futures that refers to the risk that remains after a hedge has been
implemented is:
A) Transportation risk.
B) Credit risk.
C) Delivery risk.
D) Basic risk.

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Question 52

The major risk involved with commodity spot transactions that is divided into two areas (ordinary and
extraordinary) is:
A) Transportation risk.
B) Price risk.
C) Delivery risk.
D) Credit risk.

Question 53

Which of the following commodities is very difficult to store and transport?

A) Gold.
B) Corn.
C) Oil.
D) Natural gas.
Question 54

Which of the following statements regarding the lease rate in commodity futures contracts is incorrect?
I.
II.
III.
IV.
V.

The lease rate is the return required by the lender in exchange for lending a commodity.
Assuming it is positive, as the lease rate increases, the futures price for a commodity increases.
In a cash-and-carry arbitrage, the lease rate is earned whether or not the underlying commodity is
actually loaned.
Lease rates are similar to dividends paid to the lender of a share of common stock.
If the lease rate is less than the risk-free rate, the forward market is said to be in contango.
A) III and V.
B) I, III, and V.
C) II and III.
D) II and IV.

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Question 55

Which of the following is TRUE in normal backwardation? Futures prices tend to:

A)

fall over the life of the contract because hedgers are net short and have to receive
compensation for bearing risk.

B)

fall over the life of the contract because speculators are net short and have to receive
compensation for bearing risk.

C)

rise over the life of the contract because speculators are net long and have to receive
compensation for bearing risk.

D)

rise over the life of the contract because hedgers are net long and have to receive
compensation for bearing risk.

Question 56

Which of the following contains the overall rights of the bondholders?

A) Indenture.
B) Covenant.
C) Trustee.
D) Rights offering.

Question 57

Most often the initial call price of a bond is its:

A) par value.
B) principal plus a premium.
C) par value plus one year's interest.
D) principal less a discount fee.

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Question 58

Which of the following statements regarding a sinking fund provision is most accurate?

A)

It requires that the issuer set aside money based on a predefined schedule to accumulate the
cash to retire the bonds at maturity.

B)

It must be made through the payment of cash, paid to the trustee based on a predetermined
schedule.

C) It permits the issuer to retire more than the stipulated sinking fund amount if they choose.
D)

It requires that the issuer retire a portion of the principal through a series of principal payments
over the life of the bond.

Question 59

Which of the following statements about zero-coupon bonds is NOT correct?

A) The lower the price, the greater the return for a given maturity.
B) All interest is earned at maturity.
C) A zero coupon bond may sell at a premium to par when interest rates decline.
D) A zero-coupon bond provides a single cash flow at maturity equal to its par value.

Question 60

Which of the following statements concerning a forward rate is FALSE? A forward rate is:
A) the markets best guess as to an interest rate that will exist in the future.
B) an interest rate that can be locked in for some future time period.
C) the rate of interest an investor would earn from now until some point in the future.
D)

the interest rate that makes an investor indifferent to investing over a long time period or
investing over two or more shorter time periods.

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Question 61

When planning to hold a coupon-paying Treasury bond until maturity, which of the following types of risk
would be the most important?
A) Default.
B) Reinvestment.
C) Downgrade.
D) Interest rate.

Question 62

For a 20-year, $1,000 par value, 6 percent coupon T-bond yielding 5 percent, the dollar value of a basis
point (DV01) and associated percentage price change (PPC) are closest to:
A) $1.37 and 0.12%.
B) $0.14 and 0.01%.
C) $0.57 and 0.06%.
D) $2.45 and 0.20%.

Question 63

A stock that is currently trading at $30 can move up or down by 10 percent over a 6-month time period.
The probability of the stock moving up in price in a 6-month period is 0.6074. The continuously
compounded risk-free rate is 4.25 percent. The value of a 1-year American put option with an exercise
price of $32.50 is closest to:
A) $3.42.
B) $5.50.
C) $2.75.
D) $2.49.

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Question 64

Dividends on a stock can be incorporated into the valuation model of an option on the stock by:
A) subtracting the future value of the dividend from the current stock price.
B) subtracting the present value of the dividend from the current stock price.
C) adding the future value of the dividend to the option value.
D) adding the present value of the dividend to the current stock price.

