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Test your basic knowledge |
FRM: Foundations Of Risk Management
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business-skills
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frm
Instructions:
Answer 50 questions in 15 minutes.
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study here
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Match each statement with the correct term.
Don't refresh. All questions and answers are randomly picked and ordered every time you load a test.
This is a study tool. The 3 wrong answers for each question are randomly chosen from answers to other questions. So, you might find at times the answers obvious, but you will see it re-enforces your understanding as you take the test each time.
1. Leeson took large speculative position in Nikkei 225 disguised as safe transactions by fake customers - Earthquake increased volatility and destroyed short put options - Losses of 1.25 billion and forced bankruptcy - Necessity of an independent tradi
Operational risk
Barings
Settlement risk
Solvency-related metrics
2. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Parametric VaR
Roles of risk management
Sortino ratio
Nonmarketable asset impact on CAPM
3. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Three main reasons for financial disasters
3 main types of operational risk
Effect of non- price- taking behavior on CAPM
Nonparametric VaR
4. Percentile of the distribution corresponding to the point which capital is exhausted - Typically - a minimum acceptable probability of ruin is specified - and economic capital is derived from it
Probability of ruin
Risk Management Irrelevance Proposition
Tax shield
Parametric VaR
5. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Importance of communication for risk managers
VaR- based analysis (formula)
Contango
Treynor measure
6. Asset-liability/market-liquidity risk
VaR- based analysis (formula)
Liquidity risk
Valuation vs. Risk management
Sovereign risk
7. Designate ERM champion - usually CRO - Make ERM part of firm culture - Determining all possible risks - Quantifying operational and strategic risks - Integrating risks (dependencies) - Lack of risk transfer mechanisms - Monitoring
Practical considerations related to ERM implementatio
Credit event
Risk
Firms becoming more sensitive to changes(bank deregulation)
8. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Exposure
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Derivative contract
Recovery rate
9. Quantile of an empirical distribution
Nonparametric VaR
Tracking error
RAR = relative return of portfolio (RRp)
Uncertainty
10. Efficient frontier with inclusion of risk free rate - Straight line with formula Rc = Rf + ((Ra - Rf)/std dev(a))*std dev(c) - c is the total portfolio - a is the risky asset
Asset liquidity risk
VaR - Value at Risk
Capital market line (CML)
Jensen's alpha
11. Covariance = correlation coefficient std dev(a) std dev(b)
Formula for covariance
Efficient frontier
CAPM with taxes included (equation)
Differences in financial risk management for financial companies vs industrial companies
12. Modeling approach is typically between statistical analytic models and structural simulation models
Models used in ERM framework
Banker's Trust
Shape of portfolio possibilities curve
Multi- period version of CAPM
13. Unanticipated movements in relative prices of assets in hedged position
APT (equation and assumptions)
Basic Market risk
Exposure
Settlement risk
14. Losses due to market activities ex. Interest rate changes or defaults
Liquidity risk
Nonparametric VaR
Sortino ratio
Financial risks
15. Sold complex derivatives to Proctor & Gamble and Gibson - Were sued due to claims that they deceived buyers - Need for better controls for matching complexity of trade with client sophistication - Need for price quotes independent of front office Met
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16. Returns on any stock are linearly related to a set of indexes
Forms of Market risk
Asset liquidity risk
Ri = ai + bi1l1 + bi2l2....+ei
Business risks
17. 1971: Fixed Exchange rate system broke down and was replaced by more volatile floating rate - 1973: Oil price shocks - - >high inflation - - >interest rate swings - 1987: Black Monday - OCt 19 - mkt fell 23% - 1989: Japanese stock price bubble -
Source of need for risk management
Effect of heterogeneous expectations on CAPM
Uncertainty
Nonparametric VaR
18. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Sharpe measure
Solve for minimum variance portfolio
Drysdale Securities (Chase Manhattan)
Shape of portfolio possibilities curve
19. Both probability and cost of tail events are considered
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Financial risks
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Roles of risk management
20. Multibeta CAPM Ri - Rf =
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Morningstar Rating System
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Ten assumptions underlying CAPM
21. Quantile of a statistical distribution
Parametric VaR
Roles of risk management
Drysdale Securities (Chase Manhattan)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
22. Asses firm risks - Communicate risks - Manage and monitor risks
APT in active portfolio management
Nonparametric VaR
