Errata for 10
th
 Edition of Exam FM/2 Manual
(Last updated 10/29/14)
[10/29/14] ote on !han"es in Learnin" #$%e!ti&es and 'ext eferen!es
Changes were made in the Learning Objectives and Text References for the October 2013and December 2014 exams The fo!!owing terms were e!iminated from the s"!!ab#s$ %1& investment "ear a!!ocation methods' %2& effective d#ration' %3& convertib!e bonds and mandatori!" convertib!e bonds' %4& (a"!ater strategies )!so* the term +c#rrent va!#e, wasadded to the Learning Objectives The effects of these changes on )-./s .2 man#a! are shown be!ow #nder the items dated 10214 %%There are a!so a co#(!e of correctionsof t"(os dated 10214 which are #nre!ated to the above changes&
[*/1*/11] +mportant note on immuni,ation-
.tudents ha&e reported that there ha&e $een a surprisin" num$er of uestions on immuni,ation (in!ludin" the topi!s of duration and !on&exit) on re!ent exams 'he pra!ti!e exams in this manual !ontain &er3 &er fe uestions on these topi!s 5e su""est that ou thorou"hl re&ie .e!tions 9! to 9n $efore ou ta6e the exam
112012 5age 21* 6 7 )nswer choice %8& sho#!d be 141442910 5age 21* 6 : This (rob!em sho#!d act#a!!" a((ear after -ections 1a%vi& to 1a%ix&112012 5age 29 The +;ote, at the end sho#!d refer to %1 < i&
2n
112012 5age 40* so!#tion to 6 = ;ote that there is act#a!!" no need to ex(!icit!" ca!c#!ate i2 rom 1000%1 < i2&
29
> 1*90* we have %1 < i2&
10
 > 19
1029
* ? > 1000%1 < i2&
10
 > 1000%19
1029
& > 1*2:=32712 5age 7:* so!#tion to 6 1 )dd the fo!!owing note after the so!#tion$ +-ome st#dents inter(ret$ @Ais acco#nt is credited with interest at a nomina! rate of i convertib!e semiann#a!!"/ to mean that 8r#ce/s acco#nt earns interest on!" at the end of each =Bmonth (eriod Therefore* the" reason that after :27 "ears* 8r#ce has on!" 100%1 < i2&
14
 in his acco#nt Aowever* it is ver" im(ortant to note that in xam .2* an acco#nt is a!wa"s ass#med to grow with interest contin#o#s!"* no matter how the interest rate is stated %eg* as an ann#a! effective rate* as a nomina! rate com(o#nded mBth!"* as a force of interest* etc& f there is an exce(tion to this ass#m(tion* it sho#!d be c!ear!" stated in the E#estion, :1:11 5age =7* 3
rd
 !ine from bottom* (arenthetica! remarF -ho#!d be +%eg* when %de!ta&
t
> 02t* as in the above exam(!e&,10214 5age :1* so!#tion to 6 9 )dd the fo!!owing note at the beginning of the so!#tion$  ;ote$ Occasiona!!"* "o# ma" see the term +c#rrent va!#e,* as in this E#estion This sim(!" means the va!#e of a series of (a"ments on a s(ecified date* some of which are made before that date and some after that date Th#s* +c#rrent va!#e, is the s#m of the )G and 5G of the (a"ments on the s(ecified date
 
72113 5age 9=* diagram in the midd!e of the (age 3H a((!ies to a (eriod of I of a "ear%The arrows maFe it a((ear as if 3H a((!ies to I of a (eriod* which is J of a "ear&=2712 5age * so!#tion to 6 1=* 2
nd
 !ine 100
v
 sho#!d be 100v The so!#tion #ses the correct va!#e :1:11 5age 11* so!#tion to 6 7 The first !ine of the so!#tion was omitted$ 14*113 > 1*000%aBang!eB4;& at =3H* 4; > 3=* ; > :1:11 5age 11* so!#tion to 6 :* 2
nd
 !ine R > 17090 %based on the n#mber of decima! (!aces #sed&* not 17009 The so!#tion is based on the correct va!#e 91310 5age 13=* so!#tion to 6 : On the !ast !ine* the denominator sho#!d be 1 B :71317 The answer is based on the correct denominator91310 5age 139* so!#tion to 6 1 The first !ine sho#!d sa"$ +Ksing time
39
 as the com(arison date, The so!#tion is based on time 391310 5age 223* so!#tion to 6 11 The wa" the E#estion is worded* the correct answer is %)&* not %8& )s noted in the so!#tion* the acco#nt ba!ance at the end of the 9
th
 "ear is 4=*21== M#st after the 1:
th
 f#!! scho!arshi( of 7*000 is awarded* the acco#nt ba!ance is eE#a! to %4=*21==&%109&
1:
 B 7*000%s ang!e 1:& at 9H > 4*979= )ccording to the E#estion* if there is !ess than 7*000 in the acco#nt at the end of an" "ear* the remaining amo#nt %4*979=& is immediate!" awarded as a sma!!er scho!arshi( Th#s* on!" 1: f#!! scho!arshi(s of 7*000 are awarded ;ote that the acco#nt ba!ance of 4*979= at the end of the 1:
