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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. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Shortfall risk
Security (primary vs secondary)
Risks excluded from operational risk
Shortcomings of risk metrics
2. 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
Expected return of two assets
Nonmarketable asset impact on CAPM
Allied Irish Bank
Ri = Rz + (gamma)(beta)
3. Need to assess risk and tell management so they can determine which risks to take on
Tracking error
Importance of communication for risk managers
Four major types of risk
Contango
4. Multibeta CAPM Ri - Rf =
Traits of ERM
Risk- adjusted performance measure (RAP)
Shortcomings of risk metrics
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
5. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Solve for minimum variance portfolio
CAPM assumption for EMH
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Debt overhang
6. Wrong distribution - Historical sample may not apply
CAPM with taxes included (equation)
Ways risk can be mismeasured
CAPM assumption for EMH
Importance of communication for risk managers
7. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
3 main types of operational risk
Sovereign risk
Parametric VaR
Credit event
8. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Operational risk
Zero- beta CAPM (two factor model)
Drysdale Securities (Chase Manhattan)
Standard deviation of two assets
9. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Sovereign risk
Basis
Market risk
Parametric VaR
10. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Security (primary vs secondary)
Morningstar Rating System
Debt overhang
Formula for covariance
11. Cannot exit position in market due to size of the position
VaR - Value at Risk
Asset liquidity risk
CAPM (formula)
Uncertainty
12. Changes in vol - implied or actual
Models used in ERM framework
Tax shield
Volatility Market risk
Security (primary vs secondary)
13. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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14. Rp = XaRa + XbRb
Parametric VaR
Risk
Nonmarketable asset impact on CAPM
Expected return of two assets
15. Law of one price - Homogeneous expectations - Security returns process
RAR = relative return of portfolio (RRp)
Risk types addressed by ERM
Risk
APT (equation and assumptions)
16. The lower (closer to - 1) - the higher the payoff from diversification
BTR - Below Target Risk
Ri = ai + bi1l1 + bi2l2....+ei
Correlation coefficient effect on diversification
Importance of communication for risk managers
17. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Morningstar Rating System
Business risks
Settlement risk
VaR - Value at Risk
18. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Sovereign risk
Nonparametric VaR
BTR - Below Target Risk
Tracking error
19. Probability that a random variable falls below a specified threshold level
Jensen's alpha
Shortfall risk
Basic Market risk
Roles of risk management
20. Relative portfolio risk (RRiskp) - Based on a one- month investment period
RAR = relative return of portfolio (RRp)
Importance of communication for risk managers
Derivative contract
Practical considerations related to ERM implementatio
21. Future price is greater than the spot price
Debt overhang
BTR - Below Target Risk
Business risks
Contango
22. 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
Information ratio
Valuation vs. Risk management
Kidder Peabody
CAPM with taxes included (equation)
23. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
VaR- based analysis (formula)
Security (primary vs secondary)
Ways risk can be mismeasured
Three main reasons for financial disasters
24. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Expected return of two assets
Morningstar Rating System
3 main types of operational risk
Basis risk
25. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Practical considerations related to ERM implementatio
Four major types of risk
Performance- related metrics
Nonmarketable asset impact on CAPM
26. Inability to make payment obligations (ex. Margin calls)
Funding liquidity risk
Forms of Market risk
Basis
Options motivation on volatility
27. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Kidder Peabody
Credit event
Standard deviation of two assets
LTCM
28. Quantile of an empirical distribution
Ri = ai + bi1l1 + bi2l2....+ei
Nonparametric VaR
Nonmarketable asset impact on CAPM
APT (equation and assumptions)
29. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Importance of communication for risk managers
Exposure
APT in active portfolio management
Information ratio
30. Strategic risk - Business risk - Reputational risk
Correlation coefficient effect on diversification
Banker's Trust
Risks excluded from operational risk
Jensen's alpha
31. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Source of need for risk management
EPD or ECOR - Expected Policyholder Deficit (EPD)
Standard deviation of two assets
Recovery rate
32. Asses firm risks - Communicate risks - Manage and monitor risks
Roles of risk management
Solvency-related metrics
Models used in ERM framework
What lead to the exponential growth to derivatives mkt?
33. 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
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Practical considerations related to ERM implementatio
Uncertainty
Capital market line (CML)
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
Importance of communication for risk managers
Risk types addressed by ERM
APT for passive portfolio management
Standard deviation of two assets
35. Capital structure (financial distress) - Taxes - Agency and information asymmetries
VaR- based analysis (formula)
Market imperfections that can create value
Forms of Market risk
Practical considerations related to ERM implementatio
36. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Debt overhang
Exposure
Business risks
Solvency-related metrics
37. 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
Parametric VaR
VaR- based analysis (formula)
Shortfall risk
38. Covariance = correlation coefficient std dev(a) std dev(b)
APT (equation and assumptions)
Barings
3 main types of operational risk
Formula for covariance
39. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Information ratio
Solve for minimum variance portfolio
Options motivation on volatility
Financial Risk
40. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Differences in financial risk management for financial companies vs industrial companies
Solvency-related metrics
Nonmarketable asset impact on CAPM
Importance of communication for risk managers
41. Interest rate movements - derivatives - defaults
Performance- related metrics
Financial Risk
Carry- backs and carry- forwards
LTCM
42. 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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43. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Market imperfections that can create value
Kidder Peabody
Standard deviation of two assets
Forms of Market risk
44. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Debt overhang
Roles of risk management
Banker's Trust
Business risks
45. Both probability and cost of tail events are considered
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Contango
Sharpe measure
VaR- based analysis (formula)
46. Risk of loses owing to movements in level or volatility of market prices
Risk
APT (equation and assumptions)
VaR- based analysis (formula)
Market risk
47. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Kidder Peabody
Differences in financial risk management for financial companies vs industrial companies
Risk- adjusted performance measure (RAP)
Shortfall risk
48. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Risk
Credit event
Asset transformers
Correlation coefficient effect on diversification
49. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Information ratio
APT in active portfolio management
RAR = relative return of portfolio (RRp)
Correlation coefficient effect on diversification
50. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Operational risk
Liquidity risk
Traits of ERM
Prices of risk vs sensitivity