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Test your basic knowledge |
FRM: Foundations Of Risk Management
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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. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
APT in active portfolio management
Contango
Kidder Peabody
Risk
2. Volatility of unexpected outcomes
Correlation coefficient effect on diversification
Shortcomings of risk metrics
Risk
Drysdale Securities (Chase Manhattan)
3. Losses due to market activities ex. Interest rate changes or defaults
Information ratio
Contango
Roles of risk management
Financial risks
4. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Financial risks
CAPM (formula)
Credit event
Carry- backs and carry- forwards
5. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Shortfall risk
Allied Irish Bank
3 main types of operational risk
Debt overhang
6. 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
Morningstar Rating System
Probability of ruin
Financial Risk
Tracking error
7. Inability to make payment obligations (ex. Margin calls)
Asset liquidity risk
CAPM (formula)
Funding liquidity risk
Risk
8. Both probability and cost of tail events are considered
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Risk- adjusted performance measure (RAP)
Risk
Basis
9. Probability distribution is unknown (ex. A terrorist attack)
CAPM assumption for EMH
Uncertainty
Asset transformers
Performance- related metrics
10. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Practical considerations related to ERM implementatio
Nonmarketable asset impact on CAPM
Standard deviation of two assets
Security (primary vs secondary)
11. When two payments are exchanged the same day and one party may default after payment is made
Settlement risk
Security (primary vs secondary)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Contango
12. Asset-liability/market-liquidity risk
Liquidity risk
Kidder Peabody
Effect of heterogeneous expectations on CAPM
Risk types addressed by ERM
13. Rp = XaRa + XbRb
Asset liquidity risk
Expected return of two assets
Business risks
Capital market line (CML)
14. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Treynor measure
Drysdale Securities (Chase Manhattan)
Sovereign risk
Shape of portfolio possibilities curve
15. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Asset liquidity risk
Credit event
Solve for minimum variance portfolio
Formula for covariance
16. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Where is risk coming from
Contango
APT in active portfolio management
Basic Market risk
17. The need to hedge against risks - for firms need to speculate.
What lead to the exponential growth to derivatives mkt?
RAR = relative return of portfolio (RRp)
VaR - Value at Risk
Asset liquidity risk
18. The lower (closer to - 1) - the higher the payoff from diversification
Practical considerations related to ERM implementatio
Ways risk can be mismeasured
Correlation coefficient effect on diversification
Sortino ratio
19. Asses firm risks - Communicate risks - Manage and monitor risks
Roles of risk management
Options motivation on volatility
Jensen's alpha
Asset transformers
20. Covariance = correlation coefficient std dev(a) std dev(b)
Formula for covariance
Source of need for risk management
Risk
Ten assumptions underlying CAPM
21. 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
Ten assumptions underlying CAPM
3 main types of operational risk
Morningstar Rating System
Expected return of two assets
22. Unanticipated movements in relative prices of assets in hedged position
Allied Irish Bank
Efficient frontier
Basic Market risk
LTCM
23. 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
Models used in ERM framework
CAPM with taxes included (equation)
APT for passive portfolio management
Risk- adjusted performance measure (RAP)
24. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Information ratio
Market imperfections that can create value
Settlement risk
Risk
25. 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
Basis
Zero- beta CAPM (two factor model)
Firms becoming more sensitive to changes(bank deregulation)
Ways firms can fail to account for risks
26. Hazard - Financial - Operational - Strategic
Nonmarketable asset impact on CAPM
Forms of Market risk
Risk types addressed by ERM
Funding liquidity risk
27. Derives value from an underlying asset - rate - or index - Derives value from a security
Allied Irish Bank
Tracking error
Derivative contract
Volatility Market risk
28. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Security (primary vs secondary)
Three main reasons for financial disasters
Zero- beta CAPM (two factor model)
Basis risk
29. Quantile of an empirical distribution
Nonmarketable asset impact on CAPM
Probability of ruin
Nonparametric VaR
Sharpe measure
30. 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
What lead to the exponential growth to derivatives mkt?
Capital market line (CML)
Kidder Peabody
CAPM (formula)
31. 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
Solvency-related metrics
Business Risk
Nonparametric VaR
Allied Irish Bank
32. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Exposure
VaR - Value at Risk
Solve for minimum variance portfolio
Ways risk can be mismeasured
33. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Formula for covariance
Banker's Trust
Uncertainty
Basis
34. 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
Where is risk coming from
Capital market line (CML)
Traits of ERM
Information ratio
35. Strategic risk - Business risk - Reputational risk
Risk types addressed by ERM
Risks excluded from operational risk
Kidder Peabody
Efficient frontier
36. Need to assess risk and tell management so they can determine which risks to take on
Ten assumptions underlying CAPM
Options motivation on volatility
Importance of communication for risk managers
Financial risks
37. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Sortino ratio
Firms becoming more sensitive to changes(bank deregulation)
Efficient frontier
Funding liquidity risk
38. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Four major types of risk
Credit event
Standard deviation of two assets
3 main types of operational risk
39. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Differences in financial risk management for financial companies vs industrial companies
Risk- adjusted performance measure (RAP)
Risk Management Irrelevance Proposition
Tracking error
40. Wrong distribution - Historical sample may not apply
Ways risk can be mismeasured
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
RAR = relative return of portfolio (RRp)
Allied Irish Bank
41. Returns on any stock are linearly related to a set of indexes
Ri = ai + bi1l1 + bi2l2....+ei
Basis risk
RAR = relative return of portfolio (RRp)
Business Risk
42. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Allied Irish Bank
Traits of ERM
Business risks
Uncertainty
43. Return is linearly related to growth rate in consumption
Solvency-related metrics
Treynor measure
Information ratio
Multi- period version of CAPM
44. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Morningstar Rating System
Business Risk
Shortcomings of risk metrics
CAPM assumption for EMH
45. Law of one price - Homogeneous expectations - Security returns process
LTCM
APT (equation and assumptions)
Financial risks
Multi- period version of CAPM
46. Risk of loses owing to movements in level or volatility of market prices
Formula for covariance
EPD or ECOR - Expected Policyholder Deficit (EPD)
Risk
Market risk
47. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Four major types of risk
Barings
Tax shield
Debt overhang
48. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Security (primary vs secondary)
CAPM with taxes included (equation)
VaR- based analysis (formula)
Four major types of risk
49. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Efficient frontier
Banker's Trust
Market imperfections that can create value
Debt overhang
50. Multibeta CAPM Ri - Rf =
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Zero- beta CAPM (two factor model)
Exposure
Risk types addressed by ERM
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