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FRM Updated
What is the difference between absolute VaR and relative VaR?
Absolute VaR measures the potential loss in dollar terms from the current portfolio value, while relative VaR measures the loss relative to the expected value at the horizon.
How does mean reversion work in the Vasicek model and what are its limitations?
Vasicek uses dr = a(b - r)dt + sigma dW with mean reversion speed a, long-run mean b, and constant volatility...
What's the difference between scenario analysis and RCSA in operational risk management?
Scenario analysis and RCSA are both qualitative tools in the operational risk toolkit, but they serve different purposes, involve different participants, and produce different outputs.
How does an autocallable note work and when does it redeem early?
Autocallables pay contingent coupons and redeem early if triggers are met. They are priced via Monte Carlo and perform best in sideways markets.
Can you explain affine term structure models in plain language?
Affine models express the short rate as a linear combination of latent factors, yielding closed-form bond prices...
How does the Basel standardized approach for credit risk assign risk weights and what are the main exposure categories?
The Basel Standardized Approach for credit risk uses externally assigned credit ratings and regulatory-prescribed risk weights to calculate risk-weighted assets.
How does a reverse convertible note enhance yield and what is the investor actually selling?
A reverse convertible is a high-yield bond plus short put. The investor effectively sells downside insurance on a single stock to fund the enhanced coupon.
How is the term premium estimated and why does it matter for risk management?
Term premium is the excess yield beyond expected short-rate paths, estimated via affine models or surveys...
What is the IRB approach for credit risk and how do PD, LGD, and EAD interact to determine capital requirements?
The Internal Ratings-Based (IRB) approach allows banks to use their own internal estimates of credit risk parameters to calculate regulatory capital. The four key parameters are PD, LGD, EAD, and effective maturity.
What is an equity-linked note (ELN) and how does its payoff differ from a PPN?
An ELN is structurally a bond plus short put option. Investors earn enhanced yield but face principal loss if the underlying falls below the buffer.
What are smoothing splines and when should I use them over bootstrapping?
Smoothing splines fit continuous curves by balancing pricing accuracy against curvature penalties controlled by lambda...
How does the FRTB define the boundary between the trading book and banking book, and why does it matter for capital?
The FRTB was introduced to address boundary arbitrage — banks exploiting the trading/banking book classification to minimize capital. FRTB imposes strict presumptive assignment rules and transfer restrictions.
How do principal protected notes (PPNs) achieve capital preservation while offering equity upside?
A PPN combines a zero-coupon bond (principal guarantee) with a call option (upside). The bank profits from the spread between option cost and embedded value.
How do I bootstrap a zero-coupon yield curve from coupon bond prices for FRM Part I?
Bootstrapping works iteratively from shortest to longest maturity, using previously solved zeros to discount earlier cash flows...
How is the Basel leverage ratio calculated and why was it introduced alongside risk-based capital requirements?
The Basel III leverage ratio is a simple, non-risk-weighted measure designed as a backstop to the risk-based capital framework. It was introduced because some banks appeared well-capitalized on a risk-weighted basis but were dangerously leveraged.
Why did Basel move from the AMA to the SMA for operational risk capital, and how does the SMA work?
The transition from AMA to SMA represents a shift from internal model freedom to a standardized formula. The AMA was abandoned due to excessive variability, model risk, insufficient data, and gaming potential.
Can banks use insurance to reduce operational risk capital requirements, and what are the limitations?
Under the AMA, banks could receive up to 20% capital credit for insurance, subject to strict criteria. Under the SMA, direct insurance mitigation is not recognized, though recoveries indirectly lower the Internal Loss Multiplier.
What are the key elements of a business continuity plan and how does it relate to operational resilience?
Business Continuity Planning is the process of preparing for and recovering from disruptive events. Post-2020, regulators have expanded BCP into a broader concept called operational resilience, which focuses on operating through disruptions rather than just recovering from them.
How should banks manage third-party risk, and what are the regulatory expectations for outsourcing critical functions?
Third-party risk management has become one of the most scrutinized areas of operational risk. Regulators view outsourcing as transferring the activity but not the responsibility — the bank remains fully accountable.
How is the Liquidity Coverage Ratio (LCR) calculated and what qualifies as High-Quality Liquid Assets?
The Liquidity Coverage Ratio ensures banks hold enough liquid assets to survive a 30-day stress scenario. The formula divides the stock of HQLA by total net cash outflows, with a minimum requirement of 100%.
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