Actuarial Notes

Exam F1FIE

F1FIE – Financial Products is an exam of the finance, investments and ERM track of the Canadian Institute of Actuaries' Fellowship (FCIA) pathway.

About the exam

The aim of this exam is for candidates to develop the following skills:

  1. Understand different types of financial products and their uses.

  2. Understand the main principles and techniques of pricing that are relevant to investments.

  3. Apply these principles and techniques within the context of investing.

  4. Understand how pricing links to wider business processes (e.g., business planning and capital setting).

  5. Create and evaluate hypothetical scenarios, including using judgment to assess the implications of actions and to develop appropriate proposals or recommendations relating to investment products.

Exams are administered as an open-book, four-hour exam requiring analysis in the context of a problem and written responses to specific questions. Candidates will complete the exam through the CIA learning management system.

Learning Objectives

Principal terms (0%)

  1. Define principal terms used in financial products and securities. (A1)

Mathematics, statistics and stochastic calculus (15%)

  1. Understand and apply concepts of probability and statistics important in mathematical finance. (C3)
  2. Understand the importance of the no-arbitrage condition in asset pricing. (B2)
  3. Apply the concept of martingale in asset pricing. (C3)
  4. Understand and apply Itô’s integral and stochastic differential equations. (B3)
  5. Understand and apply Itô’s lemma. (C3)
  6. Understand and apply Jensen’s inequality. (C3)
  7. Assess mathematical considerations for analyzing financial time series. (C5)
  8. Understand the importance of the Feynman-Kac theorem to diffusion processes. (C3)

Introduction to option pricing theory (20%)

  1. Understand and apply various techniques for analyzing conditional heteroscedastic models, including ARCH (autoregressive conditionally heteroscedastic) and GARCH (generalized autoregressive conditionally heteroscedastic). (C3)
  2. Perform calculations and evaluate results of option-pricing techniques and theory for equity and interest rate derivatives. (C6)
  3. Apply the basic concepts of currency markets (purchase-price parity, law of one price, etc.). (B3)
  4. Identify differences and implications of real-world versus risk-neutral probability measures. (B4)
  5. Understand and apply Girsanov’s theorem in changing measures. (C3)
  6. Understand and apply the Black-Scholes-Merton PDE (partial differential equation). (C3)
  7. Identify limitations of the Black-Scholes pricing formula.
  8. Describe and apply approaches for relaxing the assumptions used in the Black-Scholes formula. (C3)
  9. Apply and assess alternatives to the Black-Scholes-Merton model or alternative techniques that can be used to deal with option-pricing technique limitations. (B6)
  10. Demonstrate an understanding of interest rate models. (B2)
  11. Understand and apply the concept of calibration and describe the issues related to calibration. (B6)
  12. Understand and assess the Heath-Jarrow-Morton (HJM) model and the HJM no-arbitrage condition. (B6)

Introduction to credit and liquidity risk (20%)

  1. Understand events and causes of the 2008 global credit crisis relating to mortgage-backed securities (MBS) and credit-default swaps (CDS). (B2)
  2. Understand the basic concepts of credit risk modelling such as probability of default, loss given default, exposure at default, and expected loss. (B3)
  3. Apply and assess credit-valuation models. (B6)
  4. Apply and assess the Merton asset-value models in the context of credit risk. (B6)
  5. Understand and apply credit-default swaps. (C3)
  6. Apply and assess mortgage-default models in the valuation of mortgage-backed securities (B6)
  7. Measure and perform marking-to-market counterparty credit risk in credit derivatives. (C5)
  8. Understand the rationale, markets, and risks of structured finance. (B4)
  9. Compare the use of credit-spread measures in portfolio construction. (C2)
  10. Describe risk considerations in investment-grade versus high-yield bond portfolios. (C2)
  11. Understand the concept of liquidity risk and the threat it represents to financial intermediaries and markets. (B2)
  12. Measure and monitor liquidity risk, using various liquidity-measurement tools and ratios. (C5)
  13. Understand liability-termination provisions such as book-value surrender and the impact on a company’s overall liquidity risk. (B3)
  14. Apply liquidity risk models, including modelling cash flow of various types of assets under various scenario analysis and time horizons. (D6)
  15. Create liquidity risk management plans and procedures, including addressing appropriate product design, investment guidelines, and reporting given a desired liquidity risk level. (C6)
  16. Be familiar with rating agency expectations for liquidity and the implications for company ratings. (D4)

Derivatives and hedging (10%)

  1. Compare and contrast the various kinds of volatility. (C4)
  2. Compare and contrast various approaches for setting volatility assumptions in hedging. (C4)
  3. Compare and contrast different approaches to hedging. (C4)
  4. Perform delta hedging and understand the interplay between hedging assumptions and hedging outcomes. (B3)
  5. Describe and understand economic scenarios where hedging strategies may be ineffective for certain portfolios. (B2)
  6. Demonstrate how interest rate swaps, forwards, and futures can be used to modify a portfolio’s risk and return. (C3)
  7. Utilize derivatives to achieve targeted equity and interest rate risk exposures. (C3)
  8. Discuss methods of forecasting volatility and understand the applications of volatility and variance swaps. (C5)

Fixed-income securities (20%)

  1. Explain the cash-flow characteristics and pricing of government securities. (B2)
  2. Analyze par yield curves, spot curves, and forward curves and their relationship to traded security prices. (B4)
  3. Analyze the different characteristics of securities issued by government agencies. (B4)
  4. Evaluate features of provincial and municipal bonds, and the role of rating agencies in pricing them. (C5)
  5. Describe the cash flow of various corporate bonds considering underlying risks such as interest rate, credit, and event risks. (A2)
  6. Analyze cash-flow patterns and underlying drivers and risks of mortgage-backed securities and collateralized mortgage obligations. (D4)
  7. Construct portfolios of fixed-income securities using the following broad categories: (D6)
  8. Managing funds against a target return; and
  9. Evaluate strategies for managing funds and immunizing funds against single and multiple liabilities.
  10. Understand and discuss approaches to setting expectations for fixed-income returns. (D5)
  11. Evaluate the effects of capital markets expectations on the yield curve. (C5)
  12. Perform calculations of modified duration, convexity, and duration times spread (DTS) and its applications towards various fixed-income strategies (D5)
  13. Apply the model to price common interest sensitive instruments, including callable bonds, bond options, caps, floors and swaptions. (C3)

Guaranteed investment products and annuities (15%)

  1. Identify and evaluate the impact of embedded options in liabilities, specifically variable annuities guaranteed riders (guaranteed minimum accumulation benefit [GMAB], guaranteed minimum death benefit [GMDB], guaranteed minimum withdrawal benefit [GMWB], and guaranteed minimum income benefit [GMIB]). (C5)
  2. Understand risks associated with guaranteed riders, including market, insurance, policyholder behaviour, basis, credit, regulatory, and accounting. (B2)
  3. Perform risk management and dynamic hedging for existing GMxB and its embedded options. (D6)
  4. Analyze hedgeable components that are equity, interest rate, volatility, and cross Greeks. (C4)
  5. Analyze partially hedgeable or unhedgeable components that are policyholder behaviour, mortality and lapse, basis risk, counterparty exposure, foreign bonds and equities, correlation, and operation failures. (C2)
  6. Compare and contrast static vs. dynamic hedging. (C4)
  7. Analyze how differences between modeled and actual outcomes for guarantees affect financial results over time. (D4)

Source Material

Source Material

  • FCIA Syllabus – Finance, investments and ERM with option in Banking (CIA - 2024)
    • Exam F1FIE (pp. 5–7)