Question 65

Gamma is the greatest when an option:

A) is deep in the money.
B) is deep out of the money.
C) is at the money.
D) has a shorter maturity.
Question 66

A portfolio manager is concerned about the downside risk of his portfolios that contain financial products
with option-like payoffs. The manager has been using the delta-normal VAR method to assess the
portfolios downside risk. Which of the following statements most accurately describes the characteristics
of the delta-normal VAR method?
I.
II.
III.
IV.

Assumes a normal distribution.

Adjusts for non-normal distributions.
Adjusts for option-like payoffs.
Adjusts for fat-tail distributions.
A) I only.
B) I and II.
C) II and III.
D) II, III, and IV.

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Question 67
Consider the delta-normal and full-revaluation approaches to estimating the VAR of non-linear derivative instruments.
Which of the following is NOT a requirement for either the delta-normal or full-revaluation approach?
A) The VAR(1%) of the asset underlying the derivative is based on an assumed normal distribution.

B)

The VAR(1%) of the underlying asset is adjusted by a factor reflecting the price sensitivity of the
derivative price to changes in the underlying asset price.

C)

A second order adjustment is made to the underlying asset VAR(1%) to account for the non-linear
relationship between the derivative and the underlying asset.

D)

The VAR(1%) of the derivative is calculated by revaluing the derivative at the price corresponding to a
VAR(1%) decline in the value of the underlying asset.

Question 68

Which of the following statements most accurately describe an appropriate step in the structured Monte
Carlo (SMC) approach for measuring risk?
I.
II.
III.

The first step simulates thousands of valuation outcomes for the underlying assets.
The first step assumes some properties of the underlying assets return distribution (e.g.,
normality).
The second step measures the value-at-risk (VAR) for the portfolio of derivatives based on the
simulated outcomes.
A) I only.
B) II only.
C) I, II and III.
D) I and III.

Question 69
In modeling risk frequency, it is common to:
A) assume that risks are highly correlated.
B) assume risk frequency and severity are the same.
C) use a Poisson distribution.
D) use straight-line projection from the most recent loss data.

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Question 70

The process of measuring operational risk may categorize potential losses into groups in terms of:
A) size and style.
B) size and frequency.
C) frequency and style.
D) probability and frequency.

Question 71

Stress testing is a non-statistical risk management tool because:

A) non-parametric analysis is used.
B) it specifies the minimum loss that will occur for a given significance level.
C)

losses are computed based on anticipated movements in key variables without specific
probabilistic statements.

D) it is objective in its determination of scenarios to evaluate.

Question 72

Which of the following is not a step in the reverse stress testing methodology?
A) hedging.
B) events.
C) cause.
D) outcome.

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Question 73

Rating agencies are paid fees by the issuers of the securities that they rate. The primary reason that this
arrangement has not eroded the credibility of the rating process is:
A) the stringent oversight of regulators.
B) indifference on the part of the investment community.
C) the need for rating agencies to maintain their reputational capital.
D) the transparency of the rating process.

Question 74

Which of the following statements best characterizes the change in a bond rating and the price of the
firms stock?

A)

A bond downgrade produces little or no movement in the stock price, and an upgrade
produces an upward movement.

B)

A bond downgrade produces a downward movement in the stock price, and an upgrade
produces little or no movement.

C)

A bond downgrade produces an upward movement in the stock price, and an upgrade
produces a downward movement.

D) Bond downgrades and upgrades are equally ambiguous in their effects.

Question 75

Country N has an investment ratio (INVR) of 0.38. If its gross national product (GNP) is $419 billion, the
percentage of GNP used for investment is closest to:
A) 3.8%.
B) 6.2%.
C) 38.0%.
D) 62.0%.

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Question 76

Which of the following is TRUE concerning capital adequacy levels?

A) Expected loss is less important than unexpected loss in determining capital adequacy levels.
B)

Expected loss is equally as important as unexpected loss in determining capital adequacy

levels.

C) Unexpected loss is less important than expected loss in determining capital adequacy levels.
D) Expected loss is more important than unexpected loss in determining capital adequacy levels.
Question 77

Smallville Savings Bank (SSB) has a loan portfolio totaling $20,000,000 in commitments. Currently 60%
is outstanding. The bank has assessed an average internal credit rating equivalent to 2% default
probability over the next year. Drawdown upon default is assumed to be 75%. The bank has additionally
estimated a LGD of 60%. The standard deviation of EDF and LGD is 5% and 25%, respectively. The ratio
of unexpected loss to expected loss is closest to:
A) 2.0.
B) 0.50.
C) 4.0.
D) 0.25.
Question 78

