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Topics for FRM Exam Questions

Financial Markets and products is probably one of the trickiest topics of FRM Exam. It covers a wide range of topics “ From Introduction of financial markets to Options and Futures, Swaps, Fixed Income Securities and hedging! If we look at the readings assigned to this topic, we find that it has a lot of readings “ 10 chapters of John Hull, Corporate Bonds from Frank Fabozzi, 2 chapters from Saunders and 2 readings from commodity derivatives. Similar is the weight assigned to Financial markets and products section “ 30% for Part I and 15% for full Examination! In a nut shell, this section is a key section as far as FRM Exam is concerned!

Originally this section was clubbed in the market risk section of FRM Exam (Till 2008). So analyzing the history of this section becomes a little difficult. Nonetheless, if we map the learning objectives to last year’s examinations, we can find the pattern and some of the low hanging fruit.

The broad classification of topics covered in Financial Markets and Products is:

  1. Financial Markets (Primarily defining the role of various players)
  2. Futures and forwards (Definitions, Valuation and Hedging)
  3. Interest Rate and Currency (Some part is included here,
  4. Fixed Income Instruments (Again part is covered in Valuation and Risk Models)
  5. Swaps
  6. Options(Again trading strategy is included here, some part is in Valuation and Risk Models)
  7. Commodities

The number of unique topics in this section is simply flabbergasting! For anybody who is new to financial markets and instruments, the width and depth of this section can be intimidating. If we look closely at the last 3-4 years Sample papers, there are practically 2-3 questions from each of the topics! So it is difficult to single out any topic, which is important!! Anyways.. lets analyze it closely and give it a shot.

  1. By default, remember to use continuous compounding, unless otherwise mentioned!! For example, if you want to calculate returns, then use
    R = Ln(P(t)/P(t-1))
    If it is expressly mentioned that you have to use discrete compounding, then only use:
    R = {P(t) – P(t-1)}/P(t-1)
    Similarly to value futures/ other instruments, use:
    F(0,T) = S(0)*e^(rT) + C

    There are normally atleast two questions on converting rates based on different compounding frequencies. It is one of the low hanging fruits as far as this section is concerned.

    Please learn the usage of the calculator. You should be a master in usage of calculator, to make sure that you crack the exam.

  2. If we look closely at the last 2-3 years sample papers, the question that is always there relates to finding duration and modified duration. Normally not a tough question and just a couple of formulae to remember:
  3. Apart from Duration, the FRM 2009 sample exam has a lot of questions on trading strategies. This means that if you can just draw curves of payoffs, and remember the various payoffs like Straddle, Strangle, Butterfly spreads, etc. you would have done 5 questions correct! This is quite a lot!! Given that Market Risk was one of the trickiest portions and 5 questions from one chapter of Hull (That too not-so-difficult to understand), means a lot. Similarly there have been questions on payoffs of futures and swaps in the previous exams.

    To draw the curves, you just need to remember the payoffs of Long Call, Short Call, Long Put, Short Put, Long Spot, Short Spot and similarly for futures. The diagrams are easy to understand and you just have to super-impose one diagram over the other to get to the desired output.

  4. Apart from the above topics, there have been questions on Greeks. Technically this topic is now shifted to Market Risk (In Part II), but there is a mention of the topic in Part I as well. Delta Hedging of portfolio has been one of the favorites of the examiners because of its simplicity of calculation and the concept checks on the understanding of the examinee about various aspects of Options Pricing. The question on this section is relatively simple, and simple application of the definition is enough to do the question correctly.

Delta is simply the rate of change of option with respect to the underlying. So if you have an exposure to the underlying you need to change your options to make sure that you are hedged!! As simple as that!!

For delta hedging,
Number of shares = (Number of calls) x (New delta – Old delta)

Apart from this there is generally a question on relationship between delta of options and Black-Scholes model. The question would test your understanding of Black Scholes model along with Greeks.

GreekPhysical SignificanceCallPut
DeltaN(d1)N(d1) -1 

Apart from this, there are generally 2-3 questions on Swaps. The questions on pay-offs are easier, and the ones on valuation are generally tougher!! The simplest thing to remember

This is just the start, and if we look at the syllabus, there are quite a lot of things that you can be tested upon. But I think, if you are able to master these concepts, you will sail through the Financial Markets and Products Module.

Once again Pristine Advice – Strategize : Find your strengths and play on them!!

We will take some questions on the above formulae and see, how to tackle them.. in the meanwhile. Keep preparing hard!!

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