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Test your basic knowledge |
FRM: Foundations Of Risk Management
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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. 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 imperfections that can create value
Nonparametric VaR
Valuation vs. Risk management
Four major types of risk
2. The lower (closer to - 1) - the higher the payoff from diversification
3 main types of operational risk
Practical considerations related to ERM implementatio
Zero- beta CAPM (two factor model)
Correlation coefficient effect on diversification
3. Interest rate movements - derivatives - defaults
Risk
Business Risk
Traits of ERM
Financial Risk
4. Expected value of unfavorable deviations of a random variable from a specified target level
Exposure
BTR - Below Target Risk
Asset liquidity risk
Business risks
5. Strategic risk - Business risk - Reputational risk
Shortcomings of risk metrics
Performance- related metrics
Market risk
Risks excluded from operational risk
6. 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
Capital market line (CML)
Performance- related metrics
Operational risk
Debt overhang
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
Expected return of two assets
Practical considerations related to ERM implementatio
Liquidity risk
Financial risks
8. Quantile of an empirical distribution
Nonparametric VaR
Security (primary vs secondary)
Debt overhang
Risk
9. Market risk - Liquidity risk - Credit risk - Operational risk
Four major types of risk
Models used in ERM framework
APT (equation and assumptions)
Credit event
10. Law of one price - Homogeneous expectations - Security returns process
LTCM
Settlement risk
RAR = relative return of portfolio (RRp)
APT (equation and assumptions)
11. 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
Tax shield
LTCM
Market imperfections that can create value
Probability of ruin
12. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Tracking error
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Expected return of two assets
Market imperfections that can create value
13. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Security (primary vs secondary)
Morningstar Rating System
Capital market line (CML)
CAPM assumption for EMH
14. Relative portfolio risk (RRiskp) - Based on a one- month investment period
RAR = relative return of portfolio (RRp)
Traits of ERM
VaR - Value at Risk
Derivative contract
15. Quantile of a statistical distribution
Treynor measure
Valuation vs. Risk management
Parametric VaR
Multi- period version of CAPM
16. Enterprise Risk Management - ERM is a discipline - culture of enterprise - ERM applies to all industries - ERM is not just defensive - adds value - ERM encompasses all risks - ERM addresses all stakeholders
Traits of ERM
Ten assumptions underlying CAPM
Standard deviation of two assets
Correlation coefficient effect on diversification
17. Derives value from an underlying asset - rate - or index - Derives value from a security
Derivative contract
Business Risk
Market risk
CAPM assumption for EMH
18. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Importance of communication for risk managers
Efficient frontier
EPD or ECOR - Expected Policyholder Deficit (EPD)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
19. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Standard deviation of two assets
Risk Management Irrelevance Proposition
Recovery rate
Asset liquidity risk
20. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Asset liquidity risk
Sharpe measure
Uncertainty
Nonmarketable asset impact on CAPM
21. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
3 main types of operational risk
Formula for covariance
Correlation coefficient effect on diversification
Standard deviation of two assets
22. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Shape of portfolio possibilities curve
Volatility Market risk
Debt overhang
Business risks
23. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Formula for covariance
Banker's Trust
CAPM with taxes included (equation)
APT (equation and assumptions)
24. Future price is greater than the spot price
Contango
Recovery rate
Formula for covariance
Risk
25. 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
Ri = ai + bi1l1 + bi2l2....+ei
Solvency-related metrics
Financial risks
Business Risk
26. 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
Models used in ERM framework
APT for passive portfolio management
Debt overhang
Nonparametric VaR
27. When two payments are exchanged the same day and one party may default after payment is made
Parametric VaR
Settlement risk
Exposure
Liquidity risk
28. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Operational risk
Market risk
Capital market line (CML)
Treynor measure
29. 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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30. Modeling approach is typically between statistical analytic models and structural simulation models
Where is risk coming from
Models used in ERM framework
Financial risks
Kidder Peabody
31. Long Term Capital Management - Renowned quants produced great returns with arbitrage- type trades - Unexpected and extreme events resulted in devaluation of Russian Rouble - resulting in a 3.65 billion dollar bailout - Failure to account for illiquid
Ways risk can be mismeasured
VaR - Value at Risk
LTCM
CAPM (formula)
32. Prices of risk are common factors and do not change - Sensitivities can change
Sharpe measure
Prices of risk vs sensitivity
CAPM (formula)
Asset liquidity risk
33. Losses due to market activities ex. Interest rate changes or defaults
Allied Irish Bank
Nonparametric VaR
Carry- backs and carry- forwards
Financial risks
34. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
VaR - Value at Risk
Nonparametric VaR
Prices of risk vs sensitivity
Risks excluded from operational risk
35. Cannot exit position in market due to size of the position
Shape of portfolio possibilities curve
Capital market line (CML)
Multi- period version of CAPM
Asset liquidity risk
36. 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
Risks excluded from operational risk
Drysdale Securities (Chase Manhattan)
Shortcomings of risk metrics
Nonmarketable asset impact on CAPM
37. Probability that a random variable falls below a specified threshold level
Risk types addressed by ERM
Parametric VaR
Shortfall risk
CAPM with taxes included (equation)
38. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Sovereign risk
Operational risk
Shape of portfolio possibilities curve
Ri = Rz + (gamma)(beta)
39. Asses firm risks - Communicate risks - Manage and monitor risks
Treynor measure
EPD or ECOR - Expected Policyholder Deficit (EPD)
Ten assumptions underlying CAPM
Roles of risk management
40. Hazard - Financial - Operational - Strategic
Nonmarketable asset impact on CAPM
Derivative contract
Risk types addressed by ERM
Uncertainty
41. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Formula for covariance
Liquidity risk
Nonmarketable asset impact on CAPM
CAPM (formula)
42. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Efficient frontier
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Where is risk coming from
Zero- beta CAPM (two factor model)
43. Return is linearly related to growth rate in consumption
Shortcomings of risk metrics
Settlement risk
Risk
Multi- period version of CAPM
44. Absolute and relative risk - direction and non-directional
Operational risk
VaR - Value at Risk
Forms of Market risk
APT (equation and assumptions)
45. Rp = XaRa + XbRb
Volatility Market risk
BTR - Below Target Risk
Expected return of two assets
CAPM (formula)
46. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Sharpe measure
Nonparametric VaR
Basis
Uncertainty
47. Unanticipated movements in relative prices of assets in hedged position
Contango
Source of need for risk management
What lead to the exponential growth to derivatives mkt?
Basic Market risk
48. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
APT for passive portfolio management
Treynor measure
Risk- adjusted performance measure (RAP)
Market imperfections that can create value
49. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Risks excluded from operational risk
Debt overhang
Debt overhang
Information ratio
50. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Models used in ERM framework
Recovery rate
Settlement risk
Effect of heterogeneous expectations on CAPM