Financial Markets and Products: FRM® Part I
It is 30% of the 2026 Part I exam. 160+ learning outcomes across 20 learning modules.
Banks
- Name the principal risks that banks face and show how each of them comes about.
- Contrast economic capital with regulatory capital in terms of what each is and how it is used.
- Outline the regulatory capital rules set by the Basel committee together with the reasons behind them.
- Show how the existence of deposit insurance creates a moral hazard problem.
- Lay out how an investment bank can raise funds through a Dutch auction, a firm commitment, best efforts, a public offering or a private placement.
- Identify where the commercial banking, securities services and investment banking arms of a bank may have conflicts of interest, and recommend ways to resolve them.
- Distinguish a bank's banking book from its trading book.
- Explain the way the originate-to-distribute model of banking operates and discuss what it gains and what it costs.
Insurance Companies and Pension Plans
- Outline the main features of each category of insurance company and name the risks insurers are exposed to.
- Show how mortality tables are used and work out the premium that a policy holder pays.
- Distinguish mortality risk from longevity risk and outline ways of hedging each.
- Contrast defined benefit plans with defined contribution plans, setting out how they differ.
- Contrast the different kinds of life insurance policy.
- Derive and interpret four performance measures for a property-casualty insurer: the loss, expense, combined and operating ratios.
- Outline the moral hazard and adverse selection risks insurers face, give an example of each, and set out how insurers can counter them.
- Assess what capital a life insurer and a property-casualty insurer must hold.
- Compare insurers with banks in respect of the guaranty system and the regulatory requirements each faces.
Fund Management
- Tell apart exchange-traded funds (ETFs), closed-end mutual funds and open-end mutual funds.
- Recognise and outline the trading behaviours at mutual funds that are undesirable.
- Describe how an open-end mutual fund's share price is linked to its net asset value (NAV).
- Set out the main ways in which hedge funds differ from mutual funds.
- Determine what a hedge fund investment returns, and describe how the fund's incentive fee is set up, with reference to the hurdle rate, high-water mark and clawback.
- Name the risks hedge funds run and describe their strategies, which are managed futures, global macro, emerging markets, fixed income arbitrage, convertible arbitrage, merger arbitrage, distressed securities, dedicated short and long-short equity.
- Outline the performance characteristics of mutual funds and hedge funds, and describe how measurement biases distort the assessment of performance.
Introduction to Derivatives
- State what derivatives are, outline their features and uses, and contrast linear derivatives with non-linear ones.
- Outline how exchange-traded and over-the-counter markets work and weigh the pros and cons of each.
- Distinguish option contracts from forward contracts and futures contracts.
- Recognise the payoffs on option and forward contracts and compute them.
- Distinguish hedgers, speculators and arbitrageurs as broad categories of trader.
- Work out and contrast the payoffs of hedging strategies built on forward contracts versus those built on options.
- Work out and contrast the payoffs of speculative positions taken with futures versus those taken with options.
- Outline the strategy arbitrageurs follow and compute an arbitrage payoff.
- Outline the risks that can result from using derivatives.
Exchanges and OTC Markets
- Outline how exchanges help to reduce counterparty risk.
- Explain the clearing developments that have lowered risk.
- Define netting and walk through how a netting process operates.
- Outline how a margining process is put into practice and compute initial and variation margin requirements.
- Outline how stock is bought on margin when no CCP is involved and compute the margin requirements.
- Contrast exchange-traded markets with OTC markets and outline what each is used for.
- Spot the risks attached to OTC markets and set out ways to mitigate them.
- Weigh collateralization as practised in OTC trading against the margining system, covering the role it plays there.
- Account for the way special purpose vehicles (SPVs) come into play in OTC derivatives dealings.
Central Clearing
- Outline what characterises a central counterparty (CCP) and how it operates.
- Outline what CCPs do and set bilateral clearing against centralized clearing.
- Outline the benefits and costs of centrally clearing OTC derivatives.
- Describe the regulatory initiatives that have targeted OTC derivatives and what they mean for central clearing.
- Compare the margin requirements of bilateral markets with those of centrally cleared markets, and show how margin helps mitigate risk.
- Compare how netting operates in centrally cleared markets and in bilateral ones.
- Evaluate what central clearing means for financial markets more broadly.
- Name the kinds of risk that CCPs face and explain each.
- Name the risks borne by clearing members and those borne by non-members, and distinguish between the two.
Futures Markets
- Define a futures contract and its key specifications, covering delivery, limits, open interest, trading volume, contract size and price, and the underlying asset.
- Explain why futures prices and spot prices converge.
- State the function an exchange performs when futures are transacted.
