Friday, December 9, 2011

FRM Level 1 & 2: Strategy

FRM Levels  1&2  Strategy

Abstract: This article will be about the strategies and areas of FRM for the FRM exam. Strategy to crack both exams on the same day in one go, or a single.

Free recordings on FRM Part 2 -

Introduction: If you have registered for the FRM exam then this post will talk about some strategies you should take.

FRM 1:

Tough areas that are important for exam are:
  • Cheapest to deliver.
  • Bound quotation and how to use the conversion factor and other things in cheapest to deliver the entire concept.
  • Euro Dollar Futures.
  • Beta changing and hedge effectiveness using index futures.
  • Stack and Roll strategy.
  • Areas of 2nd Level when comes in First level like MBS duration (from old question bank).
  • Pension funds based long questions on liabilities and asset movements.
  • Most of the people who give this exam are very prepared and professional and each question count in this exam.

Hence It is all about exam management.

I will be developing hybrid questions which can be helpful which are 2 times as tough as the real exam where I will try to use real data:
  1. EMWA + GARCH on real data.
  2. Portfolio Management (taken from CFA L3, sortorio, information ratio, etc)..
  3. Regression based on ab initio methods (summations rules).
  4. More complex swaps, floating rate vs. fixed.
  5. Unexpected loss mixed with other's areas (and with junk data).
  6. Bigger portfolio for VAR Calculations.
  7. Multiple regression for more beta and many regression equations build on data.
  8. Questions which taken into detail Brownian motion in a more detailed way of delta-t.
  9. Greeks Management including many options and Vega+Gamma hedge using options and shares (book talks very simple questions about them).
  10. Cheapest to deliver derivations on how it all came into existence.
  11. All stories of fraud in risk management.
  12. Real case studies on Stack and Strip hedge in commodities.
  13. 1 and 2 error and hypothesis testing in more detail.
  14. Margin and maintenance variation calls and namings.
  15. Expected loss formula and the derivation of unexpected loss.
  16. convexity basic problem using common numbers.
  17. calculator advanced functions.
  18. memory cards for FRM, and mind maps.
Similar to this, these are areas of the CFA exam which are seen here so for those who are giving both exams can focus on:
  1. Types 1 and 2 errors.
  2. Hypothesis testing of non zero.
  3. Chi square test.
  4. Bayes theorem.
  5. Hardcore theory questions in corporate Finance.

Getting info about Valuation at risk models and foundation of risk management.

  1. We can start with the easiest topic "Foundation of Risk Management", which is nearly one-fourth of the exam. I will read the last few chapters i.e. ERP, Financial disaster, failures, GARP conduct codes.
  2. Quantitative part is simple, so this can be done easily.
  3. Financial Markets and product are the heart and soul of the exam respectively. It is mostly made up of derivatives.
  4. Valuation and Risk model is again theoretical and easy.
The only thing in FRM Level 1 which gives me trouble is the distributions where using and applying them is very important to understand the essence of the subject. Pareto, Beta, Extreme value, Weibull are some which are tough to understand and requires some patience. 

Foundation of Risk Management can be divided into 4 major blocks:
  1. MPT.
  2. APT Arbitrage pricing theory vs. CAPM is an important area to understand.
  3. Risk and failures.
  4. GARP Code.
This is also the most easy and scoring one.

Financial Markets and product are the toughest as well as most important part of the FRM. There are many things that gives a lot of resistance in this area to those who have not studied any of this part before, but I will be sharing all what I can on this area.
  1. Interest rate instruments options, swaps.
  2. Stock options are very easy.
  3. Commodity is easy but new.
In total, this is the most fascinating area, and most difficult.

Valuation and Risk Models

Now this chapter is very important in terms of models like Black-Scholes, binomial and other important models for valuations. When I was doing it, the most interesting was the subject of Greeks in options. It took some time to get things in. The best part about this part of FRM is that you can read more and more and understand as there is a lot of depth attached to this area. For example, the derivation from Kinetic theory gases, stochastic calculus of blacks-scholes.

Quantitative Techniques is similar to all other Quant you might have done in CFA, Engineering, Modeling so it will be skipped in my discussions.

FRM Level 1 Nov 2012 Strategy
Level 2 of FRM has been talked about very less in all forums and blogs. I will be taking about some of the course material.

Resources: Readings Core (1444 pages old of 2009), Handbook for FRM (800 pages), Scz (book and questions).

No Videos on Youtube: There were no videos on youtube so I will add videos on the same in 1 month. Bionic still remains only option.

Core Reading: Are from various books, also see the AIM statements. Does not have a lot of questions.

