Table Of ContentPart II FRM® Exam
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Vicee ien
P t
F PART II BooK 4: RisK
MANAGEMENT AND INVESTMENT
MANAGEMENT; CU NT IS SUES IN
RRE
FINANCIAL MA TS
RKE
READING ASSIGNMENTS AND LEARNING OBJECTIVES
v
RISK MANAGEMENT AND INVESTMENT MANAGEMENT
63: Portfolio Construction 1
64: Portfolio Risk: Analytical Methods 13
65: VaR and Risk Budgeting in Investment Management 30
66: Risk Monitoring and Performance Measurement 46
67: Portfolio Performance Evaluation 57
68: Illiquid Assets 79
69: Hedge Funds 93
70: Performing Due Diligence on Specific Managers and Funds 105
CU NT ISSUES IN FINANCIAL MA TS
RRE RKE
71: Forging Best Practices in Risk Management 1 19
72: Case Studies on Disruptions During the Crisis 128
73: Why Do We Need Both Liquidity Regulations and a Lender of Last Resort?
A Perspective From Federal Reserve Lending During the 2007-09 U.S.
Financial Crisis 139
74: Global Financial Markets Liquidity Study 153
75: Reforming LIBOR and Other Financial Market Benchmarks 175
76: Central Counterparties: Addressing Their Too Important to Fail Nature 1 88
77: Stress Testing Convergence 201
78: Cybersecurity 101: A Resource Guide for Bank Executives 208
SELF-TEST: RISK MANAGEMENT AND INVESTMENT MANAGEMENT;
CU NT ISSUES IN FINANCIAL MA TS
222
RRE RKE
FORMULAS
228
APPENDIX
231
INDEX
235
iii
©2016 Kaplan, Inc. Page
FRM 2016 PART II 4: NT AND
BOOK RISK A EME INVESTMENT MANAGEMENT;
MAN G
IN FINANCIAL TS
CURRENT ISSUES
MARKE
©2016 Kaplan, Inc., d.b.a. Kaplan Schweser. All rights reserved.
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PPN: 3200-7218
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Disclaimer: The SchweserNotes should be used in conjunction with the original readings as set forth
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The information contained in these books is based on the original readings and is believed to be
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accurate. However, their accuracy cannot be guaranteed nor is any warranty conveyed as to your ultimate exam
success.
iv ©2016
Page Kaplan, Inc.
READING AS SIGNMENTS AND
LEARNING OBJECTIVES
The following material is a review of the Risk Management and Investment Management, and
Current Issues in Financial Markets principles designed to address the learning objectives set forth
by the Global Association of Risk Professionals.
READING ASSIGNMENTS
Risk Management and Investment Management
Richard Grinold and Ronald Kahn, Active Portfolio Management: A Quantitative
Approach for Producing Superior Returns and Controlling Risk, 2nd Edition (New York:
McGraw-Hill, 2000).
63. "Portfolio Construction," Chapter 14 (page 1)
Philippe ]orion, Value-at-Risk: The New Benchmark for Managi,ng Financial Risk, 3rd
Edition. (New York: McGraw Hill, 2007).
64. "Portfolio Risk: Analytical Methods," Chapter 7 (page 13)
65. "VaR and Risk Budgeting in Investment Management," Chapter 17 (page 30)
Robert Litterman and the Quantitative Resources Group, Modern Investment
Management: An Equilibrium Approach (Hoboken, NJ: John Wiley & Sons, 2003).
66. "Risk Monitoring and Performance Measurement," Chapter 17 (page 46)
Zvi Bodie, Alex Kane, and Alan J. Marcus, Investments, 10th Edition (New York:
McGraw-Hill, 2013).
67. "Portfolio Performance Evaluation," Chapter 24 (page 57)
Andrew Ang, Asset Management: A Systematic Approach to Factor Investing (New York:
Oxford University Press, 2014).
68. "Illiquid Assets," Chapter 13 (page 79)
G. Constantinides, M. Harris and R. Stulz, eds., Handbook of the Economics of Finance,
Volume 2B (Oxford: Elsevier, 2013).
69. "Hedge Funds," Chapter 17 (page 93)
©2016 Kaplan, Inc. Pagev
Book4
Reading Assignments and Learning Objectives
Kevin R. Mirabile, Hedge Fund Investing: A Practical Approach to Understanding Investor
Motivation, Manager Profits, and Fund Performance (Hoboken, NJ: Wiley Finance, 2013).
70. "Performing Due Diligence on Specific Managers and Funds," Chapter 1 1
(page 105)
Current Issues in Financial Markets
71. Paul Glasserman, "Firm-Level Issues in Risk Measurement," Forging Best Practices in
Risk Management (Working Paper #0002, Office of Financial Research, U.S. Department
ofTreasury, 2012).
(page 1 1 9)
72. Tanju Yorulmazer, "Case Studies on Disruptions During the Crisis," FRBNY
Economic Policy Review, 2014. (page 128)
73. "Why Do We Need Both Liquidity Regulations and a Lender of Last Resort? A
Perspective from Federal Reserve Lending During the 2007-09 U.S. Financial Crisis,"
Federal Reserve Board, February 2015. (page 139)
74 . Global Financial Markets Liquidity Study, August 2015. (page 153)
PwC,
75. Darrell Duffie and Jeremy C. Stein, "Reforming LIBOR and Other Financial Market
Benchmarks," Journal of Economic Perspectives 29, no. 2 (Spring 2015): 19 1-212.
