FRM Level I Mock Test II: Morning Session

vandana.jain
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FRM Level I Mock Test II: Morning Session

Postby vandana.jain » Wed Nov 07, 2012 2:25 pm

The variance of the market portfolio is known to be 0.20, i.e. Sigmam2 = 0.20.
Which of the following is/are true?

I. A stock which has a variance of 0.05 gives lower returns than the market
II. A stock which has a variance of 0.3 and gives the same return as the market, has a beta greater than 1
III. A stock which has a variance of 0.27 gives a return more than the market
IV. A stock which gives the same return as the market, has a variance greater than or equal to 0.20
a. I only
b. I, II, III and IV
c. I, II and IV
d. I and IV ( Ans)
can any one explain the logic.....



Suppose the rate on 1-year zero-coupon corporate bonds is 16.3% and the implied probability of default is 5.87%. Assume Loss Given default is 100%. Then, 1-year T-bill rate is closest to:
a. 8.63%
b. 9.47% Ans
c. 10.17%
d. 7.51%
plz explain concept



Which of the following is correct:
Choose one answer. a. Daily Mark to Market is done for all securities on both OTC and Exchanges
b. Daily Mark to Market is done for all securities on Exchanges
c. Daily Mark to Market is done for only large and liquid enough securities on both OTC and Exchanges
d. Daily Mark to Market is done for only large and liquid enough securities on Exchanges

ans is D, why not b?


please help

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content.pristine
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Re: FRM Level I Mock Test II: Morning Session

Postby content.pristine » Fri Nov 09, 2012 1:06 pm

Hi Vandana,

1. The first question is a bit tricky. It uses concepts from both CML and CAPM models.
We know total risk = systematic risk + unsystematic risk.
It is pretty obvious that I and IV are true. Lets focus on why II and III are false:
II. If a stock is more volatile than the index, yet returns the same return, that means the Beta of the stock is LESS than 1.
III. A stock with more variance than the market would only get a higher return if its SYSTEMATIC risk is higher than the index. If all the excess risk is unsystematic, the investor would not get compensated because it can be diversified away.

2. Lets say we invest 1 dollar in the corporate bond for a year.
Also, lets invest 1 dollar at the 1 year T.Bill rate:
After a year, if there were no defaults, the value of the bond would be 1*(1.163) = 1.163
However, there is a probability of loss, hence the 1 dollar invested would get eroded by 5.87%. 1 dollar becomes = 1*(1-5.87%) = 94.13%
The actual amount expected after a year = 1.163*94.13% = 1.09473
This is the risk adjusted amount.
Hence this amount is equal to the T.Bill rate
Therefore, I should get 1.09473 after a year if i invested in tbills.
Hence, the T.Bill rate is 9.473%

3. This is an interesting theoretical question.
See, MTM is very important for Institutional investors.
In the case of institutional investors, they may hold $1M in a share that is not traded on a day to day basis. Hence, if they wanted to manipulate their holdings, they can sell a share worth $5 at $50 and show a great performance of millions at a loss of only $45. Hence, to prevent manipulations, only liquid securities are Marked to Market. The others have different ways to value.

Hope this helps!
8-)

balajismz
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Re: FRM Level I Mock Test II: Morning Session

Postby balajismz » Fri Nov 09, 2012 4:59 pm

All 3 Questions very well explained, thank you so much....especially the 2nd Q

Balaji

vandana.jain
Finance Junkie
Posts: 41
Joined: Tue Jul 24, 2012 4:56 pm

Re: FRM Level I Mock Test II: Morning Session

Postby vandana.jain » Fri Nov 09, 2012 7:14 pm

thank you :)


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