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Test your basic knowledge |
FRM: Foundations Of Risk Management
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frm
Instructions:
Answer 50 questions in 15 minutes.
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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. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Solve for minimum variance portfolio
VaR - Value at Risk
Risk types addressed by ERM
Sortino ratio
2. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Kidder Peabody
Morningstar Rating System
Expected return of two assets
Options motivation on volatility
3. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Risk- adjusted performance measure (RAP)
Ways firms can fail to account for risks
Funding liquidity risk
APT (equation and assumptions)
4. 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
Information ratio
Risk types addressed by ERM
Allied Irish Bank
Basis
5. Asset-liability/market-liquidity risk
Risk- adjusted performance measure (RAP)
Tracking error
Liquidity risk
RAR = relative return of portfolio (RRp)
6. Losses due to market activities ex. Interest rate changes or defaults
Financial risks
EPD or ECOR - Expected Policyholder Deficit (EPD)
BTR - Below Target Risk
Drysdale Securities (Chase Manhattan)
7. Cannot exit position in market due to size of the position
Asset liquidity risk
Efficient frontier
Risk- adjusted performance measure (RAP)
Uncertainty
8. 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
Nonmarketable asset impact on CAPM
Source of need for risk management
Drysdale Securities (Chase Manhattan)
APT in active portfolio management
9. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
EPD or ECOR - Expected Policyholder Deficit (EPD)
Tracking error
APT in active portfolio management
Prices of risk vs sensitivity
10. Concave function that extends from minimum variance portfolio to maximum return portfolio
Performance- related metrics
Prices of risk vs sensitivity
Carry- backs and carry- forwards
Efficient frontier
11. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Zero- beta CAPM (two factor model)
Exposure
Effect of heterogeneous expectations on CAPM
What lead to the exponential growth to derivatives mkt?
12. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Capital market line (CML)
Sharpe measure
Models used in ERM framework
Debt overhang
13. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Zero- beta CAPM (two factor model)
Business risks
Morningstar Rating System
Treynor measure
14. Modeling approach is typically between statistical analytic models and structural simulation models
Risk
Risk types addressed by ERM
Ways risk can be mismeasured
Models used in ERM framework
15. 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
Practical considerations related to ERM implementatio
APT for passive portfolio management
Four major types of risk
Risk- adjusted performance measure (RAP)
16. The lower (closer to - 1) - the higher the payoff from diversification
Correlation coefficient effect on diversification
Asset transformers
Sharpe measure
Settlement risk
17. 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
Effect of non- price- taking behavior on CAPM
Ways risk can be mismeasured
APT (equation and assumptions)
Shortcomings of risk metrics
18. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Effect of heterogeneous expectations on CAPM
CAPM with taxes included (equation)
Standard deviation of two assets
APT (equation and assumptions)
19. Absolute and relative risk - direction and non-directional
Practical considerations related to ERM implementatio
Forms of Market risk
Allied Irish Bank
Solvency-related metrics
20. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Volatility Market risk
Operational risk
Nonparametric VaR
Standard deviation of two assets
21. 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
Recovery rate
VaR- based analysis (formula)
Volatility Market risk
22. Interest rate movements - derivatives - defaults
Market risk
Financial Risk
Prices of risk vs sensitivity
Nonmarketable asset impact on CAPM
23. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Settlement risk
Zero- beta CAPM (two factor model)
Options motivation on volatility
Standard deviation of two assets
24. Need to assess risk and tell management so they can determine which risks to take on
Prices of risk vs sensitivity
Importance of communication for risk managers
Forms of Market risk
Security (primary vs secondary)
25. 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
Practical considerations related to ERM implementatio
APT for passive portfolio management
Risk Management Irrelevance Proposition
Risk types addressed by ERM
26. Unanticipated movements in relative prices of assets in hedged position
Risk Management Irrelevance Proposition
Risk- adjusted performance measure (RAP)
Basic Market risk
Business risks
27. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Effect of non- price- taking behavior on CAPM
Sortino ratio
Efficient frontier
RAR = relative return of portfolio (RRp)
28. Risk of loses owing to movements in level or volatility of market prices
Market risk
Business risks
Effect of heterogeneous expectations on CAPM
Sovereign risk
29. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Debt overhang
Asset liquidity risk
CAPM assumption for EMH
EPD or ECOR - Expected Policyholder Deficit (EPD)
30. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Treynor measure
Derivative contract
VaR - Value at Risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
31. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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32. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Ten assumptions underlying CAPM
Nonparametric VaR
Kidder Peabody
Performance- related metrics
33. Potential amount that can be lost
Roles of risk management
Correlation coefficient effect on diversification
Exposure
Four major types of risk
34. When two payments are exchanged the same day and one party may default after payment is made
Expected return of two assets
Settlement risk
Sortino ratio
VaR- based analysis (formula)
35. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Probability of ruin
Asset transformers
CAPM (formula)
Sortino ratio
36. Expected value of unfavorable deviations of a random variable from a specified target level
APT for passive portfolio management
Efficient frontier
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
BTR - Below Target Risk
37. Quantile of an empirical distribution
Settlement risk
Nonparametric VaR
Volatility Market risk
Roles of risk management
38. 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
Asset transformers
What lead to the exponential growth to derivatives mkt?
Ten assumptions underlying CAPM
Ways risk can be mismeasured
39. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Basis
RAR = relative return of portfolio (RRp)
Risk
Exposure
40. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
CAPM with taxes included (equation)
Where is risk coming from
Valuation vs. Risk management
Market risk
41. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Tax shield
Shape of portfolio possibilities curve
Standard deviation of two assets
Four major types of risk
42. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Financial risks
Source of need for risk management
Basis risk
Ways firms can fail to account for risks
43. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Solve for minimum variance portfolio
Risk Management Irrelevance Proposition
Drysdale Securities (Chase Manhattan)
Expected return of two assets
44. Strategic risk - Business risk - Reputational risk
Capital market line (CML)
Risks excluded from operational risk
APT for passive portfolio management
APT in active portfolio management
45. 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
Security (primary vs secondary)
Standard deviation of two assets
Business Risk
Barings
46. Future price is greater than the spot price
Liquidity risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Drysdale Securities (Chase Manhattan)
Contango
47. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Basis risk
Information ratio
Nonmarketable asset impact on CAPM
Banker's Trust
48. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Asset liquidity risk
Treynor measure
3 main types of operational risk
Effect of non- price- taking behavior on CAPM
49. Probability distribution is unknown (ex. A terrorist attack)
Uncertainty
Ways risk can be mismeasured
Carry- backs and carry- forwards
Shortfall risk
50. Derives value from an underlying asset - rate - or index - Derives value from a security
Performance- related metrics
Operational risk
APT (equation and assumptions)
Derivative contract