Research Areas: How did these distributions came into play: F stat, t sats, Chi... these three are to be known by common sense and as well from their roots. comparing variance of 2 population and formula derivation of chi-square distribution. Derivation of standard error and that root term in denominator. How and when did DoF started and how it is imp? Derivation of integration of variance formula with the denominator 12, how to convert that limit into integration? Story of Normal distribution.

Book to check out: Jogn Hull, chap. 11.

FRM Part 2: No idea about Part 2 as still looking at the resources for the exam. I saw the model papers of 2011 and 2010 and the Level 2 was very different. Questions were:
  • Theoretical and broad
  • Longer and detailed
  • Has many statements and we have to select the right combinations
  • Less Quant
  • Checking good broad knowledge
  • Requires experience and consistent reading habits
Based on these parameters you can understand that Part 2 is more about theory than quant, but this is my view based on 3-4 papers I have seen and read on internet.

There are 63 Chapters in the readings which are taken from various books. Interesting areas and overlap:
  1. Operations Risk and Sarbanes Oxleys Act (Allied areas have 25% weightage).
  2. Portfolio (maths at Level 2).
  3. MBS mortgage back securities (may be Quant).
  4. Credit Risk Quant is an imp area that is quite fun.
Reading in general and watching generic lectures will help. There is no Quant in L-2 which I was expecting.

In last 2 months you can plan to study for Operation Risk in FRM-2 and Foundations of RM in FRM-1.

Strategy for FRM is to:

Step 1: Read summary or key concepts.
Step 2: Videos youtube.
Step 3: Content of scz.
Step 4: Studying the book.
Step 5: Doing questions.

Topics for each month (FRM Level 1):

4th last 2012: VAR and Valuation and risk models.
3rd last 2012: Foundations of Risk.
2nd last 2012: Financial Market and Products.
last 2012: Quantitative techniques.

Summary of interesting things in var valuation and risk models (FRM Level 1) related to Quant:
  1. Single step binomial trees and risk neutral method.
  2. e to power sd*root(t).
  3. Delta hedging.
  4. Coherent Risk.
  5. Worst case distributions.
  6. 7 Distributions.
Tough areas that I find very interesting:
  1. Interest rate swap and 2 methods.
  2. Brownian Motion and monte carlo simulations.
  3. Formulas of Green that are derived from Black Scholes.
  4. Euro Dollar futures.
  5. Inverse normal distributions, random number generations, selecting number from 0-1 in random fashion and then taking inverse normal methods.
  6. Floating rate adjustment.
  7. Poisson distribution derivations.
  8. Merton Model for Credit.
FRM Level 2

Quantitative Areas in FRM Level 2

Copulas is an area that I came across which was followed by extreme value theorem and Pareto distribution. Then there is a much talked about VAR back testing. These are few things that you should research in general and read from wiki.

FRM from Kaplan:

The Book 2 of Scz on FRM Level is very easy, whereas the last 3 chapters of book 1 (on VAR) are toughest in the entire FRM Level 1. Some areas of book 1 especially VAR, the 3 chapters help you to get Level 2 and you should look at Level 2 to understand them more even while giving Level 1 to get them inside your brains.

Future Work: I will introduce to you tricky but interesting area and try to develop some motivation for you to study them. Because to study these areas you need to have some pre- idea, motivations, real examples, news items so that you can create right mental frame to study them. The exam is very simple if you work on the things systematically and ready to spend some time.

Important links to read from Wikipedia for FRM level 2:

Operation Risk

MBS, cdo and all types teaching securitization etc.

Correlation and Copula

Operation risk

Jensons Aplha and information ratio CAPM revision.
KMV model not on wiki.
Crediting scoring model.
Trading gamma (interview question).
Fixed income arbitrage.
Portfolio of CFA and FRM are same.


Please contact at in case of any suggestions or feedback.

Raw List of Interesting and core areas to search online are:
  1. Hypothesis testing.
  2. delta of option.
  3. Different distribution.
  4. degree of freedom.
  5. Greeks and partial derivatives.
  6. Monte carlo simulation.
  7. black scholes model.
  8. Boot strapping and spot rates.
  9. Regression and beta.
  10. Put call parity.
  11. types of duration.
  12. calculator mastery.
  13. currency.
  14. correlation matrix.
  15. technical analysis.
  16. Black Swarm (Movie and book).
  17. VB and excel modeling for Risk.
  18. Poisson and pareto distribution.
  19. Dollar value.
  20. LTCM Russian default.
  21. Interest for AAA AA A.
  22. UBS false trading of billion.

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