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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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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. Hazard - Financial - Operational - Strategic
Risks excluded from operational risk
Basic Market risk
Risk types addressed by ERM
Nonmarketable asset impact on CAPM
2. Modeling approach is typically between statistical analytic models and structural simulation models
BTR - Below Target Risk
Drysdale Securities (Chase Manhattan)
APT (equation and assumptions)
Models used in ERM framework
3. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Derivative contract
Settlement risk
Traits of ERM
Risk- adjusted performance measure (RAP)
4. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Differences in financial risk management for financial companies vs industrial companies
Morningstar Rating System
Valuation vs. Risk management
CAPM (formula)
5. 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
Valuation vs. Risk management
Asset liquidity risk
Settlement risk
Ten assumptions underlying CAPM
6. Risk of loses owing to movements in level or volatility of market prices
Tracking error
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Market risk
Morningstar Rating System
7. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Tracking error
Probability of ruin
Firms becoming more sensitive to changes(bank deregulation)
Nonmarketable asset impact on CAPM
8. 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
Efficient frontier
Business Risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
Capital market line (CML)
9. Probability that a random variable falls below a specified threshold level
Risk
Financial risks
Shortfall risk
Exposure
10. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Information ratio
Source of need for risk management
Risk
Ways risk can be mismeasured
11. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Ri = ai + bi1l1 + bi2l2....+ei
Ri = Rz + (gamma)(beta)
Basic Market risk
LTCM
12. 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
Probability of ruin
Nonparametric VaR
Solve for minimum variance portfolio
Credit event
13. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Tracking error
Options motivation on volatility
Basis
Financial Risk
14. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Standard deviation of two assets
Basic Market risk
VaR- based analysis (formula)
RAR = relative return of portfolio (RRp)
15. The lower (closer to - 1) - the higher the payoff from diversification
Contango
Business risks
Correlation coefficient effect on diversification
VaR - Value at Risk
16. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Uncertainty
Basis
Allied Irish Bank
Settlement risk
17. Probability distribution is unknown (ex. A terrorist attack)
Importance of communication for risk managers
Uncertainty
Risk- adjusted performance measure (RAP)
3 main types of operational risk
18. When two payments are exchanged the same day and one party may default after payment is made
Financial risks
Risks excluded from operational risk
Solvency-related metrics
Settlement risk
19. Return is linearly related to growth rate in consumption
Ri = Rz + (gamma)(beta)
VaR- based analysis (formula)
Multi- period version of CAPM
Valuation vs. Risk management
20. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
CAPM with taxes included (equation)
Volatility Market risk
Treynor measure
Zero- beta CAPM (two factor model)
21. Concave function that extends from minimum variance portfolio to maximum return portfolio
Multi- period version of CAPM
Parametric VaR
Efficient frontier
Risk
22. Absolute and relative risk - direction and non-directional
Credit event
Drysdale Securities (Chase Manhattan)
Three main reasons for financial disasters
Forms of Market risk
23. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
RAR = relative return of portfolio (RRp)
Treynor measure
Asset transformers
Shape of portfolio possibilities curve
24. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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25. Market risk - Liquidity risk - Credit risk - Operational risk
Financial risks
Four major types of risk
Nonparametric VaR
Where is risk coming from
26. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Asset transformers
Drysdale Securities (Chase Manhattan)
Where is risk coming from
Roles of risk management
27. Quantile of a statistical distribution
Parametric VaR
Basic Market risk
Ri = ai + bi1l1 + bi2l2....+ei
Correlation coefficient effect on diversification
28. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
CAPM (formula)
Sharpe measure
Debt overhang
Business Risk
29. 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
Shortfall risk
Practical considerations related to ERM implementatio
APT for passive portfolio management
What lead to the exponential growth to derivatives mkt?
30. 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
Settlement risk
Settlement risk
Multi- period version of CAPM
31. Sold complex derivatives to Proctor & Gamble and Gibson - Were sued due to claims that they deceived buyers - Need for better controls for matching complexity of trade with client sophistication - Need for price quotes independent of front office Met
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32. Derives value from an underlying asset - rate - or index - Derives value from a security
Information ratio
Derivative contract
LTCM
Ways firms can fail to account for risks
33. Curve must be concave - Straight line connecting any two points must be under the curve
Shape of portfolio possibilities curve
Capital market line (CML)
Ri = ai + bi1l1 + bi2l2....+ei
Banker's Trust
34. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Treynor measure
Sortino ratio
Four major types of risk
Correlation coefficient effect on diversification
35. Expected value of unfavorable deviations of a random variable from a specified target level
BTR - Below Target Risk
Risk types addressed by ERM
Uncertainty
Multi- period version of CAPM
36. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Where is risk coming from
Market imperfections that can create value
Performance- related metrics
Credit event
37. Inability to make payment obligations (ex. Margin calls)
Risk
Three main reasons for financial disasters
Funding liquidity risk
Financial Risk
38. 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
Valuation vs. Risk management
Liquidity risk
Operational risk
Financial Risk
39. Losses due to market activities ex. Interest rate changes or defaults
Source of need for risk management
Financial risks
Operational risk
Ways risk can be mismeasured
40. Cannot exit position in market due to size of the position
Asset liquidity risk
VaR - Value at Risk
Valuation vs. Risk management
Treynor measure
41. The uses of debt to fall into a lower tax rate
VaR - Value at Risk
Prices of risk vs sensitivity
Information ratio
Tax shield
42. 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
Debt overhang
Financial risks
VaR- based analysis (formula)
Kidder Peabody
43. 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
Business Risk
Shortfall risk
Market risk
LTCM
44. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Efficient frontier
Uncertainty
Solvency-related metrics
VaR- based analysis (formula)
45. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Market risk
Tracking error
Allied Irish Bank
Treynor measure
46. Future price is greater than the spot price
Security (primary vs secondary)
Contango
Asset transformers
Zero- beta CAPM (two factor model)
47. 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.
Funding liquidity risk
Risk Management Irrelevance Proposition
Capital market line (CML)
Basis risk
48. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Parametric VaR
Business risks
BTR - Below Target Risk
Probability of ruin
49. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
APT for passive portfolio management
What lead to the exponential growth to derivatives mkt?
Financial Risk
Morningstar Rating System
50. Wrong distribution - Historical sample may not apply
Nonparametric VaR
Market imperfections that can create value
Ways risk can be mismeasured
Contango