- Outline how delivery of the underlying works, and set it against cash settlement.
- Describe and compare the various order types used in trading.
- Describe how marking to market is applied to futures, along with hedge accounting.
- Contrast forward contracts with futures contracts, noting similarities and differences.
Using Futures for Hedging
- Define long hedges and short hedges, distinguish them, and identify when each is suitable.
- Discuss the case for hedging and the case against it, including any effect hedging has on a firm's profitability.
- Define the basis and compute it, then discuss where basis risk comes from and why it arises when futures are used as the hedge.
- Explain what a cross hedge is, compute its hedge ratio and interpret how effective the hedge is.
- Compute the profit or loss on a long hedge or a short hedge.
- Derive the number of futures contracts that best hedges an exposure, and clarify how tailing the hedge adjusts that number, including how to compute it.
- Describe how stock index futures can be used to alter the beta of a stock portfolio.
- Describe how a stack-and-roll strategy builds a long-term hedge and outline the risks it brings.
Foreign Exchange Markets
- Tell bid exchange rates from ask exchange rates, and describe how foreign exchange quotes work for the spot, forward and futures markets.
- Compute a bid-ask spread and explain why spot quotes and forward quotes may carry different spreads.
- Compare swap transactions with outright (forward) transactions.
- Define transaction risk, translation risk and economic risk and compare them with one another.
- Illustrate transaction, translation and economic risks with examples and explain how to hedge each one.
- Explain the reasoning behind hedging several currencies at once using options.
- Name the factors behind exchange rate determination and explain how they operate.
- Compute and explain what happens when one currency appreciates or depreciates against another.
- Explain the purchasing power parity theorem and apply it to work out a foreign currency's appreciation or depreciation.
- Describe how nominal interest rates relate to real interest rates.
- Explain why the interest rate parity theorem follows from a non-arbitrage assumption in foreign exchange markets, and use it to compute forward exchange rates.
- Distinguish covered interest rate parity from uncovered interest rate parity.
Pricing Financial Forwards and Futures
- Describe financial assets and state what the term means.
- Explain what short-selling means and determine the net profit when a dividend-paying stock is sold short.
- Explain how forward contracts and futures contracts differ, and how forward prices relate to spot prices.
- Obtain the forward price from an asset's spot price, and outline the arbitrage reasoning that links the two prices.
- Contrast a forward contract's value with its forward price.
- Value a forward on a financial asset in two cases: when the asset generates income or yield and when it generates none.
- Explain how forward prices relate to futures prices.
- Determine what a stock index futures contract is worth, and describe how index arbitrage works.
Commodity Forwards and Futures
- Explain how commodities differ in key respects from financial assets.
- State what storage costs, carry markets, the lease rate and convenience yield mean, and apply these concepts to commodities.
- Name the influences on the prices of agricultural, metal and energy commodities and of weather derivatives.
- Set out the formula by which commodity forwards are priced.
- Walk through an arbitrage trade using commodity forwards and compute the profit that could be earned.
- Show how the lease rate sets the no-arbitrage values of futures and forwards on commodities, and define the lease rate.
- Work through the cost of carry model to see how commodity forward prices and no-arbitrage bounds respond to convenience yields and to storage costs.
- Find a commodity's forward price when storing it costs money.
- Explain how a synthetic commodity position is built, then use it to account for how the forward price relates to the future spot price that is expected.
- Explain how a commodity's current futures price and expected future spot price are affected by systematic risk and by nonsystematic risk.
- Define normal backwardation and contango and interpret each.
Options Markets
- Describe the types of option and what they are used for, and define moneyness.
- Work out the profit and loss on a position in options, using the payoff function to explain it.
- Explain how a stock option's terms may be altered by dividends and stock splits.
- Explain how exchange-traded options are subject to commissions, margin requirements and exercise procedures, and what characterises how they trade.
- Explain what employee stock options, convertible bonds and warrants are.
Properties of Options
- Name the six factors that influence the price of an option.
- Determine the upper and lower bounds for option prices, whether the underlying stock pays dividends or not.
- Explain put-call parity, then apply it when valuing American and European stock options (paying dividends or not), including its expression through forward prices.
- Explain and assess the possible reasons for exercising American call and put options early.
Trading Strategies
- Account for what would motivate someone to open a protective put or a covered call position.
- Explain what principal protected notes (PPNs) are and what must be in place to create them.
- Describe how various spread strategies are used and compute their payoffs.
- Describe how combination strategies are used and explain their payoff functions.
Exotic Options
- Contrast exotic derivatives with plain vanilla ones, defining both.
- Outline some reasons why exotic derivative products have been developed.
