FRM

PART I

QUANTITATIVE

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FRM Part I - Quantitative

Question 1

In the expression representing the results of a sample regression procedure Yi = b0 + b1 Xi +ei, which of
the following is the most correct statement?
The value of b1 represents the expected change in the independent variable given a unit
change in the dependent variable.
The value of b1 represents the expected change in the dependent variable given a unit
B)
change in the independent variable.
The value of b0 represents the expected change in the dependent variable given a unit
C)
change in the independent variable.
The value of b0 represents the expected change in the independent variable given a unit
D)
change in the dependent variable.
A)

Question 2

A dummy variable would best be used to measure the effect of which of the following?
I.
II.
III.
IV.

The difference in implied volatility from one day to the next.

The difference in realized volatility from one day to the next.
The volatility of a stock on Mondays compared to that of other days.
Changes in a stocks volatility on option expiration dates compared to other dates.
A)
B)
C)
D)

II and III only.

I and III only.
III and IV only.
I and II only.

Question 3

Greg Barns, FRM, and Jill Tillman, FRM, wish to test the specification of their econometric model. Barns
suggests adding another independent variable and examining the statistics of its parameters and the
effects on the other parameters. Tillman suggests rerunning the regression using logarithms of the data
instead of the original data. Which, if either, falls under the heading of testing the specification of an
econometric model?
A)
B)
C)
D)

Neither the suggestion of Barns nor that of Tillman.

The suggestion of Barns but not the suggestion of Tillman.
Both the suggestion of Barns and that of Tillman.
The suggestion of Tillman but not the suggestion of Barns.

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Question 4

Thomas Baynes has applied to both Harvard and Yale. Baynes has determined that the probability of
getting into Harvard is 25% and the probability of getting into Yale (his fathers alma mater) is 42%.
Baynes has also determined that the probability of being accepted at both schools is 2.8%. What is the
probability of Baynes being accepted at either Harvard or Yale?
A)
B)
C)
D)

7.7%.
10.5%.
67.0%.
64.2%.

Question 5

In a multivariate normal distribution, a correlation tells the:

A)
B)
C)
D)

overall relationship between all the variables.

strength of the linear relationship between two of the variables.
relationship between the means and variances of the variables.
relationship between the means and standard deviations of the variables.

Question 6
C

The probability of A is 0.4. The probability of A is 0.6. The probability of (B|A) is 0.5, and the probability
C
of (B|A ) is 0.2. Using Bayes formula, what is the probability of (A|B)?
A)
B)
C)
D)

0.625.
0.875.
0.125.
0.375.

Question 7

A company says that whether its earnings increase depends on whether it increased its dividends. From
this we know:
A)
B)
C)
D)

P(earnings increase | dividend increase) is not equal to P(earnings increase).

P(both dividend increase and earnings increase) = P(dividend increase).
P(dividend increase or earnings increase) = P(both dividend and earnings increase).
P(dividend increase | earnings increase) is not equal to P(earnings increase).

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Question 8

Annual Returns on ABC Mutual Fund

1991 1992 1993 1994 1995 1996 1997 1998 1999

2000

11.0% 12.5% 8.0% 9.0% 13.0% 7.0% 15.0% 2.0% -16.5% 11.0%
Part 1)
What is the arithmetic mean return and the geometric mean return for ABC Mutual Fund for the period
1991-2000?
Arithmetic Mean

Geometric
Mean

A) 7.2%

6.8%

B) 7.2%

5.6%

C) 28.2%

7.4%

D) 8.2%

6.8%

Part 2)
Assuming a mean of 7.2%, what is the sample standard deviation of the returns for ABC Mutual Fund for
the period 1991-2000?
A) 7.8%.
B) 9.8%.
C) 9.1%.
D) 10.2%.

Question 9

An investor is considering two investments. Stock A has a mean annual return of 16% and a standard
deviation of 14%. Stock B has a mean annual return of 20% and a standard deviation of 30%. Calculate
the coefficient of variation (CV) of each stock and determine if Stock A has less dispersion or more
dispersion relative to B.
CV (stock A)

Dispersion

A) 1.14

Stock A has less dispersion

relative to the mean than stock B

B) 0.875

Stock A has more dispersion

relative to the mean than stock B

C) 1.14

Stock A has more dispersion

relative to the mean than stock B

D) 0.875

Stock A has less dispersion

relative to the mean than stock B

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Question 10

A sample covariance for the common stock of the Earth Company and the S&P 500 is 9.50. Which of
the following statements regarding the estimated covariance of the two variables is most accurate?
A) The two variables will have a slight tendency to move together.
The relationship between the two variables is not easily predicted by the calculated
B)
covariance.
C) The two variables will have a strong tendency to move in opposite directions.
The relationship between the two variables is highly predictable given the calculated
D)
covariance.

