(Note: this will appear tomorrow as an Article in the Study Planner, where we hope paid members can find organized access to it. I just wanted to share a copy here also)
About the Focus Reviews
Hello, this is David. Welcome to the Focus Reviews. As I mention in the video, Focus Reviews are NOT substitutes for the regular, lengthy study program: instead, these are very brief video highlights with an emphasis on a tour of selected Q&A. The weakness of the FRM is that it can be overwhelming, with arguably an over-abundance of AIMs. Statistically, you cannot be tested on even 25% of the AIMs. So, with these Focus Reviews, I'd like to share a "shortcut" that is NOT meant to replace but to supplement your regular study. The idea is to help point you to the areas that are more important.
We are dividing the 2012 Focus Reviews into eight (8) brief videos. Part 1 will sequence like this:
Focus Review P1, 1st of 8 (Foundations): Video, Practice Questions, and Learning spreadsheets
The video, the first Focus Review, is here at http://www.bionicturtle.com/how-to/video/2012.p1.-focus-review-1
Sometime before the exam, you will want to work practice questions. In general, I think the best plan is to progressively increase your allocation to practice questions as the exam date nears such that, for example, you are exclusively working practice questions in the several weeks immediately before the exam.
We've revised the Practice Question Sets that accompany Foundations. There are five:
If you are using the learning spreadsheets, there are seven (1.a.1, 1.a.2, and 1.b.1 to 1.b.5), but you really care about these three:
I parsed this Focus Review (P1: 1st of 8) into the following six sub-topics, I think this is most of what you care about (except for the Ethics/Code of Conduct: unlike the CFA, the FRM does not have a mature testing framework with respect to the Conduct, so it's really hard to know what they may quiz on this):
I actually do recommend reading Jorion's Chapter 1 (The Need for Risk Management). it contains several philosophical points that percolate and find meaningful illustration only in later P1 assignments. For example, the profound distinction between valuation (pricing) and risk measurement; e.g., the latter is satisfied with imprecision; or that derivatives are unfunded compared to, say, loans, so they are harder to risk measure.
In the video I included a single typology chart because the exam likes to quiz on the fact that strategy and reputational risks are not operational risks, but legal risks are defined as operational risks. Please note the chart highlights that our primary area of study is not even nearly the whole world of risks, it's really only just financial non-business risks which includes the three big buckets (market, credit, and operational).
CAPM/MPT
For CAPM, GARP has recently assigned chapters from a deep and somewhat theoretical text (Elton). If your goal is merely to pass the exam, much of this could be a time trap and a lot of theory you probably won't need. Lately I've observed some candidates get a little bogged down here. Don't get me wrong, it's great learning but you could spend an entire semester here; but the exam is highly unlikely to go as deep as the texts go. Frankly, a mechanical understanding of CAPM should suffice. You are in good shape here if you've got:
Easily the most common exam question here is one that asks you to apply CAPM in some way. For example, if you are given a riskless rate of 3% and the market's expected return of 8%, this means the market's excess return (aka, the price of risk) is 5%, and you should be able to immediately figure the expected return of an asset with a beta of 1.20 or whatever. Also, please make sure you can absolutely break down beta: beta(i, M) = covariance(i,M)/variance(M) = correlation(i,M)*volatility(i)/volatility(M).
But I would also memorize Elton's ten CAPM assumptions; e.g., investor homogeneity.
Value at Risk (VaR)
The "bread and butter" calculation is the computation of delta-normal VaR. Start with a portfolio volatility of 10% per annum, for example. Scale that according to confidence with a one-tailed deviate; e.g., at 95% normal confidence, 10% per annum volatility becomes 10% * 1.645 = 16.45% annual 95% VaR. Scale that by the square root of time, knowing you require i.d.d. (lack of return autocorrelation), to do so. For example, scale down the annual VaR to 10-day VaR with: 10%*1.645*SQRT(10/250) = 3.29% 10-day 95% confident VaR. Convert this into a 99% 10-day VaR with: 3.29% * 2.33/1.645 = 4.66% 10-day 99% VaR. Practice until your are comfortable translating confidence levels and time-scaling up/down.
