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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. Market risk - Liquidity risk - Credit risk - Operational risk
CAPM (formula)
Four major types of risk
Expected return of two assets
What lead to the exponential growth to derivatives mkt?
2. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Parametric VaR
VaR- based analysis (formula)
Tracking error
Carry- backs and carry- forwards
3. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Information ratio
Uncertainty
Sovereign risk
Effect of heterogeneous expectations on CAPM
4. 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
Importance of communication for risk managers
Ten assumptions underlying CAPM
VaR - Value at Risk
5. When negative taxable income is moved to a different year to offset future or past taxable income
Debt overhang
Carry- backs and carry- forwards
Expected return of two assets
Correlation coefficient effect on diversification
6. 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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7. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Risk
RAR = relative return of portfolio (RRp)
Zero- beta CAPM (two factor model)
Where is risk coming from
8. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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9. Quantile of a statistical distribution
Shortcomings of risk metrics
Parametric VaR
APT in active portfolio management
Risk- adjusted performance measure (RAP)
10. The uses of debt to fall into a lower tax rate
Jensen's alpha
Nonmarketable asset impact on CAPM
Tax shield
Three main reasons for financial disasters
11. May not scale over time- Historical data may be meaningless - Not designed to account for catastrophes - VaR says nothing about losses in excess of VaR - May not handle sudden illiquidity
VaR- based analysis (formula)
Shortcomings of risk metrics
Importance of communication for risk managers
Settlement risk
12. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Barings
Nonparametric VaR
Standard deviation of two assets
13. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Firms becoming more sensitive to changes(bank deregulation)
Differences in financial risk management for financial companies vs industrial companies
Business Risk
Recovery rate
14. Returns on any stock are linearly related to a set of indexes
What lead to the exponential growth to derivatives mkt?
Ri = ai + bi1l1 + bi2l2....+ei
Practical considerations related to ERM implementatio
Sharpe measure
15. Probability distribution is unknown (ex. A terrorist attack)
APT for passive portfolio management
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Volatility Market risk
Uncertainty
16. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Operational risk
Performance- related metrics
Barings
Volatility Market risk
17. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Market risk
Shape of portfolio possibilities curve
Debt overhang
Three main reasons for financial disasters
18. Probability that a random variable falls below a specified threshold level
Forms of Market risk
Recovery rate
Shortfall risk
Contango
19. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Effect of heterogeneous expectations on CAPM
Debt overhang
Importance of communication for risk managers
Effect of non- price- taking behavior on CAPM
20. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Standard deviation of two assets
Financial risks
EPD or ECOR - Expected Policyholder Deficit (EPD)
Jensen's alpha
21. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Four major types of risk
Basis risk
Where is risk coming from
Debt overhang
22. Potential amount that can be lost
Zero- beta CAPM (two factor model)
Practical considerations related to ERM implementatio
Exposure
Derivative contract
23. Wrong distribution - Historical sample may not apply
Jensen's alpha
Ways risk can be mismeasured
VaR- based analysis (formula)
Contango
24. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
3 main types of operational risk
Basis
Nonmarketable asset impact on CAPM
Morningstar Rating System
25. Unanticipated movements in relative prices of assets in hedged position
Basic Market risk
Settlement risk
Risks excluded from operational risk
Operational risk
26. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Three main reasons for financial disasters
Allied Irish Bank
APT (equation and assumptions)
Carry- backs and carry- forwards
27. Curve must be concave - Straight line connecting any two points must be under the curve
What lead to the exponential growth to derivatives mkt?
Zero- beta CAPM (two factor model)
Shape of portfolio possibilities curve
Tax shield
28. The lower (closer to - 1) - the higher the payoff from diversification
Shape of portfolio possibilities curve
Carry- backs and carry- forwards
Performance- related metrics
Correlation coefficient effect on diversification
29. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Derivative contract
Differences in financial risk management for financial companies vs industrial companies
Basis
Source of need for risk management
30. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Financial risks
CAPM (formula)
Tax shield
Sortino ratio
31. 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
Correlation coefficient effect on diversification
Sharpe measure
Credit event
Capital market line (CML)
32. Multibeta CAPM Ri - Rf =
Shortcomings of risk metrics
Multi- period version of CAPM
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Tail VaR or TCE - Tail Conditional Expectation(TCE)
33. 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
Valuation vs. Risk management
Where is risk coming from
Risk- adjusted performance measure (RAP)
Allied Irish Bank
34. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Probability of ruin
Business risks
Contango
Exposure
35. Law of one price - Homogeneous expectations - Security returns process
Barings
Shortcomings of risk metrics
APT (equation and assumptions)
Models used in ERM framework
36. 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
Capital market line (CML)
Probability of ruin
Nonmarketable asset impact on CAPM
VaR - Value at Risk
37. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Capital market line (CML)
LTCM
3 main types of operational risk
Risk types addressed by ERM
38. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Expected return of two assets
Shape of portfolio possibilities curve
Firms becoming more sensitive to changes(bank deregulation)
Forms of Market risk
39. Inability to make payment obligations (ex. Margin calls)
Prices of risk vs sensitivity
Multi- period version of CAPM
Basis risk
Funding liquidity risk
40. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Source of need for risk management
Sortino ratio
Sovereign risk
Effect of non- price- taking behavior on CAPM
41. Return is linearly related to growth rate in consumption
Multi- period version of CAPM
Financial Risk
Risk
Shortcomings of risk metrics
42. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Sovereign risk
Risk
APT for passive portfolio management
APT in active portfolio management
43. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Nonparametric VaR
LTCM
Prices of risk vs sensitivity
Operational risk
44. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Options motivation on volatility
Liquidity risk
Ri = Rz + (gamma)(beta)
Shortfall risk
45. Future price is greater than the spot price
Asset liquidity risk
Contango
Carry- backs and carry- forwards
Sortino ratio
46. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Source of need for risk management
Debt overhang
APT (equation and assumptions)
Ri = ai + bi1l1 + bi2l2....+ei
47. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Security (primary vs secondary)
Treynor measure
Financial Risk
What lead to the exponential growth to derivatives mkt?
48. Expected value of unfavorable deviations of a random variable from a specified target level
What lead to the exponential growth to derivatives mkt?
Shortcomings of risk metrics
BTR - Below Target Risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
49. The need to hedge against risks - for firms need to speculate.
Basis risk
What lead to the exponential growth to derivatives mkt?
Barings
LTCM
50. 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
Probability of ruin
Business risks
APT for passive portfolio management
Asset liquidity risk