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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.
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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. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Solve for minimum variance portfolio
Business risks
Models used in ERM framework
Operational risk
2. When negative taxable income is moved to a different year to offset future or past taxable income
Sharpe measure
Carry- backs and carry- forwards
Formula for covariance
Exposure
3. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Asset transformers
BTR - Below Target Risk
Morningstar Rating System
Derivative contract
4. Strategic risk - Business risk - Reputational risk
Effect of heterogeneous expectations on CAPM
Risks excluded from operational risk
Debt overhang
Exposure
5. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Ri = ai + bi1l1 + bi2l2....+ei
Effect of heterogeneous expectations on CAPM
Banker's Trust
Differences in financial risk management for financial companies vs industrial companies
6. When two payments are exchanged the same day and one party may default after payment is made
Tax shield
Importance of communication for risk managers
Settlement risk
Business Risk
7. 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.
Capital market line (CML)
Nonparametric VaR
Exposure
Risk Management Irrelevance Proposition
8. Unanticipated movements in relative prices of assets in hedged position
Volatility Market risk
Options motivation on volatility
Operational risk
Basic Market risk
9. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
CAPM (formula)
Tail VaR or TCE - Tail Conditional Expectation(TCE)
CAPM with taxes included (equation)
Basis
10. Future price is greater than the spot price
Differences in financial risk management for financial companies vs industrial companies
Derivative contract
VaR- based analysis (formula)
Contango
11. Returns on any stock are linearly related to a set of indexes
Settlement risk
Basis risk
Sortino ratio
Ri = ai + bi1l1 + bi2l2....+ei
12. Asset-liability/market-liquidity risk
Liquidity risk
RAR = relative return of portfolio (RRp)
Settlement risk
BTR - Below Target Risk
13. Cannot exit position in market due to size of the position
Parametric VaR
Valuation vs. Risk management
Asset liquidity risk
Standard deviation of two assets
14. Asses firm risks - Communicate risks - Manage and monitor risks
Effect of non- price- taking behavior on CAPM
Sortino ratio
Ri = ai + bi1l1 + bi2l2....+ei
Roles of risk management
15. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
APT in active portfolio management
Uncertainty
Importance of communication for risk managers
Debt overhang
16. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Operational risk
Shortfall risk
Sortino ratio
Expected return of two assets
17. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Effect of non- price- taking behavior on CAPM
Ri = Rz + (gamma)(beta)
Zero- beta CAPM (two factor model)
Debt overhang
18. Hazard - Financial - Operational - Strategic
Information ratio
Four major types of risk
Risk types addressed by ERM
Financial risks
19. 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
Formula for covariance
Recovery rate
Practical considerations related to ERM implementatio
Multi- period version of CAPM
20. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Information ratio
Risk- adjusted performance measure (RAP)
Banker's Trust
Sovereign risk
21. 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
Kidder Peabody
Jensen's alpha
Shape of portfolio possibilities curve
Recovery rate
22. Occurs the day when two parties exchange payments same day
Business risks
Treynor measure
Shortcomings of risk metrics
Settlement risk
23. Potential amount that can be lost
Zero- beta CAPM (two factor model)
Exposure
Capital market line (CML)
Solve for minimum variance portfolio
24. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Ri = ai + bi1l1 + bi2l2....+ei
CAPM (formula)
Business risks
Carry- backs and carry- forwards
25. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Where is risk coming from
Volatility Market risk
Correlation coefficient effect on diversification
Asset transformers
26. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Market risk
Asset liquidity risk
Derivative contract
Business risks
27. 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
Debt overhang
Financial risks
Risk
28. Both probability and cost of tail events are considered
Solvency-related metrics
Tail VaR or TCE - Tail Conditional Expectation(TCE)
CAPM (formula)
Contango
29. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Market risk
Nonmarketable asset impact on CAPM
Information ratio
Traits of ERM
30. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Importance of communication for risk managers
Standard deviation of two assets
Risk
APT (equation and assumptions)
31. CAPM requires the strong form of the Efficient Market Hypothesis = private information
CAPM assumption for EMH
Importance of communication for risk managers
RAR = relative return of portfolio (RRp)
Carry- backs and carry- forwards
32. Interest rate movements - derivatives - defaults
Credit event
Financial Risk
Nonparametric VaR
Business Risk
33. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
EPD or ECOR - Expected Policyholder Deficit (EPD)
BTR - Below Target Risk
Treynor measure
Tail VaR or TCE - Tail Conditional Expectation(TCE)
34. 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
LTCM
Market risk
Importance of communication for risk managers
APT for passive portfolio management
35. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Ri = Rz + (gamma)(beta)
Funding liquidity risk
Basis risk
Debt overhang
36. 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
Barings
CAPM (formula)
Three main reasons for financial disasters
BTR - Below Target Risk
37. 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
VaR - Value at Risk
Drysdale Securities (Chase Manhattan)
Basis
Importance of communication for risk managers
38. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Asset transformers
Sortino ratio
Settlement risk
Asset liquidity risk
39. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Financial risks
Operational risk
Liquidity risk
VaR - Value at Risk
40. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Sharpe measure
Effect of non- price- taking behavior on CAPM
Ri = ai + bi1l1 + bi2l2....+ei
CAPM with taxes included (equation)
41. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Credit event
Debt overhang
APT in active portfolio management
Standard deviation of two assets
42. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Effect of non- price- taking behavior on CAPM
Security (primary vs secondary)
RAR = relative return of portfolio (RRp)
Recovery rate
43. Prices of risk are common factors and do not change - Sensitivities can change
Information ratio
Prices of risk vs sensitivity
Ways firms can fail to account for risks
Risk
44. 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
Zero- beta CAPM (two factor model)
Allied Irish Bank
Shortcomings of risk metrics
Traits of ERM
45. Multibeta CAPM Ri - Rf =
Risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Performance- related metrics
46. Quantile of a statistical distribution
Four major types of risk
Parametric VaR
Derivative contract
Importance of communication for risk managers
47. The uses of debt to fall into a lower tax rate
Kidder Peabody
Tax shield
Models used in ERM framework
Funding liquidity risk
48. Firms became multinational - - >watched xchange rates more - deregulation and globalization
BTR - Below Target Risk
Asset transformers
Ten assumptions underlying CAPM
Firms becoming more sensitive to changes(bank deregulation)
49. Law of one price - Homogeneous expectations - Security returns process
Risks excluded from operational risk
Models used in ERM framework
Liquidity risk
APT (equation and assumptions)
50. 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
Zero- beta CAPM (two factor model)
Performance- related metrics
LTCM
Business risks