Creating value with risk management
The Stulz readings have given candidates headaches for years, trust me. Very difficult prose. Chapter 2, which is no longer assigned, is where Stulz argues that risk management CANNOT create value when MARKETS ARE PERFECT. Stulz Chapter 3 basically itemizes specific market IMPERFECTIONS and shows why, in the presence of these imperfections, risk management can add value. So, ultimately Stulz argues that risk management, in the real world, adds value. Please notice that he's generally referring to the same CAPM assumptions in Elton, so your brief study here only need concern the set of unrealistic assumptions that attach to the CAPM.
RAPMs
Almost all of these fit into the general form: unit of return per unit of risk. The Amenc reading is short, to the point, and recommended. I think the best thing you can do here is just practice calculations/questions. The exam historically does like to test Sharpe (note this is also the slope of the CML); Treynor; Jensen's alpha (which is just CAPM applied) and the information ratio.
Cases
I don't have shortcuts here, sorry. I think that GARP can always query on any of them. I would suggest that, when you read them a second time, see them through the prism of key risk factors (sorry if that's obvious). For each, there is a narrative, but an exam question is more likely to ask you about the manifested risk factors. For example, Metallgesellschaft is really a tale of epic basis risk. Almost all of them involve operational risk(s).
About the Focus Reviews
Hello, this is David. Welcome to the Focus Reviews. As I mention in the video, Focus Reviews are NOT substitutes for the regular, lengthy study program: instead, these are very brief video highlights with an emphasis on a tour of selected Q&A. The weakness of the FRM is that it can be overwhelming, with arguably an over-abundance of AIMs. Statistically, you cannot be tested on even 25% of the AIMs. So, with these Focus Reviews, I'd like to share a "shortcut" that is NOT meant to replace but to supplement your regular study. The idea is to help point you to the areas that are more important.
We are dividing the 2012 Focus Reviews into eight (8) brief videos. Part 1 will sequence like this:
- Foundation
- Quant
- Quant
- Products
- Products
- Valuation
- Valuation
- Wrap-up/Summary
Focus Review P1, 1st of 8 (Foundations): Video, Practice Questions, and Learning spreadsheets
The video, the first Focus Review, is here at http://www.bionicturtle.com/how-to/video/2012.p1.-focus-review-1
Sometime before the exam, you will want to work practice questions. In general, I think the best plan is to progressively increase your allocation to practice questions as the exam date nears such that, for example, you are exclusively working practice questions in the several weeks immediately before the exam.
We've revised the Practice Question Sets that accompany Foundations. There are five:
- Practice L1.T1_Jorion_1-25
- Practice L1.T1_Stulz_40-49
- Practice L1.T1_Elton_40-49
- Practice L1.T1_Amenc_26-32
- Practice L1.T1_Cases_50-56
If you are using the learning spreadsheets, there are seven (1.a.1, 1.a.2, and 1.b.1 to 1.b.5), but you really care about these three:
- 1.a.1. Intro to VaR: this is the two-asset portfolio VaR under mean-variance framework, one of the essential FRM calculations. You will definitely be tested on pieces of this.
- 1.b.1. CAPM: if you want the concrete illustration under the theory
- 1.b.5. PracticeBag: master this column of calculations and, seriously, you've covered most of the quant in T1
I parsed this Focus Review (P1: 1st of 8) into the following six sub-topics, I think this is most of what you care about (except for the Ethics/Code of Conduct: unlike the CFA, the FRM does not have a mature testing framework with respect to the Conduct, so it's really hard to know what they may quiz on this):
- Risk Typology
- CAPM/MPT
- Value at Risk (VaR)
- Creating Value with Risk Management (Stulz)
- RAPMs
- Cases
I actually do recommend reading Jorion's Chapter 1 (The Need for Risk Management). it contains several philosophical points that percolate and find meaningful illustration only in later P1 assignments. For example, the profound distinction between valuation (pricing) and risk measurement; e.g., the latter is satisfied with imprecision; or that derivatives are unfunded compared to, say, loans, so they are harder to risk measure.
