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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. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Performance- related metrics
Differences in financial risk management for financial companies vs industrial companies
3 main types of operational risk
Market imperfections that can create value
2. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Morningstar Rating System
Sovereign risk
Three main reasons for financial disasters
Basis
3. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Efficient frontier
Zero- beta CAPM (two factor model)
Firms becoming more sensitive to changes(bank deregulation)
Solve for minimum variance portfolio
4. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Debt overhang
Options motivation on volatility
Ten assumptions underlying CAPM
Formula for covariance
5. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Effect of non- price- taking behavior on CAPM
Traits of ERM
Nonmarketable asset impact on CAPM
CAPM (formula)
6. 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
Settlement risk
Risk
Information ratio
Traits of ERM
7. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Zero- beta CAPM (two factor model)
CAPM (formula)
Four major types of risk
Barings
8. Unanticipated movements in relative prices of assets in hedged position
Nonparametric VaR
Carry- backs and carry- forwards
Basic Market risk
Risk- adjusted performance measure (RAP)
9. Returns on any stock are linearly related to a set of indexes
Risk Management Irrelevance Proposition
CAPM with taxes included (equation)
Ri = ai + bi1l1 + bi2l2....+ei
Risk
10. 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
LTCM
3 main types of operational risk
Risk
Allied Irish Bank
11. Rp = XaRa + XbRb
Expected return of two assets
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Operational risk
Information ratio
12. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Four major types of risk
APT in active portfolio management
Probability of ruin
VaR - Value at Risk
13. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
VaR - Value at Risk
APT (equation and assumptions)
Security (primary vs secondary)
Market risk
14. Expected value of unfavorable deviations of a random variable from a specified target level
Treynor measure
Kidder Peabody
Recovery rate
BTR - Below Target Risk
15. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Recovery rate
Debt overhang
Funding liquidity risk
Liquidity risk
16. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Effect of heterogeneous expectations on CAPM
Morningstar Rating System
Basis risk
Multi- period version of CAPM
17. Future price is greater than the spot price
Contango
Formula for covariance
Volatility Market risk
Barings
18. The uses of debt to fall into a lower tax rate
Business Risk
Tax shield
CAPM with taxes included (equation)
Risk
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
Uncertainty
Practical considerations related to ERM implementatio
Basis
Roles of risk management
20. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Business Risk
Carry- backs and carry- forwards
Operational risk
Ways risk can be mismeasured
21. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
CAPM with taxes included (equation)
Multi- period version of CAPM
Firms becoming more sensitive to changes(bank deregulation)
Credit event
22. 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
Derivative contract
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Source of need for risk management
Ways firms can fail to account for risks
23. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Where is risk coming from
Solvency-related metrics
Sharpe measure
Ri = ai + bi1l1 + bi2l2....+ei
24. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Four major types of risk
Treynor measure
Morningstar Rating System
Differences in financial risk management for financial companies vs industrial companies
25. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Settlement risk
Effect of non- price- taking behavior on CAPM
Effect of heterogeneous expectations on CAPM
Risk
26. 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
Efficient frontier
Solve for minimum variance portfolio
Shape of portfolio possibilities curve
Kidder Peabody
27. Wrong distribution - Historical sample may not apply
Shape of portfolio possibilities curve
Four major types of risk
Ways risk can be mismeasured
APT (equation and assumptions)
28. Losses due to market activities ex. Interest rate changes or defaults
Effect of heterogeneous expectations on CAPM
Debt overhang
Basis
Financial risks
29. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
What lead to the exponential growth to derivatives mkt?
Settlement risk
Tracking error
Firms becoming more sensitive to changes(bank deregulation)
30. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Ten assumptions underlying CAPM
Practical considerations related to ERM implementatio
Firms becoming more sensitive to changes(bank deregulation)
Business risks
31. Market risk - Liquidity risk - Credit risk - Operational risk
Derivative contract
Ways risk can be mismeasured
Four major types of risk
Risks excluded from operational risk
32. 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
Valuation vs. Risk management
Solve for minimum variance portfolio
Tail VaR or TCE - Tail Conditional Expectation(TCE)
LTCM
33. Volatility of unexpected outcomes
Risk
Three main reasons for financial disasters
Business risks
Forms of Market risk
34. Covariance = correlation coefficient std dev(a) std dev(b)
Formula for covariance
CAPM assumption for EMH
Parametric VaR
Expected return of two assets
35. 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
Jensen's alpha
Multi- period version of CAPM
Uncertainty
Probability of ruin
36. Quantile of an empirical distribution
Liquidity risk
Nonparametric VaR
Shortfall risk
Risk types addressed by ERM
37. The lower (closer to - 1) - the higher the payoff from diversification
APT for passive portfolio management
Ri = ai + bi1l1 + bi2l2....+ei
Correlation coefficient effect on diversification
Sovereign risk
38. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Models used in ERM framework
Performance- related metrics
Differences in financial risk management for financial companies vs industrial companies
Nonmarketable asset impact on CAPM
39. Interest rate movements - derivatives - defaults
Nonparametric VaR
Business risks
Financial Risk
Sharpe measure
40. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Three main reasons for financial disasters
Risk types addressed by ERM
Liquidity risk
Operational risk
41. The need to hedge against risks - for firms need to speculate.
What lead to the exponential growth to derivatives mkt?
Four major types of risk
Multi- period version of CAPM
Valuation vs. Risk management
42. Cannot exit position in market due to size of the position
Asset liquidity risk
APT for passive portfolio management
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Exposure
43. 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.
Risk Management Irrelevance Proposition
Settlement risk
VaR- based analysis (formula)
Expected return of two assets
44. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
What lead to the exponential growth to derivatives mkt?
Jensen's alpha
Financial risks
Information ratio
45. Asset-liability/market-liquidity risk
Effect of heterogeneous expectations on CAPM
Contango
Liquidity risk
Derivative contract
46. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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47. Quantile of a statistical distribution
Parametric VaR
Morningstar Rating System
Financial risks
LTCM
48. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Differences in financial risk management for financial companies vs industrial companies
Information ratio
Liquidity risk
Solvency-related metrics
49. Absolute and relative risk - direction and non-directional
Business risks
Forms of Market risk
CAPM assumption for EMH
Carry- backs and carry- forwards
50. Inability to make payment obligations (ex. Margin calls)
Roles of risk management
Funding liquidity risk
Shortcomings of risk metrics
Ways risk can be mismeasured