FRM (Financial Risk Manager) Financial Markets and Products (Part I) Syllabus

Financial Markets and Products (Part I) syllabus — full chapter and topic list

Expand any chapter to see its topics and sub-topics. This is the whole examinable outline for Financial Markets and Products (Part I) in FRM (Financial Risk Manager), not a summary of it.

1. 1

   Derivatives Markets and Futures

   4 topics

   • Structure of Derivatives Markets
     • Exchange-traded vs. OTC markets
     • Central clearing and counterparties
   • Forwards and Futures Mechanics
     • Margin accounts and marking to market
     • Convergence of futures to spot
   • Hedging with Futures
     • Minimum variance hedge ratio
     • Basis risk and cross-hedging
   • Pricing Forwards and Futures
     • Cost-of-carry model
     • Contango and backwardation
2. 2

   Interest Rates and Fixed Income

   4 topics

   • Interest Rate Conventions
     • Compounding frequencies and continuous compounding
     • Spot, forward, and par rates
   • Bond Pricing and Yields
     • Yield to maturity and discount factors
     • Term structure of interest rates
   • Bond Risk Measures
     • Duration and modified duration
     • Convexity and DV01
   • Rate-Linked Products
     • Forward rate agreements
     • SOFR and reference rate transition
3. 3

   Swaps and Options

   4 topics

   • Interest Rate and Currency Swaps
     • Swap valuation and cash flows
     • Comparative advantage argument
   • Option Fundamentals
     • Calls, puts, moneyness, and payoffs
     • Put-call parity
   • Option Trading Strategies
     • Spreads, straddles, and strangles
     • Covered calls and protective puts
   • Exotic Options
     • Asian, barrier, and lookback options
4. 4

   Commodities, Currencies and Corporate Bonds

   4 topics

   • Commodity Forwards and Futures
     • Convenience yield and storage costs
     • Lease rates
   • Foreign Exchange Risk
     • Covered and uncovered interest rate parity
     • Currency exposure and hedging
   • Corporate Bonds and Credit
     • Credit ratings and spreads
     • Default and recovery rates
   • Mortgages and Securitized Products
     • Prepayment risk
     • Pass-through securities

Financial Markets and Products (Part I) flashcards for FRM (Financial Risk Manager)

25 of 51 cards from the Financial Markets and Products (Part I) deck — real questions with worked answers.

1. What are the two broad categories of derivatives market structure, and how do they differ in standardization?

   Exchange-traded markets (standardized contracts, fixed sizes/maturities, traded on an exchange) and over-the-counter (OTC) markets (customized, bilaterally negotiated contracts traded directly between parties).

2. List three key advantages of exchange-traded markets over OTC markets.

   Standardization (liquidity and easy offset), a central clearinghouse that guarantees performance (low counterparty/credit risk), and price transparency.

3. List two key advantages of OTC markets over exchange-traded markets.

   Customization of contract terms (size, maturity, underlying) to exactly match hedging needs, and access to instruments not available on exchanges.

4. In central clearing, what role does a central counterparty (CCP) play?

   The CCP becomes the buyer to every seller and the seller to every buyer (novation), guaranteeing performance and mutualizing counterparty credit risk; it collects margin from members.

5. How did post-2008 regulation (e.g., Dodd-Frank) change OTC derivatives clearing?

   It mandated that standardized OTC derivatives be cleared through central counterparties (CCPs) to reduce systemic counterparty risk, replacing purely bilateral clearing.

6. Define a forward contract.

   A private OTC agreement to buy or sell an asset at a specified future date for a price (the delivery/forward price) agreed today; no cash changes hands at initiation.

7. Define a futures contract and state how it differs from a forward.

   A futures contract is a standardized, exchange-traded agreement to buy/sell an asset at a future date. Unlike a forward, it is marked to market daily, requires margin, is cleared through a clearinghouse, and is highly standardized.