Roles of risk management
Standard deviation of two assets
23. Need to assess risk and tell management so they can determine which risks to take on
Ten assumptions underlying CAPM
Sovereign risk
Four major types of risk
Importance of communication for risk managers
24. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Standard deviation of two assets
Solvency-related metrics
Effect of heterogeneous expectations on CAPM
VaR - Value at Risk
25. Future price is greater than the spot price
Contango
Prices of risk vs sensitivity
Expected return of two assets
Ways firms can fail to account for risks
26. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Security (primary vs secondary)
Risk Management Irrelevance Proposition
Firms becoming more sensitive to changes(bank deregulation)
CAPM (formula)
27. Track an index with a portfolio that excludes certain stocks - Track an index that must include certain stocks - To closely track an index while tailoring the risk exposure
APT for passive portfolio management
Exposure
Morningstar Rating System
Settlement risk
28. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Settlement risk
CAPM assumption for EMH
Basis risk
Market risk
29. Wrong distribution - Historical sample may not apply
Prices of risk vs sensitivity
Efficient frontier
Morningstar Rating System
Ways risk can be mismeasured
30. Probability distribution is unknown (ex. A terrorist attack)
Ten assumptions underlying CAPM
Uncertainty
Correlation coefficient effect on diversification
Risk types addressed by ERM
31. Absolute and relative risk - direction and non-directional
Ways risk can be mismeasured
3 main types of operational risk
Forms of Market risk
Solve for minimum variance portfolio
32. Cannot exit position in market due to size of the position
Asset liquidity risk
Valuation vs. Risk management
Risks excluded from operational risk
Financial Risk
33. No transaction costs - assets infinitely divisible - no personal tax - perfect competition - investors only care about mean and variance - short- selling allowed - unlimited lending and borrowing - homogeneity: single period - homogeneity: same mean
Ten assumptions underlying CAPM
Kidder Peabody
Settlement risk
Four major types of risk
34. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Practical considerations related to ERM implementatio
VaR- based analysis (formula)
APT for passive portfolio management
CAPM with taxes included (equation)
35. Strategic risk - Business risk - Reputational risk
Business risks
Risks excluded from operational risk
Barings
LTCM
36. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Recovery rate
Financial risks
Ways firms can fail to account for risks
3 main types of operational risk
37. Rp = XaRa + XbRb
VaR - Value at Risk
Expected return of two assets
Four major types of risk
Settlement risk
38. Inability to make payment obligations (ex. Margin calls)
Nonmarketable asset impact on CAPM
Sortino ratio
Funding liquidity risk
Debt overhang
39. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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40. Obtained unsecured borrowing of 300 million by exploiting flaw in computing US government bond collateral - Had only 20 million in capital - Chase absorbed losses since they brokered deal - Called for better process control and more precise methods f
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Drysdale Securities (Chase Manhattan)
Banker's Trust
LTCM
41. Valuation focuses on mean of distribution vs risk mgmt focuses on potential variation in payoffs - needs more precision for pricing - VAR doesn't b/c noise cancels out
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Valuation vs. Risk management
Settlement risk
Basis risk
42. Law of one price - Homogeneous expectations - Security returns process
APT (equation and assumptions)
VaR- based analysis (formula)
Ways firms can fail to account for risks
Standard deviation of two assets
43. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Exposure
Risk
Drysdale Securities (Chase Manhattan)
Security (primary vs secondary)
44. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Ways firms can fail to account for risks
Sharpe measure
Formula for covariance
Effect of heterogeneous expectations on CAPM
45. Volatility of unexpected outcomes
Prices of risk vs sensitivity
Sortino ratio
3 main types of operational risk
Risk
46. Derives value from an underlying asset - rate - or index - Derives value from a security
Ten assumptions underlying CAPM
Zero- beta CAPM (two factor model)
Derivative contract
Asset liquidity risk
47. Occurs the day when two parties exchange payments same day
Traits of ERM
Solve for minimum variance portfolio
Settlement risk
VaR - Value at Risk
48. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Credit event
Practical considerations related to ERM implementatio
Financial risks
Where is risk coming from
49. May not scale over time- Historical data may be meaningless - Not designed to account for catastrophes - VaR says nothing about losses in excess of VaR - May not handle sudden illiquidity
VaR- based analysis (formula)
Funding liquidity risk
LTCM
Shortcomings of risk metrics
50. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Ways risk can be mismeasured
Risk- adjusted performance measure (RAP)
Asset liquidity risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)