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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
Four major types of risk
Tracking error
Risk- adjusted performance measure (RAP)
Prices of risk vs sensitivity
2. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Tracking error
CAPM (formula)
Treynor measure
Market imperfections that can create value
3. 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
Basic Market risk
Capital market line (CML)
Debt overhang
Credit event
4. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Basis
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Uncertainty
Morningstar Rating System
5. Risk of loses owing to movements in level or volatility of market prices
Market risk
Tax shield
Ri = ai + bi1l1 + bi2l2....+ei
Ways risk can be mismeasured
6. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Shortfall risk
Zero- beta CAPM (two factor model)
RAR = relative return of portfolio (RRp)
Banker's Trust
7. 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
Sharpe measure
Nonparametric VaR
Debt overhang
Probability of ruin
8. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Importance of communication for risk managers
Allied Irish Bank
Roles of risk management
Basis risk
9. Multibeta CAPM Ri - Rf =
Effect of heterogeneous expectations on CAPM
EPD or ECOR - Expected Policyholder Deficit (EPD)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
3 main types of operational risk
10. 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
APT for passive portfolio management
What lead to the exponential growth to derivatives mkt?
Treynor measure
Ten assumptions underlying CAPM
11. Prices of risk are common factors and do not change - Sensitivities can change
Asset liquidity risk
Kidder Peabody
Prices of risk vs sensitivity
Settlement risk
12. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Banker's Trust
Ways firms can fail to account for risks
Ri = ai + bi1l1 + bi2l2....+ei
VaR- based analysis (formula)
13. The lower (closer to - 1) - the higher the payoff from diversification
Ways risk can be mismeasured
Differences in financial risk management for financial companies vs industrial companies
Correlation coefficient effect on diversification
Kidder Peabody
14. Unanticipated movements in relative prices of assets in hedged position
Basic Market risk
Settlement risk
Roles of risk management
Shortfall risk
15. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Recovery rate
Market imperfections that can create value
Risk
Asset liquidity risk
16. Losses due to market activities ex. Interest rate changes or defaults
Credit event
Financial risks
Treynor measure
Correlation coefficient effect on diversification
17. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Ways risk can be mismeasured
Standard deviation of two assets
Treynor measure
Information ratio
18. Wrong distribution - Historical sample may not apply
Ways risk can be mismeasured
Risk Management Irrelevance Proposition
Market risk
Zero- beta CAPM (two factor model)
19. Return is linearly related to growth rate in consumption
Zero- beta CAPM (two factor model)
Parametric VaR
Multi- period version of CAPM
Basic Market risk
20. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Tracking error
Contango
Valuation vs. Risk management
Basis
21. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
VaR - Value at Risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Solvency-related metrics
Firms becoming more sensitive to changes(bank deregulation)
22. When negative taxable income is moved to a different year to offset future or past taxable income
APT in active portfolio management
Basis
Carry- backs and carry- forwards
Uncertainty
23. Concave function that extends from minimum variance portfolio to maximum return portfolio
Efficient frontier
VaR - Value at Risk
Sovereign risk
Barings
24. 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
Models used in ERM framework
Solvency-related metrics
Shortfall risk
Traits of ERM
25. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Shortfall risk
Financial Risk
Information ratio
Efficient frontier
26. Asses firm risks - Communicate risks - Manage and monitor risks
Shape of portfolio possibilities curve
What lead to the exponential growth to derivatives mkt?
Roles of risk management
Jensen's alpha
27. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
CAPM assumption for EMH
Banker's Trust
Sharpe measure
Effect of non- price- taking behavior on CAPM
28. Quantile of a statistical distribution
Solvency-related metrics
Expected return of two assets
Parametric VaR
Asset transformers
29. Absolute and relative risk - direction and non-directional
Forms of Market risk
Ways firms can fail to account for risks
Asset transformers
Shortfall risk
30. Probability distribution is unknown (ex. A terrorist attack)
Tax shield
Uncertainty
Debt overhang
Risks excluded from operational risk
31. Occurs the day when two parties exchange payments same day
Market imperfections that can create value
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Basis risk
Settlement risk
32. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Sortino ratio
Importance of communication for risk managers
Ri = ai + bi1l1 + bi2l2....+ei
Formula for covariance
33. Curve must be concave - Straight line connecting any two points must be under the curve
Shape of portfolio possibilities curve
Four major types of risk
APT in active portfolio management
Shortcomings of risk metrics
34. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Shortcomings of risk metrics
Operational risk
Options motivation on volatility
Treynor measure
35. Hazard - Financial - Operational - Strategic
Risks excluded from operational risk
Standard deviation of two assets
Tracking error
Risk types addressed by ERM
36. 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
Risk- adjusted performance measure (RAP)
Drysdale Securities (Chase Manhattan)
LTCM
Valuation vs. Risk management
37. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Differences in financial risk management for financial companies vs industrial companies
CAPM with taxes included (equation)
APT for passive portfolio management
Basis
38. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Three main reasons for financial disasters
VaR - Value at Risk
Banker's Trust
CAPM (formula)
39. Inability to make payment obligations (ex. Margin calls)
Effect of heterogeneous expectations on CAPM
Funding liquidity risk
Morningstar Rating System
Roles of risk management
40. No transaction costs - assets infinitely divisible - no personal tax - perfect competition - investors only care about mean and variance - short- selling allowed - unlimited lending and borrowing - homogeneity: single period - homogeneity: same mean
Security (primary vs secondary)
Ten assumptions underlying CAPM
Volatility Market risk
Source of need for risk management
41. 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
Three main reasons for financial disasters
LTCM
Tracking error
VaR - Value at Risk
42. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Efficient frontier
Shortfall risk
CAPM with taxes included (equation)
Ri = Rz + (gamma)(beta)
43. When two payments are exchanged the same day and one party may default after payment is made
EPD or ECOR - Expected Policyholder Deficit (EPD)
3 main types of operational risk
Settlement risk
What lead to the exponential growth to derivatives mkt?
44. 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
VaR - Value at Risk
Shape of portfolio possibilities curve
Ten assumptions underlying CAPM
45. Future price is greater than the spot price
Credit event
Contango
Treynor measure
Debt overhang
46. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Treynor measure
Basis
Importance of communication for risk managers
Performance- related metrics
47. Interest rate movements - derivatives - defaults
Banker's Trust
Financial Risk
Risk
Prices of risk vs sensitivity
48. Expected value of unfavorable deviations of a random variable from a specified target level
BTR - Below Target Risk
Valuation vs. Risk management
Kidder Peabody
Business Risk
49. 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
Drysdale Securities (Chase Manhattan)
Shortcomings of risk metrics
Information ratio
Four major types of risk
50. 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
Nonmarketable asset impact on CAPM
Practical considerations related to ERM implementatio
Market risk
Operational risk