Free GARP FRM-Part-2 Exam Questions

Which of the following statements concerning the calculation of value at a node in a fixed-income binomial interest rate tree is most accurate? The value at each node is the:

A portfolio manager at a hedge fund is applying the Merton model to estimate the volatility of a non-dividend-paying firm whose equity shares are held in the fund’s portfolio. The manager conducts preliminary analysis on the firm and obtains the following results:• Value of equity: USD 45 million• Value of the firm’s only debt maturing in 5 years: USD 60 million• d1: 3.217790• d2: 3.038905Assuming a constant volatility of firm value, what is the estimate of that volatility?

The head of the fixed-income department of a bank asks a risk analyst to review anoutstanding bond issued by Company GRN, a livestock producer. The bondcurrently trades at a spread of 250 bps over the risk-free interest rate and has arecovery rate of 75%. Senior management of the bank has expressed concernabout the slowdown in business activities in the livestock industry, which isexpected to last for the next 3 years. The analyst applies the constant hazard rateprocess in estimating default probability and assumes that, under a stressed marketscenario, the bond would trade at a spread of 480 bps over the risk-free interest ratecurve, and its recovery rate would decrease to 40%. Assuming the stress scenarioprevails, what would be the correct estimate of the probability that Company GRNwould not default on its bond over the next 3 years?

A risk manager uses the past 480 months of correlation data from the Dow Jones Industrial Average (Dow) to estimate the long-run mean correlation of common stocks and the mean reversion rate. Based on this historical data, the long-run mean correlation of Dow stocks was 34%, and the regression output estimates the following regression relationship: Y = 0.262 − 0.77X. Suppose that in April 2014, the average monthly correlation for all Dow stocks was 33%. What is the estimated one-period autocorrelation for this time period based on the mean reversion rate estimated in the regression analysis?

In the context of arbitrage trades, if the CDS spread is significantly greater than the bond yield spread, what is the most appropriate action by the investor?