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Test your basic knowledge |
FRM: Foundations Of Risk Management
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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. Risk of loses owing to movements in level or volatility of market prices
Source of need for risk management
Market risk
VaR - Value at Risk
Correlation coefficient effect on diversification
2. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Kidder Peabody
Information ratio
Drysdale Securities (Chase Manhattan)
CAPM assumption for EMH
3. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Correlation coefficient effect on diversification
Four major types of risk
Basis risk
4. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Roles of risk management
Tracking error
Recovery rate
Options motivation on volatility
5. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Ten assumptions underlying CAPM
What lead to the exponential growth to derivatives mkt?
Correlation coefficient effect on diversification
Treynor measure
6. Occurs the day when two parties exchange payments same day
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
CAPM (formula)
Risks excluded from operational risk
Settlement risk
7. Wrong distribution - Historical sample may not apply
Solve for minimum variance portfolio
Ways risk can be mismeasured
Ten assumptions underlying CAPM
Importance of communication for risk managers
8. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Asset transformers
Sovereign risk
Kidder Peabody
APT (equation and assumptions)
9. When two payments are exchanged the same day and one party may default after payment is made
Tracking error
BTR - Below Target Risk
Settlement risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
10. 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
LTCM
Morningstar Rating System
Valuation vs. Risk management
Tracking error
11. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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12. 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
Shortcomings of risk metrics
Allied Irish Bank
LTCM
Tax shield
13. Inability to make payment obligations (ex. Margin calls)
Information ratio
Treynor measure
Jensen's alpha
Funding liquidity risk
14. 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
Performance- related metrics
Four major types of risk
Valuation vs. Risk management
15. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Business Risk
Nonmarketable asset impact on CAPM
Risk
Prices of risk vs sensitivity
16. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Roles of risk management
Credit event
Forms of Market risk
Shape of portfolio possibilities curve
17. Changes in vol - implied or actual
Volatility Market risk
Sortino ratio
Drysdale Securities (Chase Manhattan)
Carry- backs and carry- forwards
18. John Rusnak - a currency option trader - produced losses of 691 million by using imaginary trades to disguise large naked positions. - Enforced need for back office controls
Ways firms can fail to account for risks
Allied Irish Bank
Ways risk can be mismeasured
Importance of communication for risk managers
19. Quantile of an empirical distribution
Nonparametric VaR
Settlement risk
Volatility Market risk
Formula for covariance
20. Unanticipated movements in relative prices of assets in hedged position
Importance of communication for risk managers
Practical considerations related to ERM implementatio
Basic Market risk
Valuation vs. Risk management
21. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Probability of ruin
Traits of ERM
Firms becoming more sensitive to changes(bank deregulation)
Tax shield
22. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Roles of risk management
Tracking error
Jensen's alpha
CAPM with taxes included (equation)
23. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Nonparametric VaR
Solve for minimum variance portfolio
Treynor measure
Morningstar Rating System
24. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Asset transformers
Debt overhang
3 main types of operational risk
Prices of risk vs sensitivity
25. Expected value of unfavorable deviations of a random variable from a specified target level
BTR - Below Target Risk
Risks excluded from operational risk
Expected return of two assets
Differences in financial risk management for financial companies vs industrial companies
26. Quantile of a statistical distribution
Parametric VaR
Ten assumptions underlying CAPM
Risks excluded from operational risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
27. Firm may ignore known risk - Somebody in firm may know about risk - but it's not captured by models - Realization of a truly unknown risk
Ways firms can fail to account for risks
Banker's Trust
Risk- adjusted performance measure (RAP)
Nonmarketable asset impact on CAPM
28. 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
Shortcomings of risk metrics
Drysdale Securities (Chase Manhattan)
Roles of risk management
Probability of ruin
29. Probability that a random variable falls below a specified threshold level
Information ratio
Operational risk
Shortfall risk
Banker's Trust
30. 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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31. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Debt overhang
CAPM assumption for EMH
Correlation coefficient effect on diversification
Prices of risk vs sensitivity
32. Relative portfolio risk (RRiskp) - Based on a one- month investment period
RAR = relative return of portfolio (RRp)
Jensen's alpha
Contango
Shape of portfolio possibilities curve
33. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Shortcomings of risk metrics
VaR- based analysis (formula)
Treynor measure
Recovery rate
34. Both probability and cost of tail events are considered
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Zero- beta CAPM (two factor model)
Effect of non- price- taking behavior on CAPM
Ten assumptions underlying CAPM
35. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Financial risks
Forms of Market risk
Ri = Rz + (gamma)(beta)
Parametric VaR
36. Modeling approach is typically between statistical analytic models and structural simulation models
Risk
Models used in ERM framework
Capital market line (CML)
Debt overhang
37. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Traits of ERM
Basis
Prices of risk vs sensitivity
Effect of non- price- taking behavior on CAPM
38. Future price is greater than the spot price
Contango
Source of need for risk management
APT for passive portfolio management
Three main reasons for financial disasters
39. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Zero- beta CAPM (two factor model)
Standard deviation of two assets
Three main reasons for financial disasters
Ri = Rz + (gamma)(beta)
40. RM cannot increase firm value when it costs the same to bear a risk w/in the firm or outside the firm - For RM to increase firm value it must be more expensive to bear risks internally than to pay capital markets to bear them.
Where is risk coming from
Traits of ERM
Market imperfections that can create value
Risk Management Irrelevance Proposition
41. Probability distribution is unknown (ex. A terrorist attack)
Asset transformers
Uncertainty
Settlement risk
Market imperfections that can create value
42. Returns on any stock are linearly related to a set of indexes
APT in active portfolio management
Ri = ai + bi1l1 + bi2l2....+ei
Market imperfections that can create value
Differences in financial risk management for financial companies vs industrial companies
43. Market risk - Liquidity risk - Credit risk - Operational risk
Kidder Peabody
Solvency-related metrics
Four major types of risk
Barings
44. Asset-liability/market-liquidity risk
Nonparametric VaR
EPD or ECOR - Expected Policyholder Deficit (EPD)
Liquidity risk
Security (primary vs secondary)
45. The need to hedge against risks - for firms need to speculate.
Options motivation on volatility
APT in active portfolio management
Risk Management Irrelevance Proposition
What lead to the exponential growth to derivatives mkt?
46. Concave function that extends from minimum variance portfolio to maximum return portfolio
CAPM assumption for EMH
Efficient frontier
Shortfall risk
Credit event
47. Return is linearly related to growth rate in consumption
Multi- period version of CAPM
Operational risk
APT in active portfolio management
Solve for minimum variance portfolio
48. 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
Nonparametric VaR
Sharpe measure
Contango
49. 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
Business Risk
Standard deviation of two assets
Ten assumptions underlying CAPM
Recovery rate
50. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Asset liquidity risk
CAPM (formula)
Options motivation on volatility
Basic Market risk