(page 175)
76. Froukelien Wendt, "Central Counterparties: Addressing their Too Important to Fail
Nature" (Working paper, International Monetary Fund, 2015). (page 1 88)
77. German Gutierrez Gallardo, Til Schuermann, and Michael Duane, "Stress Testing
Convergence," 2015. (page 201)
78. "Cybersecurity 101: A Resource Guide for Bank Executives," Conference of State
Banking Supervisors, December 2014. (page 208)
©2016 Inc.
Page vi Kaplan,
Book4
Reading Assignments and Learning Objectives
LEARNING OBJECTIVES
63. Portfolio Construction
After completing this reading, you should be able to:
1. Distinguish among the inputs to the portfolio construction process. (page 1)
2. Evaluate the methods and motivation for refining alphas in the implementation
process. (page 1)
3. Describe neutralization and methods for refining alphas to be neutral. (page 2)
4. Describe the implications of transaction costs on portfolio construction. (page 3)
5.
Assess the impact of practical issues in portfolio construction such as determination
of risk aversion, incorporation of specific risk aversion, and proper alpha coverage.
(page 4)
6. Describe portfolio revisions and rebalancing and evaluate the tradeoffs between
5)
alpha, risk, transaction costs and time horizon. (page
7. Determine the optimal no-trade region for rebalancing with transaction costs.
5)
(page
8. Evaluate the strengths and weaknesses of the following portfolio construction
techniques: screens, stratification, linear programming, and quadratic programming.
(page 6)
9. Describe dispersion, explain its causes and describe methods for controlling forms
of dispersion. (page 7)
64. Portfolio Risk: Analytical Methods
After completing this reading, you should be able to:
1. Define, calculate, and distinguish between the following portfolio VaR measures:
individual VaR, incremental VaR, marginal VaR, component VaR, undiversified
portfolio VaR, and diversified portfolio VaR. (page 13)
2. Explain the role of correlation on portfolio risk. (page 14)
3. Describe the challenges associated with VaR measurement as portfolio size increases.
(page 1 8)
4. Apply the concept of marginal VaR to guide decisions about portfolio VaR.
(page 22)
5.
Explain the risk-minimizing position and the risk and return-optimizing position of
a portfolio. (page 22)
6. Explain the difference between risk management and portfolio management, and
describe how to use marginal VaR in portfolio management. (page 23)
VaR
65. and Risk Budgeting in Investment Management
After completing this reading, you should be able to:
1. Define risk budgeting. (page 30)
2. Describe the impact of horizon, turnover and leverage on the risk management
process in the investment management industry. (page 30)
3. Describe the investment process of large investors such as pension funds. (page 31)
4. Describe the risk management challenges associated with investments in hedge
funds. (page 32)
5.
Distinguish among the following types of risk: absolute risk, relative risk, policy
mix risk, active management risk, funding risk and sponsor risk. (page 32)
6. Apply VaR to check compliance, monitor risk budgets and reverse engineer sources
5)
of risk. (page 3
©2016 vii
Kaplan, Inc. Page
Book4
Reading Assignments and Learning Objectives
7. Explain how VaR can be used in the investment process and the development of
investment guidelines. (page 37)
8. Describe the risk budgeting process and calculate risk budgets across asset classes
and active managers. (page 38)
66. Risk Monitoring and Performance Measurement
After completing this reading, you should be able to:
1. Define, compare, and contrast VaR and tracking error as risk measures. (page 46)
2. Describe risk planning, including its objectives, effects and the participants in its
development. (page 4 7)
3. Describe risk budgeting and the role of quantitative methods in risk budgeting.
(page 48)
4. Describe risk monitoring and its role in an internal control environment. (page 48)
5. Identify sources of risk consciousness within an organization. (page 48)
6. Describe the objectives and actions of a risk management unit in an investment
management firm. (page 49)
7. Describe how risk monitoring can confirm that investment activities are consistent
with expectations. (page 50)
8. Explain the importance of liquidity considerations for a portfolio. (page 50)
9. Describe the use of alpha, benchmark, and peer group as inputs in performance
measurement tools. (page 52)
10. Describe the objectives of performance measurement. (page 51)
67. Portfolio Performance Evaluation
After completing this reading, you should be able to:
1. Differentiate between time-weighted and dollar-weighted returns of a portfolio and
describe their appropriate uses. (page 57)
2. Describe and distinguish between risk-adjusted performance measures, such
as Sharpe's measure, Treynor's measure, Jensen's measure Qensen's alpha), and
information ratio. (page 60)
3. Describe the uses for the Modigliani-squared and Treynor's measure in comparing
two portfolios, and the graphical representation of these measures. (page 60)
4. Determine the statistical significance of a performance measure using standard error
and the t-statistic. (page 67)
5. Explain the difficulties in measuring the performance of hedge funds. (page 68)
6. Explain how changes in portfolio risk levels can affect the use of the Sharpe ratio to
measure performance. (page 68)
7. Describe techniques to measure the market timing ability of fund managers with a
regression and with a call option model, and compute return due to market timing.
(page 69)
8. Describe style analysis. (page 71)
9. Describe and apply performance attribution procedures, including the asset
allocation decision, sector and security selection decision and the aggregate
contribution. (page 71)
68. Illiquid Assets
After completing this reading, you should be able to:
1. Evaluate the characteristics of illiquid markets. (page 79)
2. Examine the relationship between market imperfections and illiquidity. (page 80)
3. Assess the impact of biases on reported returns for illiquid assets. (page 81)
©2016 Inc.
Page viii Kaplan,