Question 11

An investment has a mean return of 15% and a standard deviation of returns equal to 10%. Which of the
following statements is least accurate? The probability of obtaining a return:
A)
B)
C)
D)

greater than 35% is 0.025.

greater than 25% is 0.32.
less than 5% is 0.16.
between 5% and 25% is 0.68.

Question 12

When is the t-distribution the appropriate distribution to use? The t-distribution is the appropriate
distribution to use when constructing confidence intervals based on:
A)
B)
C)
D)

small samples from populations with unknown variance that are at least approximately normal.
small samples from populations with known variance that are at least approximately normal.
large samples from populations with known variance that are nonnormal.
large samples from populations with known variance that are at least approximately normal.

Question 13

The annual returns for a portfolio are normally distributed with an expected value of 50 million and a
standard deviation of 25 million. What is the probability that the value of the portfolio one year from
today will be between 91.13 million and 108.25 million?
A)
B)
C)
D)

0.025.
0.040.
0.075.
0.090.

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Question 14

The distribution of annual returns for a bond portfolio is approximately normal with an expected value of
$120 million and a standard deviation of $20 million. Which of the following is closest to the probability
that the value of the portfolio one year from today will be between $110 million and $170 million?
A)
B)
C)
D)

74%.
58%.
66%.
42%.

Question 15

A survey is taken to determine whether the average starting salaries of CFA charterholders is equal to or
greater than $59,000 per year. What is the test statistic given a sample of 135 newly acquired CFA
charterholders with a mean starting salary of $64,000 and a standard deviation of $5,500?
A)
B)
C)
D)

0.91.
-10.56.
10.56.
-0.91.

Question 16

The mean daily return for an equity portfolio over 60 months is 1.5 percent. The standard deviation is 3.0
percent. The value of the test statistic to test the hypothesis that mean monthly return is equal to zero is
closest to:
A)
B)
C)
D)

0.50.
30.00.
2.19.
3.87.

Question 17

If the variance of the sampling distribution of an estimator is smaller than all other unbiased estimators of
the parameter of interest, the estimator is:
A)
B)
C)
D)

reliable.
unbiased.
consistent.
efficient.

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Question 18

Shawn Choate is thinking about his graduate thesis. Still in the preliminary stage, he wants to choose a
variable of study that has the most desirable statistical properties. The statistic he is presently considering
has the following characteristics:

The expected value of the sample mean is equal to the population mean.
The variance of the sampling distribution is smaller than that for other estimators of the
parameter.
As the sample size increases, the standard error of the sample mean rises and the sampling
distribution is centered more closely on the mean.

Select the best choice. Choates estimator is:

A)
B)
C)
D)

unbiased, efficient, and consistent.

efficient and consistent.
unbiased and consistent.
unbiased and efficient.

Question 19

A call center receives an average of two phone calls per hour. The probability that they will receive 20
calls in an 8-hour day is closest to:
A)
B)
C)
D)

16.56%.
3.66%.
5.59%.
6.40%.

Question 20

An analyst has determined that the probability that the S&P 500 index will increase on any given day is
0.60 and the probability that it will decrease is 0.40. The expected value and variance of the number of up
days in a 5-day period are closest to:
A)
B)
C)
D)

3.0 and 1.2.

3.0 and 1.1.
2.0 and 0.5.
2.0 and 2.1.

Question 21

In the scatter plot below, the correlation between the return on stock A and the market index is:

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A)
B)
C)
D)

negative.
zero.
not discernable using the scatter plot.
positive.

