FRM 2 UPDATED ACTUAL Exam Questions and CORRECT Answers

FRM 2 UPDATED ACTUAL Exam
Questions and CORRECT Answers
Netting Factor - CORRECT ANSWER - sqrt(n + n (n - 1) p) / n



Ho-Lee Model - CORRECT ANSWER - dr = lambda(t)*dt + sigma*dw



Vasicek Model - CORRECT ANSWER - dr = k*(theta - r)*dt + sigma*dw


Half-life = ln(2)/k


Cox-Ingersoll-Ross Model (CIR) - CORRECT ANSWER - dr = k*(theta - r)*dt +
sigma*sqrt(r)*dw


Friction 1: Mortgagor and Originator - CORRECT ANSWER - The borrower may not
even be aware of the financing options available. On the other hand, the lender may steer the
borrower to products that are not suitable.


Friction 2: Originator and Arranger - CORRECT ANSWER - The arranger (issuer)
purchases the loans from the originators for the purpose of resale through securitized products.
The originator has superior knowledge about the borrower (adverse selection problem).


Friction 3: Arranger and third-parties - CORRECT ANSWER - The arranger of the pool of
mortgages will possess better information about the borrower than third parties including rating
agencies, asset managers, and warehouse lenders.


Friction 4: Servicer and Mortgagor - CORRECT ANSWER - The servicer's role is to
manage the cash flows of the pool and follow up on delinquencies and foreclosures. A conflict of
interest arises for delinquent loans.

,Friction 5: Servicer and third-parties - CORRECT ANSWER - The servicer faces a moral
hazard problem because their (lack of) effort can impact the asset manager and credit rating
agencies without directly affecting their own cash flow distribution.


Friction 6: Asset manger and investor - CORRECT ANSWER - The investor relies on the
asset manager's expertise to identify and analyze potential investments


Friction 7: Investor and credit rating agencies - CORRECT ANSWER - Rating agencies
are compensated by the arranger and not the end user, the investor.


Default time distribution - CORRECT ANSWER - F(t) = 1 - e^(-lambda*t)



Coherent Risk Measure: Monotonicity - CORRECT ANSWER - If X < Y, then p(Y) <
p(X)


If the expected value of Y is greater than X, then the risk of Y is less than the risk of X


Coherent Risk Measure: Sub-additivity - CORRECT ANSWER - p(X + Y) < p(X) + p(Y)


The portfolio's risk should not be greater than the sum of its parts


Coherent Risk Measure: Positive Homogenity - CORRECT ANSWER - p(lambda*X) =
lambda*p(X)


Double portfolio, double the risk


Coherent Risk Measure: Translation Invariance - CORRECT ANSWER - p(X + c) = p(X)
-c


Like adding cash

, Operational Risk Management: 3 Lines of Defense - CORRECT ANSWER - 1. Business
Line Management
2. Independent Corporate operation RM function
3. Independent review/audit


Basel Suggestions for Sound Operational Risk Managemnet - CORRECT ANSWER - 1.
Strong risk management culture
2. Fully integrated with overall RM process
3. Board of directors reviews OR framework
4. Board approves risk appetite/tolerance
5. Well defined governance structure
6. Incentives incorporate risks taken
7. Approval for new line of business
8. Constant monitoring of OR
9. Internal controls to mitigate/transfer risk
10. Major business disruption plans
11. Disclosure


Risk Capacity - CORRECT ANSWER - Max level of risk an institution can take



Risk Appetitte - CORRECT ANSWER - Aggregate level and types of risks willing to take
given risk capacity


Operational Risk Taxonomy - CORRECT ANSWER - Process of identifying and
classifying operational risks.
1. System Failures
2. Natural Disasters
3. Employee practices & workplace safety (HR Function)