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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. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Expected return of two assets
Financial Risk
Risk
Ri = Rz + (gamma)(beta)
2. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
BTR - Below Target Risk
Risk Management Irrelevance Proposition
Financial Risk
Standard deviation of two assets
3. The uses of debt to fall into a lower tax rate
Efficient frontier
BTR - Below Target Risk
Carry- backs and carry- forwards
Tax shield
4. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Three main reasons for financial disasters
Treynor measure
Expected return of two assets
Effect of heterogeneous expectations on CAPM
5. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Four major types of risk
Exposure
Solvency-related metrics
Barings
6. 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.
EPD or ECOR - Expected Policyholder Deficit (EPD)
Settlement risk
Security (primary vs secondary)
Risk Management Irrelevance Proposition
7. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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8. Prices of risk are common factors and do not change - Sensitivities can change
Prices of risk vs sensitivity
Importance of communication for risk managers
Market risk
CAPM with taxes included (equation)
9. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Recovery rate
RAR = relative return of portfolio (RRp)
Liquidity risk
Risk
10. 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
Uncertainty
Risk
Probability of ruin
Banker's Trust
11. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Practical considerations related to ERM implementatio
VaR - Value at Risk
Allied Irish Bank
Debt overhang
12. Covariance = correlation coefficient std dev(a) std dev(b)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
3 main types of operational risk
Importance of communication for risk managers
Formula for covariance
13. Changes in vol - implied or actual
EPD or ECOR - Expected Policyholder Deficit (EPD)
Volatility Market risk
Practical considerations related to ERM implementatio
Debt overhang
14. The need to hedge against risks - for firms need to speculate.
Shape of portfolio possibilities curve
CAPM (formula)
APT for passive portfolio management
What lead to the exponential growth to derivatives mkt?
15. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Parametric VaR
Recovery rate
EPD or ECOR - Expected Policyholder Deficit (EPD)
Multi- period version of CAPM
16. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Three main reasons for financial disasters
VaR - Value at Risk
Roles of risk management
Debt overhang
17. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Operational risk
Market imperfections that can create value
Carry- backs and carry- forwards
CAPM with taxes included (equation)
18. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Tax shield
APT in active portfolio management
3 main types of operational risk
BTR - Below Target Risk
19. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Four major types of risk
Allied Irish Bank
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Basis
20. 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
APT for passive portfolio management
Security (primary vs secondary)
Risk
21. Need to assess risk and tell management so they can determine which risks to take on
Importance of communication for risk managers
Carry- backs and carry- forwards
Asset transformers
Allied Irish Bank
22. Volatility of unexpected outcomes
Market imperfections that can create value
Risk
Exposure
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
23. 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
Settlement risk
Debt overhang
Basis
APT for passive portfolio management
24. Probability distribution is unknown (ex. A terrorist attack)
Uncertainty
BTR - Below Target Risk
Nonmarketable asset impact on CAPM
Operational risk
25. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Valuation vs. Risk management
Debt overhang
Ri = Rz + (gamma)(beta)
Carry- backs and carry- forwards
26. Modeling approach is typically between statistical analytic models and structural simulation models
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Zero- beta CAPM (two factor model)
Models used in ERM framework
CAPM (formula)
27. Probability that a random variable falls below a specified threshold level
3 main types of operational risk
Practical considerations related to ERM implementatio
Shortfall risk
Settlement risk
28. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Market imperfections that can create value
Solve for minimum variance portfolio
Credit event
Solvency-related metrics
29. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Firms becoming more sensitive to changes(bank deregulation)
Morningstar Rating System
Security (primary vs secondary)
Ri = Rz + (gamma)(beta)
30. Return is linearly related to growth rate in consumption
Jensen's alpha
Uncertainty
Practical considerations related to ERM implementatio
Multi- period version of CAPM
31. 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
Carry- backs and carry- forwards
Ten assumptions underlying CAPM
Information ratio
32. Derives value from an underlying asset - rate - or index - Derives value from a security
Risk
Derivative contract
3 main types of operational risk
APT for passive portfolio management
33. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Operational risk
CAPM assumption for EMH
RAR = relative return of portfolio (RRp)
Asset liquidity risk
34. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Zero- beta CAPM (two factor model)
Practical considerations related to ERM implementatio
Business Risk
Morningstar Rating System
35. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Market risk
Sortino ratio
Solve for minimum variance portfolio
EPD or ECOR - Expected Policyholder Deficit (EPD)
36. Occurs the day when two parties exchange payments same day
Four major types of risk
Carry- backs and carry- forwards
Settlement risk
Source of need for risk management
37. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Tail VaR or TCE - Tail Conditional Expectation(TCE)
BTR - Below Target Risk
Funding liquidity risk
VaR - Value at Risk
38. Interest rate movements - derivatives - defaults
Source of need for risk management
Capital market line (CML)
Financial Risk
Ten assumptions underlying CAPM
39. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Forms of Market risk
CAPM with taxes included (equation)
Debt overhang
Ri = Rz + (gamma)(beta)
40. Inability to make payment obligations (ex. Margin calls)
Funding liquidity risk
Business risks
Debt overhang
Standard deviation of two assets
41. Quantile of a statistical distribution
LTCM
Ten assumptions underlying CAPM
Parametric VaR
Settlement risk
42. Potential amount that can be lost
Risk- adjusted performance measure (RAP)
Probability of ruin
APT (equation and assumptions)
Exposure
43. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Tracking error
Credit event
Risk
Probability of ruin
44. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Ways firms can fail to account for risks
Settlement risk
Recovery rate
Security (primary vs secondary)
45. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Jensen's alpha
Correlation coefficient effect on diversification
Three main reasons for financial disasters
Firms becoming more sensitive to changes(bank deregulation)
46. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Models used in ERM framework
Traits of ERM
Sovereign risk
Performance- related metrics
47. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
BTR - Below Target Risk
Funding liquidity risk
Ways risk can be mismeasured
Effect of heterogeneous expectations on CAPM
48. Absolute and relative risk - direction and non-directional
Effect of non- price- taking behavior on CAPM
Solve for minimum variance portfolio
Forms of Market risk
VaR - Value at Risk
49. Losses due to market activities ex. Interest rate changes or defaults
Risk
Basic Market risk
Parametric VaR
Financial risks
50. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Correlation coefficient effect on diversification
Shortfall risk
Sovereign risk
Settlement risk