th
 "ear wo#!d have grown to 7*249=7 at the end of the 19
th
 "ear at 9H This wo#!d have (ermitted an 19
th
 f#!! scho!arshi( to have been awarded* b#t this wo#!d not fo!!ow the reE#irements of the E#estion 10214 5age 2=2* 3
rd
 (aragra(h #nder the ca(tion +Nie!d Rate or nterna! Rate of Ret#rn %RR&,* 4
th
 sentence -ho#!d be + the (resent va!#e of the ret#rns of
500
 and 900 decrease,10214 5age 299 nvestment "ear a!!ocation methods are no !onger inc!#ded in the s"!!ab#s Read on!" the first = (aragra(hs of -ection 7f and ignore the rest of this section %inc!#ding the E#estions at the end of the section&:1:11 5age 302* first !ine #nder +b Ksing the TG. registers, 4*3249 sho#!d be 4*3239 32712 5age 3:* so!#tion to 6 * !ast !ine 1*0992: sho#!d be 1*094 =2712 5age 424* so!#tion to 6 2* 1
st
 !ine The reference sho#!d be to -ection 9%b&* not -ection :%g&72114 5ages 433B43: -ince the 10
th
 edition of this man#a! was (#b!ished* the .2 exam committee has ado(ted standard termino!og" for forward rates for exam (#r(oses %)s noted on (age 43= #nder +Tra( )!ertP Qarning on Termino!og" for orward RatesP,* the vario#s -#ggested TextbooFs #se man" different wa"s of describing the same forward rate Th#s* it/s a good move on the (art of the exam committee to fina!!" s(ecif" standard termino!og"& This is how a forward rate is defined in +;otation and termino!og" #sed for xam .2, %avai!ab!e on www8e)n)ct#ar"org&$ 
 Forward rate: An m-year spot rate that comes into effect t years in the future will be referred to as the “m-year forward rate, deferred t years” or as the “m-year forward rate, starting in t years”.
 Let/s taFe an exam(!e -#((ose we are to!d that the +3B"ear forward rate* deferred 2 "ears* is =H, %or that the +3B"ear forward rate* starting in 2 "ears* is =H,& Qhat this means is that we
 
 co#!d maFe an investment 2 "ears from now that wo#!d earn =H (er ann#m over the next 3 "ears %ie* over the (eriod from time 2 to time 7 Th#s* if we were to invest* sa"* 10*700 at time 2* we wo#!d have an acc#m#!ated va!#e of 10*700%10=&
3
 at time 7 Let/s taFe another exam(!e Aow wo#!d "o# ex(!ain the fo!!owing forward rate The 2B"ear forward rate* deferred 3 "ears is 4H %or the 2B"ear forward rate* starting in 3 "ears is 4H& This means that we co#!d maFe an investment 3 "ears from now that wo#!d earn 4H (er ann#m over  the next 2 "ears* ie* over the (eriod from time 3 to time 7 On (ages 433 and s#bseE#ent in the man#a!* nat#ra!!" we don/t #se the officia! termino!og" for forward rates* since the 10
th
 edition was (#b!ished before this termino!og" was ado(ted ;ow that the exam committee has s(oFen* "o# sho#!d ex(ect to see the new termino!og" on f#t#re exams Ger" often* "o# wi!! dea! with forward rates that are in effect for on!" one "ear %ie* forward rates for which the +m, in the definition of a forward rate is eE#a! to 1& or exam(!e* if 7H is the oneB"ear forward rate deferred 7 "ears* it means that we co#!d maFe an investment at time 7 that wo#!d earn 7H over the oneB"ear (eriod r#nning from time 7 to time = %;ote that this is the same forward rate described in the third (aragra(h #nder +orward Rates, on (age 433* which does not #se the officia! termino!og"& No# sho#!d !earn how to determine forward rates from s(ot rates b" reading (ages 433B43= and doing exam(!es =* : and 9 on (ages 437B43= )!tho#gh the officia! termino!og" is not #sed on these (ages* "o# sho#!d not have a (rob!em #nderstanding the conce(ts See( in mind that "o# ma" have to modif" E#estions on forward rates in the )-. man#a! in terms of the officia! termino!og"or exam(!e* see E#estion 2 on (age 43 The E#estion asFs "o# to +Ca!c#!ate the oneB"ear forward rate for "ear 2 %ie* the oneB"ear effective rate d#ring "ear  2&, Qhi!e this is (rett" c!ear* it wo#!d have been worded as fo!!ows #sing the officia! termino!og"$ +Ca!c#!ate the oneB"ear forward rate* deferred one "ear, %or +Ca!c#!ate the oneB "ear forward rate* starting in one "ear,&:1:11 5age 449* 9 !ines from the bottom )dd the fo!!owing sentence to the (arenthesis$ n fact* in +;otation and termino!og" #sed for xam .xam 2,* which "o# can find on www8e)n)ct#ar"org* the -O)C)- sa"s that* #n!ess otherwise stated* +d#ration, means .aca#!a" d#ration:1:11 5age 470* so!#tion to %c&* 3
