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Financial Risk Manager Introduction

Category Technology
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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

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    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

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    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

$$ FV=PV\lim_{m\rightarrow\infty}(1+\frac{r}{m})^{mn}=PVe^{nr} $$

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

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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
 FRM, Finance
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