- Show how a zero-cost version of any derivative can be created.
- Show how a nonstandard American option can be engineered from a standard one.
- Recognise the characteristics and payoff structures of basket, exchange, Asian, lookback, binary, barrier, chooser, compound, forward start and gap options.
- Contrast volatility swaps with variance swaps and describe each.
- Outline the basic reasoning of static option replication, and how hedges of exotic options can be built with it.
Properties of Interest Rates
- Describe Treasury rates, repo rates and the Secured Overnight Financing Rate (SOFR), and clarify the meaning of the risk-free rate.
- Work out how much an investment is worth under various compounding frequencies.
- Compute a bond's value from its coupon and yield.
- Use spot rates to price a bond theoretically.
- Work out three duration measures for a bond: dollar duration, modified duration and Macaulay duration.
- Evaluate where duration falls short and how convexity covers some of those shortcomings.
- Estimate a bond's price change when interest rates move, using its duration and convexity.
- Use a set of spot rates to obtain forward interest rates.
- Price the payments of a forward rate agreement (FRA) by working out the value of its cash flows.
- Use bootstrapping to derive zero-coupon rates.
- Weigh the main theories of how interest rates vary with maturity against each other, namely the term structure of interest rates theories.
Corporate Bonds
- Outline how bonds are traded and account for how bond yields behave.
- Explain the bond indenture and the part a corporate trustee plays under it.
- Define high-yield bonds, then describe the kinds of issuers that sell them and the payment features that are unique to them.
- Contrast credit spread risk with credit default risk.
- Outline event risk and the circumstances in which it may materialise for corporate bonds.
- Outline bond features including collateral, interest rate, maturity and issuer.
- Outline how a corporate bond may be retired before it matures.
- State the meaning of recovery rate and default rate, and tell a dollar default rate from an issue default rate.
- Assess the return a bond investment is expected to deliver and name its components.
Mortgages and Mortgage-Backed Securities
- Survey the different residential mortgage products.
- Work out the payment on a fixed-rate mortgage and how much of it is principal and how much is interest.
- Outline how mortgage-backed securities (MBS) are created through securitization, especially how mortgage pools are formed, including specific pools and to-be-announced (TBAs).
- Work out the single monthly mortality rate (SMM), conditional prepayment rate (CPR), weighted average maturity and weighted average coupon for a mortgage pool.
- Describe how pass-through agency MBS are traded.
- Explain the mechanics of agency MBS products such as interest-only securities (IOs), principal-only securities (POs) and collateralized mortgage obligations (CMOs).
- Outline a dollar roll transaction and the way it is valued.
- Explain prepayment modeling and its four components (curtailments, defaults, turnover and refinancing), and outline the mortgage prepayment option together with the factors influencing it.
- Outline the Monte Carlo simulation steps used to value an MBS.
- Explain the uses and the challenges of Option Adjusted Spread (OAS), starting from its definition.
Interest Rate Futures
- Recognise the most widely used day count conventions, the markets in which each normally applies, and how to use each in an interest calculation.
- Work out the price of a US Treasury bill given its discount rate.
- Distinguish a US Treasury bond's clean price from its dirty price, and compute its accrued interest and dirty price.
- Compute the conversion factor of a US Treasury bond futures contract and explain what it represents.
- Determine the expense of handing over a given bond to settle a Treasury bond futures contract.
- Describe how the yield curve's level and shape affect which Treasury bond is cheapest to deliver.
- Derive the theoretical price of a futures contract on a Treasury bond.
- Create a duration-based hedging strategy in interest rate futures, starting with working out the hedge ratio.
- Explain the limitations of a hedging strategy based on duration.
Swaps
- Work out the cash flows of a plain vanilla interest rate swap, explaining how it operates.
- Show how a plain vanilla interest rate swap converts an asset or liability into a different one, and work out the cash flows that result.
- Describe how financial intermediaries function in the market for swaps.
- State what function confirmation serves in a swap transaction.
- Set out the comparative advantage argument behind interest rate swaps and evaluate some objections to it.
- Describe how a plain vanilla interest rate swap's discount rates are computed.
- Value a plain vanilla interest rate swap as two bond positions held simultaneously.
- Treat a plain vanilla interest rate swap as a strip of FRAs and use that to value it.
- Show how a currency swap converts an asset or a liability into another and compute the cash flows that follow.
- Value a currency swap as two bond positions held simultaneously.
- Use a series of forward exchange rates to value a currency swap.
- Recognise exotic swaps, credit default swaps, volatility swaps and commodity swaps as further types of swap and describe them.
- Outline how credit risk exposure arises for a party holding a swap position.
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