Financial Risk Manager Introduction

The Financial Risk Manager (FRM) Certification is the true standard for educational excellence in risk management and a gateway to achieving new career heights in the risk profession.

Key Concepts

Interest Rates

Required Rate of Return

• Required rate of return / 要求回报率 / yield
• Influenced by the supply and demand of funds in the market.
• Represents the return that investors and savers need to convince them to willingly lend their money.
• Typically associated with a specific investment.
• Example: If I deposit my money in a bank, what would the interest rate be?
  • In this case:
  • Interest rate = Required Rate of Return = Real Risk-free Return (真实无风险收益率) + Inflation Rate (通货膨胀收益率)
• Breaking down the required rate of return:
  • Nominal risk-free rate = real risk-free rate + expected inflation rate.
  • Required interest rate on a security = nominal risk-free rate + default risk premium + liquidity risk premium + maturity risk premium.

Discount Rate

• Discount rate / 折现率
• This is the interest rate used to discount future payments.
• It is often used interchangeably with the term “interest rate”.
• Depending on the situation, “interest rate” can have different names:
  • Example 1: I deposit $100 in a bank for one year and receive a 10% interest rate. After one year, I have 110.
    • In this scenario, the 10% interest rate is referred to as the 10% Required Rate of Return.
  • Example 2: I want to have $10 after one year. If the interest rate is 10%, how much should I deposit in the bank? Using the formula (x+10)/(1+10%) = x, we find x = 100.
    • In this scenario, the 10% interest rate is referred to as the 10% Discount Rate.

Opportunity Cost

• Opportunity cost / 机会成本
• This can be seen as a type of interest rate. It represents the value that investors give up when they choose a particular course of action.

Basic Calculation

Future Value (FV)

• Amount to which investment grows after one or more compounding periods

Present Value (PV)

• Current value of some future cash flow

• If interests are compounded m times per year, and invest 1 year:

  $$FV=PV(1+\frac{r}{m})^m$$

• If interests are compounded m times per year, and invest n years:

  $$FV=PV(1+\frac{r}{m})^{mn}$$

  Where:

  m is the compounding frequency;

  r is the nominal / quoted annual interest rate

Simple Interest

• Simple Interest / 单利

• Interest is compounded annually at 10% per annum

• sequenceDiagram
  	Note over Start Deposit: PV = 100$
      Start Deposit->>First Year End: 10%
      Note over First Year End: 100+100*10%
      First Year End->>Second Year End: 10%
      Note over Second Year End: FV = 100+100*10%*2
  

•   
      sequenceDiagram
      	Note over Start Deposit: PV = 100$
          Start Deposit->>First Year End: 10%
          Note over First Year End: 100+100*10%
          First Year End->>Second Year End: 10%
          Note over Second Year End: FV = 100+100*10%*2
    
      
  

Compound Interest

• Compound Interest / 利滚利

• Interest is compounded annually at 10% per annum

• sequenceDiagram
  	Note over Start Deposit: PV = 100$
      Start Deposit->>First Year End: 10%
      Note over First Year End: 100*(1+10%)
      First Year End->>Second Year End: 10%
      Note over Second Year End: FV = 100*(1+10%)^2
  

• 
      sequenceDiagram
      	Note over Start Deposit: PV = 100$
          Start Deposit->>First Year End: 10%
          Note over First Year End: 100*(1+10%)
          First Year End->>Second Year End: 10%
          Note over Second Year End: FV = 100*(1+10%)^2
  
      
  

Continuously Compounding:

• Interest is compounded m times per year at an annual rate of r%, then after n years

Annuity

• Annuity / 年金
• Annuity is a stream of equal cash flows that occurs at equal intervals over a given period
• Classify:
  • Annuity due - 先付年金(年初支付)
  • Ordinary annuity - 后付年金(年末支付)

Framework of FRM Program

Outline

PART Ⅰ

1. Foundations of Risk Management 风险管理基础(20%)
   • 基础知识，学完其他三门基本掌握该部分知识
2. Quantitative Analysis 数量分析(20%)
   • 金融：在不确定的情况下，资产的跨期配置
   • 概率论和统计学
3. Financial Markets and Products 金融市场与金融产品(30%)⭐
   • Part Ⅰ 3/4 是二级市场分险的基础
   • Part Ⅰ 3/4 最好放在一起学习
4. Valuation and Risk Models 估值与风险建模(30%)⭐

PART Ⅱ

1. Market Risk Measurement and Management 市场分险测量与管理(25%)
2. Credit Risk Measurement and Management 信用分险测量与管理(25%)
3. Operational and Integrated Risk Management 操作及综合风险管理(25%)
4. Risk Management and Investment Management 投资风险管理(15%)
5. Current Issues in Financial Markets 金融市场前沿话题(10%)

PART Ⅰ

Foundations of Risk Management

1. Risk Management (Best practice)⭐
   • Risk management and Corporate Governance Perspective
   • Implementing Risk Appetite Frameworks
   • Principles for Effective Data Aggregation and Risk Reporting
   • Risk Management Failures
2. Capital Asset Pricing Model (Theory)⭐⭐⭐
   • The Standard Capital Asset Pricing Model
   • Arbitrage Pricing Theory and Multifactor Models of Risk and Return
   • Applying the CAPM to Performance Measurement
3. Information Risk and Data Quality Management
4. Financial Disasters⭐⭐
5. The Credit Crisis of 2007
6. GARP Code of Conduct

Risk

• Definition of Risk
  • Risk is defined as the unexpected variability of asset prices and/or earnings. It is a mix of danger and opportunity
• Sources of Risk
  • Business risk is the risk that a firm is subjected to during daily operations and includes the risks that result from business decisions and the business environment
  • Financial risks are the results of a firm’s financial market activities

Quantitative Analysis

1. Probability
2. Basic Statistics
3. Distributions
4. Hypothesis Tests and Confidence Intervals
5. Linear Regression
   • Linear Regression with One Regressor
   • Linear Regression with Multiple Regressors
6. Simulation Modeling⭐
7. Estimating Volatilities and Correlations⭐
8. Correlation and Copulas

Financial Markets and Products

1. Derivative Contract
   • Structure and mechanics of OTC and exchange markets
   • Structure, mechanics, and valuation of Derivative Contracts
     • Forwards, Futures and Swaps
     • Options
   • Hedging wit derivatives
2. Financial Product (Fixed Income)
   • Interest rates and measures of interest rate sensitivity
   • Foreign exchange risk
   • Corporate bonds
   • Mortgage-backed securities
   • Rating agencies

Valuation and Risk Models

1. Valuation
   • Option valuation
   • Fixed income valuation
2. Risk Models
   • Value-at-Risk (VaR)
   • Expected shortfall (ES)
   • Stress testing and scenario analysis
3. Risk Management
   • Hedging
   • Country and sovereign risk models and management
   • External and internal credit ratings
   • Expected and unexpected losses
   • Operational risk