In the video I included a single typology chart because the exam likes to quiz on the fact that strategy and reputational risks are not operational risks, but legal risks are defined as operational risks. Please note the chart highlights that our primary area of study is not even nearly the whole world of risks, it's really only just financial non-business risks which includes the three big buckets (market, credit, and operational).
CAPM/MPT
For CAPM, GARP has recently assigned chapters from a deep and somewhat theoretical text (Elton). If your goal is merely to pass the exam, much of this could be a time trap and a lot of theory you probably won't need. Lately I've observed some candidates get a little bogged down here. Don't get me wrong, it's great learning but you could spend an entire semester here; but the exam is highly unlikely to go as deep as the texts go. Frankly, a mechanical understanding of CAPM should suffice. You are in good shape here if you've got:
- The capital market line (CML) which has an x-axis of volatility (total risk); it becomes the efficient frontier after the introduction of the risk-free rate.
- The SML which has an x-axis of systematic risk (beta)
- Application of the CAPM, including finding implied Jensen's alpha using the CAPM
Easily the most common exam question here is one that asks you to apply CAPM in some way. For example, if you are given a riskless rate of 3% and the market's expected return of 8%, this means the market's excess return (aka, the price of risk) is 5%, and you should be able to immediately figure the expected return of an asset with a beta of 1.20 or whatever. Also, please make sure you can absolutely break down beta: beta(i, M) = covariance(i,M)/variance(M) = correlation(i,M)*volatility(i)/volatility(M).
But I would also memorize Elton's ten CAPM assumptions; e.g., investor homogeneity.
Value at Risk (VaR)
The "bread and butter" calculation is the computation of delta-normal VaR. Start with a portfolio volatility of 10% per annum, for example. Scale that according to confidence with a one-tailed deviate; e.g., at 95% normal confidence, 10% per annum volatility becomes 10% * 1.645 = 16.45% annual 95% VaR. Scale that by the square root of time, knowing you require i.d.d. (lack of return autocorrelation), to do so. For example, scale down the annual VaR to 10-day VaR with: 10%*1.645*SQRT(10/250) = 3.29% 10-day 95% confident VaR. Convert this into a 99% 10-day VaR with: 3.29% * 2.33/1.645 = 4.66% 10-day 99% VaR. Practice until your are comfortable translating confidence levels and time-scaling up/down.
Creating value with risk management
The Stulz readings have given candidates headaches for years, trust me. Very difficult prose. Chapter 2, which is no longer assigned, is where Stulz argues that risk management CANNOT create value when MARKETS ARE PERFECT. Stulz Chapter 3 basically itemizes specific market IMPERFECTIONS and shows why, in the presence of these imperfections, risk management can add value. So, ultimately Stulz argues that risk management, in the real world, adds value. Please notice that he's generally referring to the same CAPM assumptions in Elton, so your brief study here only need concern the set of unrealistic assumptions that attach to the CAPM.
RAPMs
Almost all of these fit into the general form: unit of return per unit of risk. The Amenc reading is short, to the point, and recommended. I think the best thing you can do here is just practice calculations/questions. The exam historically does like to test Sharpe (note this is also the slope of the CML); Treynor; Jensen's alpha (which is just CAPM applied) and the information ratio.
Cases
I don't have shortcuts here, sorry. I think that GARP can always query on any of them. I would suggest that, when you read them a second time, see them through the prism of key risk factors (sorry if that's obvious). For each, there is a narrative, but an exam question is more likely to ask you about the manifested risk factors. For example, Metallgesellschaft is really a tale of epic basis risk. Almost all of them involve operational risk(s).
, I agree with you all of the answers are wrong due to imprecise statements. (I even agree with your tendency to select C, but even that's imprecise: C would be an arbitrage opportunity if it read "A European put option on a share of stock has the same price as a European call option, with identical strike price and maturity, on the same underlying share.").