Book 1: Foundations of Risk Management SchweserNotes™ 2020 FRM Part I FRM_P1B1_book.indb 3 1/17/2020 3:02:52 PM FRM 2020 PART I BOOK 1: FOUNDATIONS OF RISK MANAGEMENT ©2020 Kaplan, Inc. All rights reserved. Published in 2020 by Kaplan, Inc. Printed in the United States of America. ISBN: 978-1-07-880179-9 Required Disclaimer: GARP® does not endorse, promote, review, or warrant the accuracy of the products or services offered by Kaplan Schweser of FRM® related information, nor does it endorse any pass rates claimed by the provider. Further, GARP® is not responsible for any fees or costs paid by the user to Kaplan Schweser, nor is GARP® responsible for any fees or costs of any person or entity providing any services to Kaplan Schweser. FRM®, GARP®, and Global Association of Risk ProfessionalsTM are trademarks owned by the Global Association of Risk Professionals, Inc. These materials may not be copied without written permission from the author. 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FRM_P1B1_book.indb 4 1/17/2020 3:02:52 PM CONTENTS Welcome to the 2020 SchweserNotes™ ........................................................................viii Learning Objectives and Reading Assignments ............................................................. x READING 1 The Building Blocks of Risk Management ................................................1 Exam Focus .............................................................................................................................1 Module 1.1: Introduction to Risk Management .............................................................. 1 Module 1.2: Types of Risk ....................................................................................................9 Key Concepts ........................................................................................................................16 Answer Key for Module Quizzes ......................................................................................18 READING 2 How Do Firms Manage Financial Risk? ...................................................21 Exam Focus ...........................................................................................................................21 Module 2.1: Corporate Risk Management .....................................................................21 Module 2.2: Risk Management Methods and Instruments .......................................30 Key Concepts ........................................................................................................................36 Answer Key for Module Quizzes ......................................................................................38 READING 3 The Governance of Risk Management ...................................................39 Exam Focus ...........................................................................................................................39 Module 3.1: Corporate Governance and Risk Management ....................................39 Module 3.2: Risk Governance Implementation ............................................................46 Key Concepts ........................................................................................................................52 Answer Key to Module Quizzes ........................................................................................54 READING 4 Credit Risk Transfer Mechanisms ...........................................................57 Exam Focus ...........................................................................................................................57 Module 4.1: Credit Risk Transfer and Mitigation ..........................................................57 Key Concepts ........................................................................................................................65 Answer Key for Module Quizzes ......................................................................................66 READING 5 Modern Portfolio Theory and Capital Asset Pricing Model .................67 Exam Focus ...........................................................................................................................67 Module 5.1: Modern Portfolio Theory and the Capital Market Line .......................67 Module 5.2: Deriving and Applying the Capital Asset Pricing Model ......................71 Module 5.3: Performance Evaluation Measures ..........................................................77 Key Concepts ........................................................................................................................83 Answer Key for Module Quizzes ......................................................................................85 ©2020 Kaplan, Inc. Page v FRM_P1B1_book.indb 5 1/17/2020 3:02:53 PM Contents READING 6 The Arbitrage Pricing Theory and Multifactor Models of Risk and Return .........................................................................................................87 Exam Focus ...........................................................................................................................87 Module 6.1: Multifactor Model Assumptions and Inputs ..........................................87 Module 6.2: Applying Multifactor Models ......................................................................90 Key Concepts ........................................................................................................................96 Answer Key for Module Quizzes ......................................................................................97 READING 7 Principles for Effective Data Aggregation and Risk Reporting.............99 Exam Focus ...........................................................................................................................99 Module 7.1: Data Quality, Governance, and Infrastructure ......................................99 Module 7.2: Risk Data Aggregation and Reporting Capabilities ............................ 105 Key Concepts ..................................................................................................................... 114 Answer Key for Module Quizzes ................................................................................... 116 READING 8 Enterprise Risk Management and Future Trends ...............................117 Exam Focus ........................................................................................................................ 117 Module 8.1: Enterprise Risk Management ................................................................. 117 Module 8.2: Risk Culture and Scenario Analysis ....................................................... 122 Key Concepts ..................................................................................................................... 129 Answer Key for Module Quizzes ................................................................................... 131 READING 9 Learning from Financial Disasters ........................................................133 Exam Focus ........................................................................................................................ 133 Module 9.1: Case Studies on Interest Rate Risk, Liquidity Risk, and Hedging Strategy ............................................................................................................... 134 Module 9.2: Case Studies on Model Risk and Rogue Trading ............................... 139 Module 9.3: Case Studies on Financial Engineering, Reputation Risk, Corporate Governance, and Cyber Risk ...................................................................... 144 Key Concepts ..................................................................................................................... 149 Answer Key for Module Quizzes ................................................................................... 151 READING 10 Anatomy of the Great Financial Crisis of 2007-2009 ..........................153 Exam Focus ........................................................................................................................ 153 Module 10.1: The Financial Crisis of 2007–2009 ...................................................... 153 Key Concepts ..................................................................................................................... 159 Answer Key for Module Quizzes ................................................................................... 160 READING 11 GARP Code of Conduct ...........................................................................161 Exam Focus ........................................................................................................................ 161 Module 11.1: GARP Code of Conduct .......................................................................... 161 Answer Key for Module Quizzes ................................................................................... 167 Page vi ©2020 Kaplan, Inc. FRM_P1B1_book.indb 6 1/17/2020 3:02:53 PM Contents Formulas ............................................................................................................................