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Test your basic knowledge |
FRM: Foundations Of Risk Management
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business-skills
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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. 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 -
Settlement risk
Effect of non- price- taking behavior on CAPM
Drysdale Securities (Chase Manhattan)
Source of need for risk management
2. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
CAPM (formula)
Prices of risk vs sensitivity
Carry- backs and carry- forwards
Credit event
3. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Tracking error
Contango
BTR - Below Target Risk
Basis risk
4. 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
Models used in ERM framework
Basic Market risk
Business Risk
Recovery rate
5. 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
CAPM with taxes included (equation)
Drysdale Securities (Chase Manhattan)
Kidder Peabody
Efficient frontier
6. 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
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Basis
Valuation vs. Risk management
7. Prices of risk are common factors and do not change - Sensitivities can change
Effect of non- price- taking behavior on CAPM
Forms of Market risk
Asset transformers
Prices of risk vs sensitivity
8. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Effect of heterogeneous expectations on CAPM
APT in active portfolio management
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Sovereign risk
9. 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 - Value at Risk
Settlement risk
APT for passive portfolio management
Capital market line (CML)
10. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Effect of non- price- taking behavior on CAPM
Sharpe measure
Sovereign risk
Differences in financial risk management for financial companies vs industrial companies
11. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Probability of ruin
Tracking error
Barings
Basis risk
12. Hazard - Financial - Operational - Strategic
Ten assumptions underlying CAPM
Tracking error
Risk types addressed by ERM
Multi- period version of CAPM
13. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Three main reasons for financial disasters
Debt overhang
Sovereign risk
Nonparametric VaR
14. Derives value from an underlying asset - rate - or index - Derives value from a security
Derivative contract
Zero- beta CAPM (two factor model)
Practical considerations related to ERM implementatio
Settlement risk
15. When two payments are exchanged the same day and one party may default after payment is made
Efficient frontier
Asset transformers
Settlement risk
Financial risks
16. Changes in vol - implied or actual
Tracking error
Volatility Market risk
Settlement risk
Allied Irish Bank
17. Absolute and relative risk - direction and non-directional
Credit event
Models used in ERM framework
Solve for minimum variance portfolio
Forms of Market risk
18. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Sortino ratio
Tracking error
Performance- related metrics
Basis
19. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Carry- backs and carry- forwards
Risk
Risk Management Irrelevance Proposition
Operational risk
20. Interest rate movements - derivatives - defaults
Financial Risk
Importance of communication for risk managers
Ten assumptions underlying CAPM
Correlation coefficient effect on diversification
21. Losses due to market activities ex. Interest rate changes or defaults
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Three main reasons for financial disasters
Security (primary vs secondary)
Financial risks
22. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Nonmarketable asset impact on CAPM
Ri = ai + bi1l1 + bi2l2....+ei
Ri = Rz + (gamma)(beta)
Differences in financial risk management for financial companies vs industrial companies
23. The lower (closer to - 1) - the higher the payoff from diversification
Correlation coefficient effect on diversification
Ri = Rz + (gamma)(beta)
Risk
APT (equation and assumptions)
24. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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25. Relative portfolio risk (RRiskp) - Based on a one- month investment period
RAR = relative return of portfolio (RRp)
Valuation vs. Risk management
CAPM with taxes included (equation)
Operational risk
26. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Sharpe measure
BTR - Below Target Risk
Operational risk
Basis
27. 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
Ways firms can fail to account for risks
APT in active portfolio management
Firms becoming more sensitive to changes(bank deregulation)
Models used in ERM framework
28. 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
Allied Irish Bank
Barings
Four major types of risk
Effect of heterogeneous expectations on CAPM
29. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Traits of ERM
What lead to the exponential growth to derivatives mkt?
VaR - Value at Risk
Sovereign risk
30. Quantile of a statistical distribution
Multi- period version of CAPM
Market risk
Differences in financial risk management for financial companies vs industrial companies
Parametric VaR
31. The uses of debt to fall into a lower tax rate
Tax shield
Correlation coefficient effect on diversification
Settlement risk
Ways firms can fail to account for risks
32. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Credit event
CAPM assumption for EMH
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Basis risk
33. Modeling approach is typically between statistical analytic models and structural simulation models
Models used in ERM framework
Shape of portfolio possibilities curve
Information ratio
Settlement risk
34. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Banker's Trust
Correlation coefficient effect on diversification
Sortino ratio
Sovereign risk
35. Potential amount that can be lost
Exposure
Importance of communication for risk managers
Multi- period version of CAPM
Carry- backs and carry- forwards
36. Probability that a random variable falls below a specified threshold level
Formula for covariance
Shortfall risk
Solvency-related metrics
Morningstar Rating System
37. Future price is greater than the spot price
LTCM
Morningstar Rating System
Risk
Contango
38. 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
Basis risk
Practical considerations related to ERM implementatio
Risk types addressed by ERM
Efficient frontier
39. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Debt overhang
Funding liquidity risk
Options motivation on volatility
Standard deviation of two assets
40. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Multi- period version of CAPM
Correlation coefficient effect on diversification
3 main types of operational risk
Nonparametric VaR
41. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Sovereign risk
Firms becoming more sensitive to changes(bank deregulation)
Standard deviation of two assets
Valuation vs. Risk management
42. Multibeta CAPM Ri - Rf =
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Settlement risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Basis risk
43. Rp = XaRa + XbRb
APT in active portfolio management
Risk
Expected return of two assets
Volatility Market risk
44. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Formula for covariance
3 main types of operational risk
VaR- based analysis (formula)
Barings
45. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Operational risk
Derivative contract
Risk Management Irrelevance Proposition
Market imperfections that can create value
46. 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
Nonmarketable asset impact on CAPM
Importance of communication for risk managers
Sharpe measure
Shortcomings of risk metrics
47. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Multi- period version of CAPM
Expected return of two assets
APT for passive portfolio management
Ri = Rz + (gamma)(beta)
48. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
APT (equation and assumptions)
Effect of non- price- taking behavior on CAPM
Debt overhang
Risk- adjusted performance measure (RAP)
49. Occurs the day when two parties exchange payments same day
Ri = Rz + (gamma)(beta)
Prices of risk vs sensitivity
Settlement risk
Business Risk
50. 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
CAPM with taxes included (equation)
Kidder Peabody
Tracking error
Ri = ai + bi1l1 + bi2l2....+ei