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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.
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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. 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
Carry- backs and carry- forwards
Effect of non- price- taking behavior on CAPM
What lead to the exponential growth to derivatives mkt?
2. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Importance of communication for risk managers
Business Risk
VaR - Value at Risk
APT in active portfolio management
3. 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 -
Source of need for risk management
Risk Management Irrelevance Proposition
EPD or ECOR - Expected Policyholder Deficit (EPD)
Capital market line (CML)
4. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Information ratio
APT for passive portfolio management
LTCM
Basis
5. Derives value from an underlying asset - rate - or index - Derives value from a security
Derivative contract
Zero- beta CAPM (two factor model)
Barings
3 main types of operational risk
6. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Financial Risk
Sharpe measure
What lead to the exponential growth to derivatives mkt?
RAR = relative return of portfolio (RRp)
7. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Operational risk
Kidder Peabody
Three main reasons for financial disasters
Prices of risk vs sensitivity
8. 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
Traits of ERM
3 main types of operational risk
Business Risk
Allied Irish Bank
9. Quantile of a statistical distribution
Correlation coefficient effect on diversification
Kidder Peabody
Risks excluded from operational risk
Parametric VaR
10. The lower (closer to - 1) - the higher the payoff from diversification
Correlation coefficient effect on diversification
Basis
APT for passive portfolio management
Three main reasons for financial disasters
11. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Nonparametric VaR
Sortino ratio
Allied Irish Bank
CAPM (formula)
12. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Security (primary vs secondary)
Tax shield
Ways risk can be mismeasured
Shape of portfolio possibilities curve
13. Potential amount that can be lost
Basic Market risk
Exposure
Performance- related metrics
Risk
14. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Market risk
Sovereign risk
Effect of heterogeneous expectations on CAPM
Sharpe measure
15. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Firms becoming more sensitive to changes(bank deregulation)
Business risks
Risk
Financial Risk
16. Risk of loses owing to movements in level or volatility of market prices
Jensen's alpha
Market risk
Debt overhang
Basis
17. Returns on any stock are linearly related to a set of indexes
Ri = ai + bi1l1 + bi2l2....+ei
Security (primary vs secondary)
Asset liquidity risk
Valuation vs. Risk management
18. 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
Three main reasons for financial disasters
APT for passive portfolio management
Banker's Trust
Traits of ERM
19. Absolute and relative risk - direction and non-directional
Formula for covariance
Correlation coefficient effect on diversification
Forms of Market risk
Tax shield
20. Asset-liability/market-liquidity risk
Sortino ratio
Liquidity risk
Funding liquidity risk
Ways firms can fail to account for risks
21. Need to assess risk and tell management so they can determine which risks to take on
Multi- period version of CAPM
Tracking error
Importance of communication for risk managers
Ways risk can be mismeasured
22. 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
Valuation vs. Risk management
Sharpe measure
Probability of ruin
Settlement risk
23. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Firms becoming more sensitive to changes(bank deregulation)
Multi- period version of CAPM
Standard deviation of two assets
Basis risk
24. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Financial risks
Nonmarketable asset impact on CAPM
Liquidity risk
CAPM assumption for EMH
25. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Market risk
APT in active portfolio management
Practical considerations related to ERM implementatio
CAPM assumption for EMH
26. Losses due to market activities ex. Interest rate changes or defaults
Tracking error
Probability of ruin
Financial risks
VaR - Value at Risk
27. 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
Information ratio
Debt overhang
Drysdale Securities (Chase Manhattan)
Sharpe measure
28. Wrong distribution - Historical sample may not apply
Volatility Market risk
Firms becoming more sensitive to changes(bank deregulation)
APT for passive portfolio management
Ways risk can be mismeasured
29. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Firms becoming more sensitive to changes(bank deregulation)
BTR - Below Target Risk
Effect of non- price- taking behavior on CAPM
Standard deviation of two assets
30. Multibeta CAPM Ri - Rf =
Risk- adjusted performance measure (RAP)
Kidder Peabody
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Nonparametric VaR
31. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Operational risk
Ri = ai + bi1l1 + bi2l2....+ei
Shape of portfolio possibilities curve
Zero- beta CAPM (two factor model)
32. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
CAPM assumption for EMH
Effect of heterogeneous expectations on CAPM
Ri = Rz + (gamma)(beta)
Jensen's alpha
33. Curve must be concave - Straight line connecting any two points must be under the curve
Shape of portfolio possibilities curve
Firms becoming more sensitive to changes(bank deregulation)
Three main reasons for financial disasters
Allied Irish Bank
34. When two payments are exchanged the same day and one party may default after payment is made
Forms of Market risk
Ri = ai + bi1l1 + bi2l2....+ei
Models used in ERM framework
Settlement risk
35. Prices of risk are common factors and do not change - Sensitivities can change
Prices of risk vs sensitivity
Derivative contract
Shortfall risk
Sovereign risk
36. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Probability of ruin
EPD or ECOR - Expected Policyholder Deficit (EPD)
VaR - Value at Risk
BTR - Below Target Risk
37. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Probability of ruin
Ways risk can be mismeasured
Zero- beta CAPM (two factor model)
Business risks
38. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Kidder Peabody
Tracking error
EPD or ECOR - Expected Policyholder Deficit (EPD)
CAPM (formula)
39. Quantile of an empirical distribution
Ways firms can fail to account for risks
Nonparametric VaR
CAPM assumption for EMH
Performance- related metrics
40. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Market imperfections that can create value
Solvency-related metrics
Debt overhang
Ten assumptions underlying CAPM
41. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Sovereign risk
Formula for covariance
Ways risk can be mismeasured
Basic Market risk
42. Volatility of unexpected outcomes
Nonmarketable asset impact on CAPM
VaR - Value at Risk
Recovery rate
Risk
43. 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
Risk
Basis
Market risk
Capital market line (CML)
44. Concave function that extends from minimum variance portfolio to maximum return portfolio
Source of need for risk management
Efficient frontier
APT for passive portfolio management
Performance- related metrics
45. Probability distribution is unknown (ex. A terrorist attack)
Formula for covariance
Four major types of risk
Uncertainty
Firms becoming more sensitive to changes(bank deregulation)
46. 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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47. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Standard deviation of two assets
Capital market line (CML)
Tracking error
APT (equation and assumptions)
48. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Treynor measure
Tax shield
Tail VaR or TCE - Tail Conditional Expectation(TCE)
EPD or ECOR - Expected Policyholder Deficit (EPD)
49. Both probability and cost of tail events are considered
Four major types of risk
Three main reasons for financial disasters
Shortcomings of risk metrics
Tail VaR or TCE - Tail Conditional Expectation(TCE)
50. Hazard - Financial - Operational - Strategic
Risk types addressed by ERM
Volatility Market risk
Recovery rate
Asset transformers