8. What is the payoff at maturity of a long forward/futures position with delivery price $K$ and terminal spot price $S_T$?

   $$\text{Payoff}_{\text{long}} = S_T - K$$ The short position payoff is $K - S_T$.

9. What is an initial margin in a futures account?

   The amount a trader must deposit with the broker when opening a futures position, serving as collateral against potential losses.

10. What is the maintenance margin, and what happens when the balance falls below it?

    A threshold (below initial margin) that the account balance must not drop below. If it does, a margin call is issued and the trader must deposit a variation margin to restore the balance to the initial margin level.

11. Explain marking to market in futures.

    At the end of each trading day, gains and losses are credited or debited to each trader's margin account based on the daily settlement price change, so contracts are effectively settled daily.

12. For a long futures position, what is the daily change in the margin account balance?

    $$\Delta \text{Balance} = (F_{t} - F_{t-1}) \times N \times Q$$ where $F$ is the futures price, $N$ the number of contracts, and $Q$ the contract size (negative of this for a short).

13. What is the convergence property of futures prices?

    As the delivery date approaches, the futures price converges to the spot price of the underlying; at expiration $F_T = S_T$ (otherwise arbitrage exists).

14. Why must the futures price equal the spot price at expiration?

    At delivery the futures contract is equivalent to buying the asset immediately; any gap between $F_T$ and $S_T$ would create a riskless arbitrage profit, so $F_T = S_T$.

15. Distinguish a long hedge from a short hedge.

    A short hedge (sell futures) protects against a fall in the price of an asset you own or will sell. A long hedge (buy futures) protects against a rise in the price of an asset you plan to buy.

16. Define basis in the context of hedging.

    $$\text{Basis} = S - F$$ the spot price of the asset being hedged minus the futures price; basis risk arises when this relationship is uncertain.

17. What causes basis risk?

    Mismatch between the hedge and exposure: differences in the asset vs. the futures underlying (cross-hedge), differences in maturity/delivery dates, or uncertainty in the spot-futures relationship over time.

18. What is a cross hedge?

    Hedging an exposure using a futures contract whose underlying asset differs from the asset being hedged (e.g., hedging jet fuel with crude oil futures), introducing additional basis risk.

19. State the formula for the minimum variance hedge ratio $h^{*}$.

    $$h^{*} = \rho \, \frac{\sigma_{S}}{\sigma_{F}}$$ where $\rho$ is the correlation between spot and futures price changes, $\sigma_S$ the std. dev. of spot changes, and $\sigma_F$ that of futures changes.

20. How does the minimum variance hedge ratio relate to a regression of spot changes on futures changes?

    $h^{*}$ equals the slope coefficient ($\beta$) of a regression of changes in the spot price ($\Delta S$) on changes in the futures price ($\Delta F$).

21. What is the hedge effectiveness in a minimum variance hedge?

    It is the proportion of variance of the hedged position's value eliminated, equal to $\rho^{2}$ (the $R^{2}$ of the spot-on-futures regression).

22. What is the optimal number of futures contracts $N^{*}$ for a hedge?

    $$N^{*} = h^{*} \, \frac{Q_{A}}{Q_{F}}$$ where $Q_A$ is the size of the position being hedged and $Q_F$ is the size of one futures contract.

23. State the cost-of-carry model for the forward price of an investment asset paying no income.

    $$F_{0} = S_{0} \, e^{rT}$$ where $S_0$ is the spot price, $r$ the continuously compounded risk-free rate, and $T$ the time to maturity.

24. State the forward price formula for an asset providing a known continuous dividend/convenience yield $q$.

    $$F_{0} = S_{0} \, e^{(r - q)T}$$

25. State the forward price formula for an asset providing known discrete income with present value $I$.

    $$F_{0} = (S_{0} - I)\, e^{rT}$$ where $I$ is the present value of income (e.g., dividends or coupons) paid during the contract's life.

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