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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. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
What lead to the exponential growth to derivatives mkt?
Solvency-related metrics
Ri = ai + bi1l1 + bi2l2....+ei
Jensen's alpha
2. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Four major types of risk
Solve for minimum variance portfolio
Jensen's alpha
Asset transformers
3. Losses due to market activities ex. Interest rate changes or defaults
APT in active portfolio management
Debt overhang
Ten assumptions underlying CAPM
Financial risks
4. 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
RAR = relative return of portfolio (RRp)
Risk- adjusted performance measure (RAP)
Volatility Market risk
5. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Financial Risk
APT (equation and assumptions)
Risks excluded from operational risk
Three main reasons for financial disasters
6. Interest rate movements - derivatives - defaults
Contango
Barings
Tax shield
Financial Risk
7. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Asset transformers
Kidder Peabody
Firms becoming more sensitive to changes(bank deregulation)
Drysdale Securities (Chase Manhattan)
8. Covariance = correlation coefficient std dev(a) std dev(b)
Risk
Basic Market risk
Operational risk
Formula for covariance
9. Multibeta CAPM Ri - Rf =
Market imperfections that can create value
Operational risk
Risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
10. Hazard - Financial - Operational - Strategic
APT in active portfolio management
Nonparametric VaR
Zero- beta CAPM (two factor model)
Risk types addressed by ERM
11. Quantile of an empirical distribution
Shortfall risk
Formula for covariance
Differences in financial risk management for financial companies vs industrial companies
Nonparametric VaR
12. The need to hedge against risks - for firms need to speculate.
Firms becoming more sensitive to changes(bank deregulation)
Basic Market risk
What lead to the exponential growth to derivatives mkt?
Market risk
13. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
3 main types of operational risk
APT for passive portfolio management
Source of need for risk management
Credit event
14. Asses firm risks - Communicate risks - Manage and monitor risks
Roles of risk management
Parametric VaR
Source of need for risk management
Morningstar Rating System
15. Probability distribution is unknown (ex. A terrorist attack)
Uncertainty
Ri = ai + bi1l1 + bi2l2....+ei
Effect of heterogeneous expectations on CAPM
RAR = relative return of portfolio (RRp)
16. Quantile of a statistical distribution
Effect of heterogeneous expectations on CAPM
Effect of non- price- taking behavior on CAPM
Parametric VaR
RAR = relative return of portfolio (RRp)
17. Future price is greater than the spot price
Basic Market risk
Contango
BTR - Below Target Risk
Probability of ruin
18. Probability that a random variable falls below a specified threshold level
Shortfall risk
Funding liquidity risk
Options motivation on volatility
Barings
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
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Practical considerations related to ERM implementatio
Drysdale Securities (Chase Manhattan)
Solve for minimum variance portfolio
20. 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
CAPM assumption for EMH
LTCM
Ri = ai + bi1l1 + bi2l2....+ei
Settlement risk
21. 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 -
Importance of communication for risk managers
Source of need for risk management
What lead to the exponential growth to derivatives mkt?
Debt overhang
22. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Practical considerations related to ERM implementatio
Basic Market risk
Asset transformers
Ri = Rz + (gamma)(beta)
23. 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
Allied Irish Bank
Security (primary vs secondary)
Ways firms can fail to account for risks
Morningstar Rating System
24. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Liquidity risk
Volatility Market risk
CAPM with taxes included (equation)
Risk
25. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Debt overhang
Source of need for risk management
Uncertainty
Financial Risk
26. Absolute and relative risk - direction and non-directional
Forms of Market risk
Risk- adjusted performance measure (RAP)
Four major types of risk
Capital market line (CML)
27. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Sortino ratio
VaR- based analysis (formula)
Correlation coefficient effect on diversification
28. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Basis
Risk Management Irrelevance Proposition
Nonparametric VaR
Effect of heterogeneous expectations on CAPM
29. 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
Business Risk
Importance of communication for risk managers
Probability of ruin
Allied Irish Bank
30. 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
Options motivation on volatility
Drysdale Securities (Chase Manhattan)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Differences in financial risk management for financial companies vs industrial companies
31. 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
Market risk
3 main types of operational risk
Formula for covariance
Business Risk
32. 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
Shape of portfolio possibilities curve
Kidder Peabody
BTR - Below Target Risk
Differences in financial risk management for financial companies vs industrial companies
33. Potential amount that can be lost
Exposure
RAR = relative return of portfolio (RRp)
What lead to the exponential growth to derivatives mkt?
Volatility Market risk
34. Unanticipated movements in relative prices of assets in hedged position
Solve for minimum variance portfolio
Valuation vs. Risk management
Basic Market risk
Risk Management Irrelevance Proposition
35. Risk of loses owing to movements in level or volatility of market prices
Market risk
Basis
Liquidity risk
Effect of heterogeneous expectations on CAPM
36. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Drysdale Securities (Chase Manhattan)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Solvency-related metrics
Morningstar Rating System
37. Occurs the day when two parties exchange payments same day
Options motivation on volatility
Business risks
Settlement risk
Contango
38. 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
Traits of ERM
Risk
Recovery rate
APT (equation and assumptions)
39. Cannot exit position in market due to size of the position
Financial risks
Options motivation on volatility
Asset liquidity risk
Shortfall risk
40. 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
Allied Irish Bank
Formula for covariance
Shortfall risk
Ri = ai + bi1l1 + bi2l2....+ei
41. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Performance- related metrics
Capital market line (CML)
Asset liquidity risk
Sovereign risk
42. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Solve for minimum variance portfolio
Credit event
Correlation coefficient effect on diversification
Volatility Market risk
43. Returns on any stock are linearly related to a set of indexes
APT (equation and assumptions)
Ri = ai + bi1l1 + bi2l2....+ei
Basis risk
Treynor measure
44. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Risk Management Irrelevance Proposition
Liquidity risk
Recovery rate
EPD or ECOR - Expected Policyholder Deficit (EPD)
45. Law of one price - Homogeneous expectations - Security returns process
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Ten assumptions underlying CAPM
Effect of heterogeneous expectations on CAPM
APT (equation and assumptions)
46. Leeson took large speculative position in Nikkei 225 disguised as safe transactions by fake customers - Earthquake increased volatility and destroyed short put options - Losses of 1.25 billion and forced bankruptcy - Necessity of an independent tradi
Basic Market risk
Settlement risk
Barings
Asset liquidity risk
47. Volatility of unexpected outcomes
Business Risk
Tracking error
CAPM (formula)
Risk
48. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Treynor measure
Sharpe measure
Zero- beta CAPM (two factor model)
Efficient frontier
49. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
APT in active portfolio management
LTCM
Capital market line (CML)
Debt overhang
50. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
CAPM (formula)
Correlation coefficient effect on diversification
APT for passive portfolio management
Probability of ruin