Question 22

An analyst is examining the relationship between two random variables, RCRANTZ and GSTERN. He
performs a linear regression that produces an estimate of the relationship:
RCRANTZ = 61.4 5.9GSTERN
Which interpretation of this regression equation is least accurate?
A) If GSTERN increases by one unit, RCRANTZ should increase by 5.9 units.
B) The covariance of RCRANTZ and GSTERN is negative.
C) The intercept term implies that if GSTERN is zero, RCRANTZ is 61.4.
In this regression, RCRANTZ is the dependent variable and GSTERN is the independent
D)
variable.
Question 23

Sera Smith, a research analyst, had a hunch that there was a relationship between the percentage
change in a firms number of salespeople and the percentage change in the firms sales during the
following period. Smith ran a regression analysis on a sample of 50 firms, which resulted in a slope of
2
0.72, an intercept of +0.01, and an R value of 0.65. Based on this analysis, if a firm made no changes in
the number of sales people, what percentage change in the firms sales during the following period does
the regression model predict?
A) +1.00%.
B) +0.72%.
C) +0.65%.
D) +0.10%.

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Question 24

Trudy Baker, FRM and Steven Phillips, FRM are planning to do a regression analysis. They discuss
2
specifying the equation they wish to estimate. Baker proposes the specification E(Yi|Xi) = B0 + (B1) (Xi ).
2
Phillips proposes the specification (Yi|Xi) = B0 + (B1 Xi) . Which, if either, is appropriate using linear
regression?
A)
B)
C)
D)

Neither the specification of Baker nor that of Phillips.

The specification of Baker but not that of Phillips.
The specification of Phillips but not that of Baker.
Both the specification of Baker and Phillips.

Question 25

Assume you ran a multiple regression to gain a better understanding of the relationship between lumber
sales, housing starts, and commercial construction. The regression uses lumber sales as the dependent
variable with housing starts and commercial construction as the independent variables. The results of the
regression are:

Coefficient

Standard Error

t-statistics

Intercept

5.37

1.71

3.14

Housing starts

0.76

0.09

8.44

Commercial construction

1.25

0.33

3.78

The level of significance for a 95% confidence level is 1.96

Part 1)
Construct a 95% confidence interval for the slope coefficient for Housing Starts.
A)
B)
C)
D)

0.76 1.96(8.44).
1.25 1.96(0.33).
0.76 1.96(0.09).
1.25 1.96(3.78).

Part 2)
Construct a 95% confidence interval for the slope coefficient for Commercial Construction.
A) 1.25 1.96(3.78).
B) 1.25 1.96(0.33).
C) 0.76 1.96(0.09).
D) 0.76 1.96(8.44).

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Question 26
2

A simple linear regression equation had a coefficient of determination (R ) of 0.8. What is the correlation
coefficient between the dependent and independent variables and what is the covariance between the
two variables if the variance of the independent variable is 4 and the variance of the dependent variable is
9?
Correlation
coefficient

Covariance

A) 0.89

5.34

B) 0.91

4.80

C) 0.89

4.80

D) 0.91

5.34

Question 27

An analyst has been assigned the task of evaluating revenue growth for an online education provider
company that specializes in training adult students. She has gathered information about student ages,
number of courses offered to all students each year, years of experience, annual income and type of
college degrees, if any. A regression of annual dollar revenue on the number of courses offered each
year yields the results shown below.
Coefficient Estimates
Predictor

Coefficient Standard Error of the Coefficient

Intercept

0.10

0.50

Slope (Number of Courses)

2.20

0.60

Which statement about the slope coefficient is most correct, assuming a 5 percent level of significance
and 50 observations?
A)
B)
C)
D)

t-Statistic: 3.67. Slope: Not significantly different from zero.

t-Statistic: 3.67. Slope: Significantly different from zero.
t-Statistic: 0.20. Slope: Not significantly different from zero.
t-Statistic: 0.20. Slope: Significantly different from zero.

Question 28
2

A regression equation with 4 independent variables is estimated using 20 data points. The R is 0.46. An
analyst is testing to see whether all of the coefficients are equal to zero. The p-value for the test is:
A)
B)
C)
D)

lower than 0.025.

between 0.025 and 0.05.
between 0.05 and 0.10.
greater than 0.10.

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Question 29

In a recent analysis of salaries (in $1,000) of financial analysts, a regression of salaries on education,
experience, and gender is run. Gender equals one for men and zero for women. The regression results
from a sample of 230 financial analysts are presented below, with t-statistics in parenthesis.
Salaries = 34.98 + 1.2 Education + 0.5 Experience + 6.3 Gender
(29.11)

(8.93)

(2.98)

(1.58)

Part 1)
What is the expected salary (in $1,000) of a woman with 16 years of education and 10 years of
experience?
A)
B)
C)
D)

59.18.
54.98.
61.28.
65.48.

