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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. Need to assess risk and tell management so they can determine which risks to take on
Importance of communication for risk managers
Source of need for risk management
Ri = Rz + (gamma)(beta)
Barings
2. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Risk
VaR- based analysis (formula)
Risks excluded from operational risk
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
Capital market line (CML)
Exposure
Models used in ERM framework
Source of need for risk management
4. 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
3 main types of operational risk
Allied Irish Bank
Prices of risk vs sensitivity
Practical considerations related to ERM implementatio
5. Covariance = correlation coefficient std dev(a) std dev(b)
Formula for covariance
Security (primary vs secondary)
Practical considerations related to ERM implementatio
Uncertainty
6. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Market risk
Contango
Recovery rate
Formula for covariance
7. 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
VaR- based analysis (formula)
Tracking error
APT for passive portfolio management
Correlation coefficient effect on diversification
8. Probability distribution is unknown (ex. A terrorist attack)
Uncertainty
Morningstar Rating System
Standard deviation of two assets
Risks excluded from operational risk
9. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Financial Risk
Debt overhang
Treynor measure
Correlation coefficient effect on diversification
10. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Effect of non- price- taking behavior on CAPM
Roles of risk management
Market imperfections that can create value
Firms becoming more sensitive to changes(bank deregulation)
11. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Debt overhang
Security (primary vs secondary)
Ri = ai + bi1l1 + bi2l2....+ei
Drysdale Securities (Chase Manhattan)
12. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Three main reasons for financial disasters
Information ratio
3 main types of operational risk
Nonparametric VaR
13. Quantile of an empirical distribution
Basic Market risk
Nonparametric VaR
Models used in ERM framework
Parametric VaR
14. Asset-liability/market-liquidity risk
Derivative contract
Sortino ratio
APT in active portfolio management
Liquidity risk
15. 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
Importance of communication for risk managers
Solve for minimum variance portfolio
Shortfall risk
Allied Irish Bank
16. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Contango
Asset liquidity risk
Differences in financial risk management for financial companies vs industrial companies
Probability of ruin
17. Expected value of unfavorable deviations of a random variable from a specified target level
Contango
Exposure
BTR - Below Target Risk
Ways firms can fail to account for risks
18. Inability to make payment obligations (ex. Margin calls)
Funding liquidity risk
Solve for minimum variance portfolio
Carry- backs and carry- forwards
Business risks
19. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
VaR - Value at Risk
CAPM assumption for EMH
Risk- adjusted performance measure (RAP)
Ri = Rz + (gamma)(beta)
20. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Basis risk
Formula for covariance
Shortfall risk
CAPM assumption for EMH
21. When negative taxable income is moved to a different year to offset future or past taxable income
Firms becoming more sensitive to changes(bank deregulation)
Carry- backs and carry- forwards
VaR- based analysis (formula)
Business risks
22. When two payments are exchanged the same day and one party may default after payment is made
Asset liquidity risk
Settlement risk
Risk- adjusted performance measure (RAP)
Liquidity risk
23. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Barings
Treynor measure
APT in active portfolio management
Solvency-related metrics
24. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Market risk
Risk
Basis
Performance- related metrics
25. Derives value from an underlying asset - rate - or index - Derives value from a security
Debt overhang
Prices of risk vs sensitivity
Sharpe measure
Derivative contract
26. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Risk
Correlation coefficient effect on diversification
APT in active portfolio management
Risk Management Irrelevance Proposition
27. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Nonmarketable asset impact on CAPM
Firms becoming more sensitive to changes(bank deregulation)
Differences in financial risk management for financial companies vs industrial companies
VaR - Value at Risk
28. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Financial Risk
CAPM assumption for EMH
Four major types of risk
Shortcomings of risk metrics
29. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Ways firms can fail to account for risks
Where is risk coming from
Nonmarketable asset impact on CAPM
Sharpe measure
30. 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
EPD or ECOR - Expected Policyholder Deficit (EPD)
Security (primary vs secondary)
Traits of ERM
Solvency-related metrics
31. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Three main reasons for financial disasters
Financial Risk
Expected return of two assets
Market risk
32. Return is linearly related to growth rate in consumption
Solve for minimum variance portfolio
Business Risk
CAPM assumption for EMH
Multi- period version of CAPM
33. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Sovereign risk
APT in active portfolio management
Derivative contract
Models used in ERM framework
34. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Formula for covariance
Market imperfections that can create value
Nonparametric VaR
Risks excluded from operational risk
35. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Financial Risk
CAPM (formula)
Source of need for risk management
Solve for minimum variance portfolio
36. Interest rate movements - derivatives - defaults
Parametric VaR
Basic Market risk
Financial Risk
Solvency-related metrics
37. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
VaR- based analysis (formula)
Formula for covariance
Sortino ratio
Nonmarketable asset impact on CAPM
38. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Effect of heterogeneous expectations on CAPM
Volatility Market risk
Jensen's alpha
Market risk
39. Changes in vol - implied or actual
CAPM (formula)
Roles of risk management
Valuation vs. Risk management
Volatility Market risk
40. 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
Options motivation on volatility
Effect of heterogeneous expectations on CAPM
Risk
41. Curve must be concave - Straight line connecting any two points must be under the curve
Shape of portfolio possibilities curve
Ways risk can be mismeasured
Barings
Roles of risk management
42. Potential amount that can be lost
Morningstar Rating System
Exposure
Shortfall risk
Solvency-related metrics
43. Market risk - Liquidity risk - Credit risk - Operational risk
Importance of communication for risk managers
Derivative contract
Asset liquidity risk
Four major types of risk
44. Concave function that extends from minimum variance portfolio to maximum return portfolio
Practical considerations related to ERM implementatio
Standard deviation of two assets
VaR - Value at Risk
Efficient frontier
45. Hazard - Financial - Operational - Strategic
Drysdale Securities (Chase Manhattan)
Shape of portfolio possibilities curve
Risk types addressed by ERM
Tracking error
46. Both probability and cost of tail events are considered
Tail VaR or TCE - Tail Conditional Expectation(TCE)
VaR- based analysis (formula)
Standard deviation of two assets
Shape of portfolio possibilities curve
47. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
BTR - Below Target Risk
Carry- backs and carry- forwards
Ri = Rz + (gamma)(beta)
Four major types of risk
48. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
VaR- based analysis (formula)
What lead to the exponential growth to derivatives mkt?
Financial Risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
49. 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
Basis risk
Financial risks
Valuation vs. Risk management
Solvency-related metrics
50. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Firms becoming more sensitive to changes(bank deregulation)
Probability of ruin
RAR = relative return of portfolio (RRp)
Ways risk can be mismeasured