Vijay Ranjin, CFA, is a portfolio manager with Golson Investment Group. He manages a fixed-coupon
bond portfolio with a face value of $120.75 million and a current market value of $116.46 million. Golsons
economics department has forecast that interest rates are going to change by 50 basis points. Based on
this forecast, Ranjin estimates that the portfolios value will increase by $2.12 million if interest rates fall
and will decrease by $2.07 million if interest rates rise. Which of the following choices is closest to the
portfolios effective duration?
A) 3.6
B) 0.4
C) 2.9
D) 4.3

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Question 79
Werner Baltz, CFA, has regressed 30 years of data to forecast future sales for National Motor Company based on the
percent change in gross domestic product (GDP) and the change in price of a U.S. gallon of fuel at retail. The results
are presented below. Note: results must be multiplied by $1,000,000:

Coefficient Estimates
< >>
< >>
< >>
Standard Error
< >>
< >>
Predictor Coefficient of the Coefficient
Intercept
78
13.710
1 GDP
30.22
12.120
2$ Fuel 412.39
183.981

Analysis of Variance Table (ANOVA)

< >>
< >>
< >>
< >>
Source
Degrees of Freedom Sum of Squares Mean Square
Regression
291.30
145.65
Error
27
132.12
Total
29
423.42
< >>

Part 1)
In 2002, if GDP rises 2.2% and the price of fuels falls $0.15, Baltzs model will predict Company sales in
2002 to be (in $ millions) closest to:
A) $206.
B) $128.
C) $82.
D) $254.
Part 2)
Baltz proceeds to test the hypothesis that none of the independent variables has significant explanatory
power. He concludes that, at a 5% level of significance:
A)

B)

all of the independent variables have explanatory power, because the calculated F-statistic
exceeds its critical value.
none of the independent variables has explanatory power, because the calculated F-statistic
does not exceed its critical value.

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C)

at least one of the independent variables has explanatory power, because the calculated Fstatistic exceeds its critical value.

D)

at least one of the independent variables has explanatory power, because the calculated Fstatistic does not exceed its critical value.

Part 3)
Baltz then tests the individual variables, at a 5% level of significance, to determine whether sales are explained by
individual changes in GDP and fuel prices. Baltz concludes that:

A) neither GDP nor fuel price changes explain changes in sales.

B) only GDP changes explain changes in sales.
C) only fuel price changes explain changes in sales.
D) both GDP and fuel price changes explain changes in sales.
Question 80
Estimated price changes using only duration tend to:

A)

overestimate the increase in price that occurs with a decrease in yield for large changes in
yield.

B)

underestimate the increase in price that occurs with a decrease in yield for large changes in
yield.

C)

underestimate the decrease in price that occurs with an increase in yield for large changes in
yield.

D)

overestimate the increase in price that occurs with a decrease in yield for small changes in
yield.

Question 81
A Type I error:
A) rejects a false null hypothesis.
B) fails to reject a false null hypothesis.
C) fails to reject a true null hypothesis.
D) rejects a true null hypothesis.

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Question 82
2

A simple linear regression equation had a coefficient of determination (R ) of 0.8. What is the correlation
coefficient between the dependent and independent variables and what is the covariance between the
two variables if the variance of the independent variable is 4 and the variance of the dependent variable is
9?
Correlation
coefficient

Covariance

A) 0.91

4.80

B) 0.89

5.34

C) 0.89

4.80

D) 0.91

5.34

Question 83

Let A and B be two mutually exclusive events with P(A) = 0.40 and P(B) = 0.20. Therefore:
A) P(B|A) = 0.20.
B) P(A and B) = 0.
C) P(A or B) = 0.52.
D) P(A and B) = 0.08.
Question 84

John Starwall, CFA, is assigned the task of estimating the risk and return for security X, which is being
considered as an addition to his current portfolio. If the investment is accepted, then the total portfolio will
consist of five different equities that are not highly correlated. Security X has an estimated beta of 1.4.
The probabilities of various states of the economy and the expected return for security X given each state
are as follows:
State of Economy

Pi

E(Ri)

Recession

0.3

0.01

Average Economy

0.6

0.10

Boom

0.1

0.20

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Part 1)
Based on the information above, what is the estimated expected return for security X?
A) 8.0%.
B) 15.5%.
C) 10.0%.
D) 8.3%.
Part 2)
Based on the information above, what is the estimated standard deviation for security X?
A) 0.3%.
B) 10.1%.
C) 5.6%.
D) 7.8%.
Part 3)
Based on the information above, what are the appropriate measures for assessing whether or not this
security should be added to the portfolio?
A) Expected return and beta of the security.
B) Expected return and standard deviation of the security.
C) Expected return, beta, and standard deviation of the security.
D) Beta and standard deviation of the security.
Question 85

Unlike the coefficient of determination, the coefficient of correlation:

A) indicates whether the slope of the regression line is positive or negative.
B) measures the strength of association between the two variables more exactly.
C) can have an absolute value greater than 1.
D) indicates the percentage of variation explained by a regression model.

