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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. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Efficient frontier
Uncertainty
Derivative contract
Treynor measure
2. 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
Performance- related metrics
Capital market line (CML)
APT in active portfolio management
Asset transformers
3. Asset-liability/market-liquidity risk
Risk
Three main reasons for financial disasters
Liquidity risk
Sortino ratio
4. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Risk Management Irrelevance Proposition
EPD or ECOR - Expected Policyholder Deficit (EPD)
Source of need for risk management
Standard deviation of two assets
5. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Ten assumptions underlying CAPM
Settlement risk
3 main types of operational risk
Market imperfections that can create value
6. Relative portfolio risk (RRiskp) - Based on a one- month investment period
RAR = relative return of portfolio (RRp)
Allied Irish Bank
Shortcomings of risk metrics
APT (equation and assumptions)
7. Both probability and cost of tail events are considered
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Liquidity risk
Settlement risk
Security (primary vs secondary)
8. Probability that a random variable falls below a specified threshold level
Tax shield
Shortfall risk
Shortcomings of risk metrics
Banker's Trust
9. Covariance = correlation coefficient std dev(a) std dev(b)
Formula for covariance
Asset liquidity risk
Liquidity risk
Nonmarketable asset impact on CAPM
10. 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
APT (equation and assumptions)
Risk
Formula for covariance
Ways firms can fail to account for risks
11. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Solve for minimum variance portfolio
Risk- adjusted performance measure (RAP)
CAPM (formula)
Risk types addressed by ERM
12. 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 Management Irrelevance Proposition
Traits of ERM
Efficient frontier
13. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Probability of ruin
VaR - Value at Risk
Uncertainty
Sharpe measure
14. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Valuation vs. Risk management
VaR- based analysis (formula)
Sortino ratio
Barings
15. 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
LTCM
Models used in ERM framework
Performance- related metrics
BTR - Below Target Risk
16. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Liquidity risk
Standard deviation of two assets
CAPM assumption for EMH
Ri = Rz + (gamma)(beta)
17. Quantile of an empirical distribution
Nonparametric VaR
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
CAPM with taxes included (equation)
Multi- period version of CAPM
18. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
CAPM with taxes included (equation)
Basis risk
Ri = Rz + (gamma)(beta)
CAPM (formula)
19. 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
Standard deviation of two assets
Four major types of risk
Probability of ruin
Nonmarketable asset impact on CAPM
20. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Source of need for risk management
Kidder Peabody
Ri = Rz + (gamma)(beta)
Practical considerations related to ERM implementatio
21. Concave function that extends from minimum variance portfolio to maximum return portfolio
Effect of non- price- taking behavior on CAPM
Efficient frontier
Information ratio
Settlement risk
22. The uses of debt to fall into a lower tax rate
Tax shield
Performance- related metrics
Settlement risk
Correlation coefficient effect on diversification
23. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Solve for minimum variance portfolio
VaR - Value at Risk
Financial Risk
Exposure
24. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Risk- adjusted performance measure (RAP)
Firms becoming more sensitive to changes(bank deregulation)
Financial Risk
CAPM (formula)
25. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Sovereign risk
Source of need for risk management
VaR - Value at Risk
Options motivation on volatility
26. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Debt overhang
Market imperfections that can create value
Four major types of risk
Financial risks
27. Multibeta CAPM Ri - Rf =
Settlement risk
Financial risks
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
APT (equation and assumptions)
28. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Performance- related metrics
Uncertainty
Traits of ERM
CAPM assumption for EMH
29. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Risk
Multi- period version of CAPM
Market imperfections that can create value
Effect of heterogeneous expectations on CAPM
30. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Differences in financial risk management for financial companies vs industrial companies
Operational risk
Solve for minimum variance portfolio
Debt overhang
31. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Zero- beta CAPM (two factor model)
Tracking error
Risk
Kidder Peabody
32. 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
Business Risk
RAR = relative return of portfolio (RRp)
Morningstar Rating System
Parametric VaR
33. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Shortcomings of risk metrics
Nonmarketable asset impact on CAPM
Debt overhang
Differences in financial risk management for financial companies vs industrial companies
34. Derives value from an underlying asset - rate - or index - Derives value from a security
Firms becoming more sensitive to changes(bank deregulation)
Barings
Recovery rate
Derivative contract
35. Absolute and relative risk - direction and non-directional
Forms of Market risk
Credit event
CAPM (formula)
Correlation coefficient effect on diversification
36. 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
Models used in ERM framework
Drysdale Securities (Chase Manhattan)
Risk- adjusted performance measure (RAP)
Ways firms can fail to account for risks
37. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Basis
Traits of ERM
Business risks
38. The lower (closer to - 1) - the higher the payoff from diversification
Correlation coefficient effect on diversification
Derivative contract
Expected return of two assets
Roles of risk management
39. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Information ratio
3 main types of operational risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Effect of non- price- taking behavior on CAPM
40. Volatility of unexpected outcomes
Market imperfections that can create value
Funding liquidity risk
Risk
Security (primary vs secondary)
41. Law of one price - Homogeneous expectations - Security returns process
Forms of Market risk
Uncertainty
APT (equation and assumptions)
Importance of communication for risk managers
42. When negative taxable income is moved to a different year to offset future or past taxable income
Carry- backs and carry- forwards
Importance of communication for risk managers
BTR - Below Target Risk
Derivative contract
43. Expected value of unfavorable deviations of a random variable from a specified target level
Shortfall risk
Roles of risk management
Importance of communication for risk managers
BTR - Below Target Risk
44. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Liquidity risk
CAPM with taxes included (equation)
Source of need for risk management
Forms of Market risk
45. Cannot exit position in market due to size of the position
Treynor measure
Expected return of two assets
Security (primary vs secondary)
Asset liquidity risk
46. 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
APT (equation and assumptions)
Morningstar Rating System
Shortcomings of risk metrics
47. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Market risk
APT in active portfolio management
Ways risk can be mismeasured
Formula for covariance
48. 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
Security (primary vs secondary)
Allied Irish Bank
Effect of non- price- taking behavior on CAPM
Practical considerations related to ERM implementatio
49. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Risk types addressed by ERM
Morningstar Rating System
Differences in financial risk management for financial companies vs industrial companies
Risks excluded from operational risk
50. 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
Source of need for risk management
Debt overhang
Treynor measure