rd
 !ine The reference to footnote 2 sho#!d be to footnote 3:1:11 5age 4=2* footnote 7 nsert the fo!!owing sentence j#st after the 2
nd
 sentence of the footnote$ n fact* in +;otation and termino!og" #sed for xam .xam 2,* which "o# can find on www8e)n)ct#ar"org
 
* the -O)C)- sa"s that* #n!ess otherwise stated* +convexit", means modified convexit"72113 5age 474* so!#tion to xam(!e 1 The 2
nd
 sentence sho#!d refer to xam(!e 2* not xam(!e 310214 5age 4:4 gnore -ection n* since +effective d#ration, is no !onger on the s"!!ab#s:1:11 5ages 499B49* +Qhat abo#t interest, ;ote that the E#estion of interest on the (roceeds of a short sa!e is sti!! not covered b" the -t#d" ;otes Aowever* in a re(!" to an emai! sent b" a st#dent in 2010* the d#cation -taff noted that new exam E#estions wi!! be based on .cDona!d* which ass#mes that this interest is (aid ) n#mber of E#estions on the 7 (ractice exams in this man#a! are based on the +noBinterest, ass#m(tion -ee the errata !ist be!ow for (ages =90 and s#bseE#ent
 
:1:11 5age 703* ig 112 and (age 707* ig 113 The !ine showing the (a"off on the !ong forward sho#!d intersect the " axis at B104* not B1009:13 5age 713* =
th
 !ine ;ote that +8erm#dian, is a!so s(e!!ed +8erm#dan, 10214 5age 7=:* so!#tion to 6 3 The +;ote, sho#!d refer to -ections* 17a* 17b and 17c* not =a* =b and =c:1:11 5age 799* +The )s"mmetric 8#tterf!" -(read,* 2
nd
 !ine of +)nswer, -ho#!d sa" +:7H of the wa" from 0 to 110,:1:11 5age 79* !ast !ine of +.emor" )!ertP, The (arenthesis sho#!d sa"$ +%0 and 110&,* not +%0 and 100&,:1:11 5age =17* tab!e at the to( The first 4 entries in the co!#mn headed +5rofit on 100B110 Co!!ar, sho#!d end in 30* not 2= or 3= The next 3 entries in this co!#mn sho#!d end in :0* not :4 )!! of the entries in the +Combined 5rofit, co!#mn sho#!d end in 30* not 2=10214 5age =1= gnore the materia! #nder the ca(tion +5a"!ater,* since this is no !onger on the s"!!ab#s 42910 5age =1* 6 3 The (rob!em sho#!d have made it c!ear that ? and N re(resent the highest and !owest (rofit* res(ective!"* if the (#ts are
 purchased.
:1:11 5age =49* the !ine j#st before -ection 1d The res#!t of the ca!c#!ation is :77* not :7110214 5ages ==1 and s#bseE#ent %5ractice xams& 8eca#se the to(ic of investment "ear a!!ocation methods is no !onger on the s"!!ab#s* ignore the fo!!owing E#estions in the 5ractice xams$ 5 1* 6 22' 5 2* 6 20' 5 3* 6 9' 5 7* 6 30:1:11 5age ==3 Qe s#ggest that "o# do 5ractice xams 4 and 7 first* since most st#dents thinF the" are easier than 5ractice xams 1 to 342910 5age =:4* !ast 2 !ines 103747 sho#!d be 103047 The fina! answer of 103= is correct:1:11 5age =90* 611* (age ==* 6:* (age :12* 6 23 and (age :2=* 6 2: )!! of these E#estions sho#!d sa" that "o# sho#!d ass#me that no interest is (aid to the shortBse!!er on the (roceeds of the short sa!e ;ote that if this is not stated* "o# sho#!d ass#me that this interest
is
 (aid %-ee  (ages 499B49* +Qhat abo#t interest,&:1:11 5age :0:* so!#tion to 6 34* 3
rd
 eE#ation The n#mber in the ang!eBbracFet sho#!d be 292 %> 3=0 U :9&* not 3=0 The res#!t is based on the correct va!#e42910 5age :11* 6 17 The (#t o(tions in this (rob!em are (riced incorrect!"* since the (remi#ms sho#!d increase as the striFe (rice increases The so!#tion is based on the (remi#ms as shown112012 5age :17* !ast !ine The s"mbo! v
03
 sho#!d be v
03
:1:11 5age :27* 6 1 The E#estion sho#!d asF for the nonBVero va!#e of ?42910 5age :27* 6 20 The E#estion sho#!d maFe it c!ear that the (rod#ction cost of 1:70 is inc#rred at the time of sa!e* ie* one "ear from now:1:11 5age :2=* 6 23 The E#estion sho#!d maFe it c!ear that the bond was srcina!!" (#rchased to "ie!d a
minimum
of 9H )!so* it sho#!d sa" that the bond mat#res at (ar in 30 "ears
of 5