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Question 86

Which statement best describes the return to loans after ratings change?
A) Loan returns are asymmetric since the lender only partially absorbs the downside losses.
B)

Loan returns are symmetric as the lender absorbs all the downside losses and absorb the
upside.

C) Loan returns are symmetric as the lender enjoys upside benefits.

D)

Loan returns are asymmetric as the lender absorbs all the downside losses and none of the
upside.

Question 87

An analyst is testing to see if the mean of a population is less than 133. A random sample of 50
observations had a mean of 130. Assume a standard deviation of 5. The test is to be made at the 1%
level of significance.
z

0.00

0.01

0.02

0.03

0.04

0.05

0.06

0.0

0.0000

0.0040

0.0080

0.0120

0.0160

0.0199

0.0239

0.1

0.0398

0.0438

0.0478

0.0517

0.0557

0.0596

0.0636

0.2

0.0793

0.0832

0.0871

0.0910

0.0948

0.0987

0.1026

0.3

0.1179

0.1217

0.1255

0.1293

0.1331

0.1368

0.1406

1.7

0.4554

0.4564

0.4573

0.4582

0.4591

0.4599

0.4608

1.8

0.4641

0.4649

0.4656

0.4664

0.4671

0.4678

0.4686

1.9

0.4713

0.4719

0.4726

0.4732

0.4738

0.4744

0.4750

2.0

0.4772

0.4778

0.4783

0.4788

0.4793

0.4798

0.4803

2.1

0.4821

0.4826

0.4830

0.4834

0.4838

0.4842

0.4846

2.2

0.4861

0.4864

0.4868

0.4871

0.4875

0.4878

0.4881

2.3

0.4893

0.4896

0.4898

0.4901

0.4904

0.4906

0.4909

2.4

0.4918

0.4920

0.4922

0.4925

0.4927

0.4929

0.4931

Part 1)
The null hypothesis is:

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A) > 133.
B) 133.
C) = 133.
D) 133.
Part 2)
The calculated test statistic is:
A) -4.24.
B) +1.33.
C) -1.33.
D) -3.00.
Part 3)
The critical value is:
A) 2.17.
B) -2.33.
C) -2.38.
D) 2.47.
Part 4)
You should:
A) reject the null hypothesis.
B) accept the null hypothesis.
C) reject the alternative hypothesis.
D) Cannot be determined with the information given.
Question 88

A put option on DCY stock matures six months from today and sells for $0.49. A call option on DCY stock
with the same strike price sells for $4.52. Both the put and the call are European options. DCY stock is
priced at $55 and the risk-free rate of interest is 4 percent. The strike price of the put and call options is
closest to:
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A) $51.
B) $53.
C) $52.
D) $50.

Question 89
Consider the following graph of a distribution for the prices of various bottles of champagne.

Which of the following statements regarding the distribution is least accurate?

A) The distribution is negatively skewed.
B) At least 40% of observations fall within 1.3 standard deviations of the mean.
C) The mean value will be less than the mode.
D) Point A represents the mode.

Question 90
Which of the following statements regarding multicollinearity is FALSE?
A) Multicollinearity may be a problem even if the Multicollinearity is not perfect.

B)

ulticollinearity makes it difficult to determine the contribution to explanation of the dependent variable of
an individual explanatory variable.

C) Multicollinearity may be present in any regression model.

D)

If the t-statistics for the individual independent variables are insignificant, yet the F-statistic is significant,
this indicates the presence of Multicollinearity.

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Question 91

Assume that the current price of a stock is $100. A call option on that stock with an exercise price of $97
costs $7. A call option on the stock with the same expiration and an exercise price of $103 costs $3.
Using these options what is the expiration profit of a bear call spread if the stock price is equal to $110?
A) -$2.
B) -$6.
C) $2.
D) $6.

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