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Test your basic knowledge |
FRM: Foundations Of Risk Management
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Subjects
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business-skills
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certifications
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frm
Instructions:
Answer 50 questions in 15 minutes.
If you are not ready to take this test, you can
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. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
3 main types of operational risk
Solve for minimum variance portfolio
Roles of risk management
Debt overhang
2. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Carry- backs and carry- forwards
3 main types of operational risk
Asset liquidity risk
Basis
3. The need to hedge against risks - for firms need to speculate.
What lead to the exponential growth to derivatives mkt?
Firms becoming more sensitive to changes(bank deregulation)
RAR = relative return of portfolio (RRp)
Volatility Market risk
4. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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5. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Market imperfections that can create value
Debt overhang
CAPM with taxes included (equation)
Efficient frontier
6. Law of one price - Homogeneous expectations - Security returns process
Basic Market risk
Ri = ai + bi1l1 + bi2l2....+ei
APT (equation and assumptions)
Kidder Peabody
7. Potential amount that can be lost
Exposure
Risk
Treynor measure
Debt overhang
8. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Effect of heterogeneous expectations on CAPM
Risk Management Irrelevance Proposition
Derivative contract
Three main reasons for financial disasters
9. Multibeta CAPM Ri - Rf =
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Where is risk coming from
Correlation coefficient effect on diversification
Risk
10. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Operational risk
Forms of Market risk
VaR- based analysis (formula)
Practical considerations related to ERM implementatio
11. 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
Jensen's alpha
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Ways firms can fail to account for risks
APT for passive portfolio management
12. 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
Nonparametric VaR
Capital market line (CML)
Barings
Nonmarketable asset impact on CAPM
13. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Solvency-related metrics
Market imperfections that can create value
Performance- related metrics
Capital market line (CML)
14. Volatility of unexpected outcomes
Solve for minimum variance portfolio
What lead to the exponential growth to derivatives mkt?
Risk
Basis
15. Return is linearly related to growth rate in consumption
Multi- period version of CAPM
Sovereign risk
CAPM assumption for EMH
Four major types of risk
16. When negative taxable income is moved to a different year to offset future or past taxable income
Efficient frontier
Risk
Tracking error
Carry- backs and carry- forwards
17. Modeling approach is typically between statistical analytic models and structural simulation models
LTCM
Tracking error
Jensen's alpha
Models used in ERM framework
18. Cannot exit position in market due to size of the position
Kidder Peabody
Basic Market risk
Basis risk
Asset liquidity risk
19. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Debt overhang
VaR - Value at Risk
Three main reasons for financial disasters
Sortino ratio
20. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Operational risk
Ways firms can fail to account for risks
Models used in ERM framework
VaR- based analysis (formula)
21. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Zero- beta CAPM (two factor model)
Efficient frontier
Basis risk
Four major types of risk
22. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Funding liquidity risk
Where is risk coming from
Sharpe measure
VaR - Value at Risk
23. The uses of debt to fall into a lower tax rate
Security (primary vs secondary)
3 main types of operational risk
Ways risk can be mismeasured
Tax shield
24. Interest rate movements - derivatives - defaults
BTR - Below Target Risk
Models used in ERM framework
Funding liquidity risk
Financial Risk
25. Strategic risk - Business risk - Reputational risk
Risks excluded from operational risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Morningstar Rating System
Uncertainty
26. Curve must be concave - Straight line connecting any two points must be under the curve
Asset liquidity risk
Shape of portfolio possibilities curve
Source of need for risk management
Four major types of risk
27. Rp = XaRa + XbRb
Morningstar Rating System
Firms becoming more sensitive to changes(bank deregulation)
Expected return of two assets
Forms of Market risk
28. Country specific - Foreign exchange controls that prohibit counterparty's obligations
What lead to the exponential growth to derivatives mkt?
Where is risk coming from
Parametric VaR
Sovereign risk
29. Derives value from an underlying asset - rate - or index - Derives value from a security
LTCM
Liquidity risk
VaR- based analysis (formula)
Derivative contract
30. Inability to make payment obligations (ex. Margin calls)
Formula for covariance
Funding liquidity risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Sovereign risk
31. When two payments are exchanged the same day and one party may default after payment is made
Ways firms can fail to account for risks
Where is risk coming from
Basic Market risk
Settlement risk
32. Joseph Jett exploited an accounting glitch to book 350 million of false profits (government bonds) - Massive misreporting resulted in loss of confidence in management - Failed to take into account the present value of a forward - Learn to investigate
3 main types of operational risk
CAPM (formula)
Solvency-related metrics
Kidder Peabody
33. Need to assess risk and tell management so they can determine which risks to take on
Importance of communication for risk managers
Tax shield
Source of need for risk management
Morningstar Rating System
34. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Basis risk
Asset transformers
Volatility Market risk
Derivative contract
35. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Treynor measure
Debt overhang
Derivative contract
Volatility Market risk
36. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Ri = Rz + (gamma)(beta)
Tracking error
Tax shield
Jensen's alpha
37. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Business Risk
Ri = Rz + (gamma)(beta)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Market risk
38. Wrong distribution - Historical sample may not apply
Ways risk can be mismeasured
Risk- adjusted performance measure (RAP)
Valuation vs. Risk management
Four major types of risk
39. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Morningstar Rating System
Differences in financial risk management for financial companies vs industrial companies
Prices of risk vs sensitivity
Firms becoming more sensitive to changes(bank deregulation)
40. Probability that a random variable falls below a specified threshold level
Shortfall risk
Shape of portfolio possibilities curve
Standard deviation of two assets
Basis risk
41. Future price is greater than the spot price
BTR - Below Target Risk
Contango
Ri = ai + bi1l1 + bi2l2....+ei
Settlement risk
42. Quantile of a statistical distribution
Parametric VaR
Sortino ratio
Market risk
Effect of non- price- taking behavior on CAPM
43. Absolute and relative risk - direction and non-directional
Forms of Market risk
Debt overhang
APT for passive portfolio management
Market imperfections that can create value
44. Hazard - Financial - Operational - Strategic
Basis
Risk types addressed by ERM
Allied Irish Bank
Shortcomings of risk metrics
45. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Drysdale Securities (Chase Manhattan)
Carry- backs and carry- forwards
Risk
CAPM assumption for EMH
46. Relative portfolio risk (RRiskp) - Based on a one- month investment period
RAR = relative return of portfolio (RRp)
Sovereign risk
Allied Irish Bank
Asset liquidity risk
47. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Ways risk can be mismeasured
Banker's Trust
Forms of Market risk
Sortino ratio
48. Those which corporations assume whillingly to create competitive advantage/add shareholder value - Business Decisions: investment decisions - prod - dev choices - marketing strategies - organizational struct. - Business Environment: competitive and
Business Risk
Source of need for risk management
Financial Risk
Market imperfections that can create value
49. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Financial Risk
Basis risk
CAPM (formula)
50. 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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