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1. EXAMPLE 12.1: FRM EXAM 2000—QUESTION 78 What feature of cash and futures prices tends to make hedging possible? a. They always move together in the same direction and by the same amount. b. They move in opposite directions by the same amount. c. They tend to move together, generally in the same direction and by the same amount. d. They move in the same direction by different amounts. ---------------------------------------------------------------------------------- ANSWER Example 12.1: FRM Exam 2000—Question 78 c) Hedging is made possible by the fact that cash and futures prices usually move in the same direction and by the same amount. ---------------------------------------------------------------------------------- 2. EXAMPLE 12.2: FRM EXAM 2000—QUESTION 79 Under which scenario is basis risk likely to exist? a. A hedge (which was initially matched to the maturity of the underlying) is lifted before expiration. b. The correlation of the underlying and the hedge vehicle is less than one and their volatilities are unequal. c. The underlying instrument and the hedge vehicle are dissimilar. d. All of the above are correct. ---------------------------------------------------------------------------------- ANSWER Example 12.2: FRM Exam 2000—Question 79 d) Basis risk occurs if movements in the value of the cash and hedged positions do not offset each other perfectly. This can happen if the instruments are dissimilar or if the correlation is not unity. Even with similar instruments, if the hedge is lifted before the maturity of the underlying, there is some basis risk. ---------------------------------------------------------------------------------- 3. EXAMPLE 14.1: FRM EXAM 1999—QUESTION 64 Under what circumstances is it appropriate to scale up a VAR estimate from a shorter holding period to a longer holding period using the square root of time? a. It is never appropriate. b. It is always appropriate. c. When either mean reversion or