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Hey to all those who will be giving the FRM (Financial Risk Manager) exam this May! We at EduPristine decided to compile a list of concepts that will guarantee your success at clearing the FRM exam with flying colors!

For all those who are ready, or are in the process of getting ready, for the FRM exam that is due to take place in May 2015, you might be feeling like you have a sword hanging over your head. But not to worry! We are there to help. You have embarked on a journey that is not necessarily easy. But we commend your courage and your strength for continuing this long.

The list compiled by us is a concise and systematic analysis of certain concepts. By now, you have come across various FRM concepts and FRM theories. Just to ensure that you are thorough with them, try and recall the ones that you have studied.

Let’s get started now! Mentioned below are nine important concepts of FRM.

1. Exotic Options/ Vanilla Options :

Do you remember what Exotic and Vanilla Options are? There are Himalaya Options, Digital Options, Range Options, Basket Options. Do these terms ring a bell? Before you move into Exotic/ Vanilla Options, you would be advised to read about Asian Options, Barrier Options, Chooser Options, Callability, Putability. This may appear vast to you if you aren’t thorough with the concepts.

2. Shortcomings Of Value at Risk Methodologies :

Usually when one makes an investment, his or her first instinctive thought is about the risks involved. Value at Risk attempts to provide an answer to that particular thought. However, it does have its shortcomings. For instance, there is a tendency to use ‘Normal Distributions’ in the assumption and thus a lower probability of extremes. VaR also does not distinguish portfolio liquidity. VaR is a static measure of risk and does not capture the dynamics of possible losses if a portfolio were to be unwound. Read more about the Shortcomings of VaRhere

3. Margins, Margin Calls, and Margin Requirements :

Kitten pic

During your FRM Exam, if you get stuck on a question on Margins, etc., remember the cute kitten!

But back to the point. Would you be able to answer every question on Margins? If not, read about Margins, Margin Calls and Margin Requirements to re-hash your memory! A margin is essentially the difference between a product’s selling price and the cost of production. There are various types of margin requirements, such as Current liquidating margin, Variation margin, Premium margin, Additional margin, etc. So if you want to know more.

4. Normal Distribution :

Under this concept, you will learn all about bell-shaped curves, otherwise known as a Gaussian Curve. You will also learn about deviation of the data from the normal behavior. This can be further checked by various test statistics like Kolmogorov-Smirnov test, Anderson-Darling, Wilk-Shapiro test, Jarque-Berra test, Rankit plot, Q-Q plot, P-P plots etc. So if you want to cross-check your own understanding of Normal Distribution, go through the concepts of Normal Distribution again!

5. Stack and Roll Hedge:

Rolling hedge is a strategy for reducing risk that involves using the high levels of liquidity typically present with exchange-traded futures and options in order to achieve a continual risk-offsetting position. A rolling hedge is done by closing out existing positions as they near maturity and then concurrently opening new positions with maturity dates further in the future. Stack hedging is a strategy which involves buying various futures contracts that are concentrated in nearby delivery months to increase the liquidity position.

Seem familiar? If not, read more about Stack and Roll Hedging!

6. Fitting Distribution to Operational Risk Data :

There are various methods of fitting distributions to data such as:

  • Moments Matching (estimating distribution parameters such that moments such as mean, variance of the data are matched)
  • Quantile/Percentile Matching (estimating distribution parameters such that quantiles like 50th Quantile i.e. Median, 99% percentile etc. are matched)
  • Probability Weighted Moments
  • Maximum Likelihood Estimation (MLE).

If you think you need to read more about MLEs, i.e., Maximum Likelihood Estimation, in Excel or about Operational Risk Modeling Techniques here

7. Boot Strap Method :

Bootstrapping Spot Rate Curve (Zero Curve), also known as a zero curve refers to the yield curve constructed using the spot rates such as Treasury spot rates instead of the yields. So you will learn how to construct build a spot rate curve using a method called Bootstrapping.

8. Options Trading Strategies :

Option strategies are the simultaneous, and often mixed, buying or selling of one or more options that differ in one or more of the options’ variables. This is often done to gain exposure to a specific type of opportunity or risk while eliminating other risks as part of a options trading strategy.

Read more about it here!

9. Introduction to Operational Risk :

Operational Risk is another important concept under FRM. Operational risk defies a single consensus, concrete definition. It is tempting to want operational risk to equal everything that is not market or credit risk. This is a good place to start, but we generally further exclude business risks, including business strategy and direct environmental factors like competition and technology.

Do you think you remember everything about Operational Risks? If not, read more about it here!

I hope this article on important concepts of FRM or Financial Risk Manager has been useful to you. For any queries, write to us or post your questions on our forum!

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