Part 2)
Holding everything else constant, do men get paid more than women? Use a 5% level of significance. No,
since the t-value:
A) exceeds the critical value of 1.65.
B) exceeds the critical value of 1.96.
C) does not exceed the critical value of 1.65.
D) does not exceed the critical value of 1.96.

Question 30

One of the underlying assumptions of a multiple regression is that the variance of the residuals is
constant for various levels of the independent variables. This quality is referred to as:
A)
B)
C)
D)

homoskedasticity.
a normal distribution.
a linear relationship.
serial correlation.

Question 31

Consider the following four GARCH equations:

2

Equation 1: n = 0.83 + 0.05 n-1 + 0.93 n-1

2
2
2
Equation 2: n = 0.06 + 0.04 n-1 + 0.95 n-1
2
2
2
Equation 3: n = 0.60 + 0.10 n-1 + 0.94 n-1
2
2
2
Equation 4: n = 0.03 + 0.03 n-1 + 0.93 n-1

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Which of the following statements regarding these equations is (are) CORRECT?

I. Equation 1 is a stationary model.
II. Equation 2 shows no mean reversion
III. Volatility will revert to a long run mean level faster with Equation 1 than it will for Equation 4.
IV. Volatility will revert to a long run mean level faster with Equation 3 than it will for Equation 2.
A)
III only.
B)
I only.
C)
II and III only.
D)
II and IV only.
Question 32

You estimate the following GARCH model:

2

= 0.04 + 0.30

2
t-1

+ 0.50

n-1

If the most recent volatility estimate and error term are 0.15 and 0.02, respectively, the long-run average
volatility is closest to:
A)
B)
C)
D)

0.16.
0.20.
0.23.
0.04.

Question 33

Which value at risk methodology is most subject to model risk?

A)
B)
C)
D)

Parametric.
Variance/covariance.
Historical.
Monte Carlo simulation.

Question 34

Hugo Nelson is preparing a presentation on the attributes of value at risk. Which of Nelsons following
statements is not correct?
VAR can account for the diversified holdings of a financial institution, reducing capital
requirements.
B) VAR(10%) = $0 indicates a positive dollar return is likely to occur on 90 out of 100 days.
VAR(1%) can be interpreted as the number of days that a loss in portfolio value will exceed
C)
1%.
VAR was developed in order to more closely represent the economic capital necessary to
D)
ensure commercial bank solvency.
A)

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Question 35

Which of the following is (are) an advantage(s) of nonparametric methods compared to parametric

methods for quantifying volatility?
I.
II.
III.
IV.

Nonparametric models require assumptions regarding the entire distribution of returns.

Data is used more efficiently with nonparametric methods than parametric methods.
Fat tails, skewness and other deviations from some assumed distribution are no longer a concern
in the estimation process for nonparametric methods.
Multivariate density estimation (MDE) allows for weights to vary based on how relevant the data
is to the current market environment by weighting the most recent data more heavily.
A)
B)
C)
D)

III only.
I and II.
I and III.
III and IV.

Question 36

A $2 million balanced portfolio is comprised of 40 percent stocks and 60 percent intermediate bonds. For
the next year, the expected return on the stock component is 9 percent and the expected return on the
bond component is 6 percent. The standard deviation of the stock component is 18 percent and the
standard deviation of the bond component is 8 percent. What is the annual VAR for the portfolio at a 1
percent probability level if the correlation between the stock and the bond component is 0.25?
A) $303,360.
B) $126,768.
C) $149,500.
D) $152,250.
Question 37

We can transform a simulated distribution of two independent random variables, 1 and 2, into two
random variables with a correlation coefficient of by defining the two outcomes as:
2 1/2
A) 1 = 1 and 2 = 1 + (1- ) 2.
1/2
B) 1 = 1 and 2 = 1 + (1- ) 2.
C) 1 = 1 and 2 = 1 + 2.
1/2
D) 1 = 1 and 2 = 1 + (1- ) 2.
Question 38

VAR estimates based on simulations usually assume a price process to generate the price paths. The
price process often used to approximate equity and foreign exchange securities, which can be
represented by dSt = t Stdt + t Stdzt, is:
A) arithmetic Brownian motion.
B) geometric Brownian motion (GBM).
C) arithmetic Ito motion.
D) lognormal Ito motion.

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Question 39

When conducting a simulation using multiple variables, which of the following are techniques used to
account for correlations between multiple simulated variables?
I. Use principal components to reduce the number of risk factors.
II. Generate a simulated distribution of two variables with a correlation coefficient.
III. Extend the correlation to more than two variables using a Cholesky factorization.
IV. Adjust distributions with positive-definite characteristics using the Cox, Ingersoll, Ross (CIR) model.
A)
I, II, and III only.
B)
II and III only.
C)
II and IV only.
D)
I and II only.

Question 40

Annual volatility: = 20.0%

Annual risk-free rate = 6.0%
Exercise price (X) = 24
Time to maturity = 3 months
Stock price, S

$21.00

$22.00

$23.00

$24.00

$24.75

$25.00

Value of call, C

$0.13

$0.32

$0.64

$1.14

$1.62

$1.80

% Decrease in S

16.00%

12.00%

8.00%

4.00%

1.00%

< >>

% Decrease in C

92.83%

82.48%

64.15%

36.56%

9.91%

< >>

5.80

6.87

8.02

9.14

9.91

< >>

Delta (C% / S%)

Suppose that the stock price is currently at $25.00 and the 3-month call option with an exercise price of
$24.00 is $1.60. Using the linear derivative VAR method and the information in the above table, what is a
5% VAR for the call options weekly return?
A)
B)
C)
D)

50.7%.
43.4%.
45.3%.
21.6%.

Question 41

Consider a study of 100 university endowment funds that was conducted to determine if the funds annual
risk-adjusted returns could be explained by the size of the fund and the percentage of fund assets that
are managed to an indexing strategy. The equation used to model this relationship is:
ARARi = b0 + b1Sizei + b2Indexi + ei
Where:
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Sizei

the average annual risk-adjusted percent returns for the fund i over the 1998= 2002 time period.
= the natural logarithm of the average assets under management for fund i.

Indexi

= the percentage of assets in fund i that were managed to an indexing strategy.

ARARi

The table below contains a portion of the regression results from the study.
Partial Results from Regression ARAR on Size and Extent of Indexing
Coefficients

Standard Error

t-Statistic

Intercept

???

0.55

5.2

Size

0.6

0.18

???

Index

1.1

???

2.1

Part 1)
Which of the following is the most accurate interpretation of the slope coefficient for size? ARAR:
will change by 0.6% when the natural logarithm of assets under management changes by 1.0,
holding index constant.
will change by 1.0% when the natural logarithm of assets under management changes by 0.6,
B)
holding index constant.
and index will change by 1.1% when the natural logarithm of assets under management
C)
changes by 1.0.
will change by 1.1% when the natural logarithm of assets under management changes by 1.0
D)
and index changes by 0.6.
A)

Part 2)
Which of the following is the estimated standard error of the regression coefficient for index?
A) 0.52.
B) 1.91.
C) 2.31.
D) 1.00.
Part 3)
Which of the following is the t-statistic for size?
A) 0.30.
B) 3.33.
C) 0.12.
D) 0.70.
Part 4)
Which of the following is the estimated intercept for the regression?
A) 2.86.
B) 0.11.
C) 9.45.
D) 4.65.

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Part 5)
Which of the following statements is most accurate regarding the significance of the regression
parameters at a 5% level of significance?
The parameter estimates for the intercept are significantly different than zero. The slope
A)
coefficients for index and size are not significant.
The parameter estimates for the intercept and the independent variable size are significantly
B)
different than zero. The coefficient for index is not significant.
None of the regression parameters are significantly different than zero at the 5% level of
C)
significance.
All of the parameter estimates are significantly different than zero at the 5% level of
D)
significance.
Question 42

Consider the following graph of a distribution for the prices of various bottles of champagne.

Which of the following statements regarding the distribution is least accurate?

A)
B)
C)
D)

Point A represents the mode.

The distribution is negatively skewed.
At least 40% of observations fall within 1.3 standard deviations of the mean.
The mean value will be less than the mode.

Question 43

The mean and standard deviation of returns for Stock A is represented below.
Arithmetic Mean

Standard Deviation

20%

8%

Stock A

The coefficient of variation of Stock A is:

A)
B)
C)
D)

0.40
3.00
2.50
0.33

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