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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. The lower (closer to - 1) - the higher the payoff from diversification
APT in active portfolio management
APT for passive portfolio management
Correlation coefficient effect on diversification
Forms of Market risk
2. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Models used in ERM framework
Treynor measure
Firms becoming more sensitive to changes(bank deregulation)
Business risks
3. Absolute and relative risk - direction and non-directional
3 main types of operational risk
Forms of Market risk
Financial risks
Basic Market risk
4. 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
Jensen's alpha
VaR - Value at Risk
Financial risks
APT for passive portfolio management
5. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Information ratio
Importance of communication for risk managers
Forms of Market risk
Basis
6. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Valuation vs. Risk management
LTCM
Recovery rate
Solve for minimum variance portfolio
7. Prices of risk are common factors and do not change - Sensitivities can change
Sortino ratio
Nonmarketable asset impact on CAPM
Prices of risk vs sensitivity
RAR = relative return of portfolio (RRp)
8. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
CAPM assumption for EMH
VaR - Value at Risk
Information ratio
CAPM (formula)
9. Occurs the day when two parties exchange payments same day
Settlement risk
Valuation vs. Risk management
BTR - Below Target Risk
Shortcomings of risk metrics
10. Hazard - Financial - Operational - Strategic
Risks excluded from operational risk
Uncertainty
Tracking error
Risk types addressed by ERM
11. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Nonmarketable asset impact on CAPM
Carry- backs and carry- forwards
Source of need for risk management
Financial risks
12. Asses firm risks - Communicate risks - Manage and monitor risks
APT (equation and assumptions)
Expected return of two assets
Roles of risk management
Sovereign risk
13. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Contango
Efficient frontier
Asset liquidity risk
Risk- adjusted performance measure (RAP)
14. Risk of loses owing to movements in level or volatility of market prices
Market risk
Debt overhang
Risk Management Irrelevance Proposition
Asset transformers
15. Strategic risk - Business risk - Reputational risk
Recovery rate
Carry- backs and carry- forwards
Ten assumptions underlying CAPM
Risks excluded from operational risk
16. 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
Carry- backs and carry- forwards
Morningstar Rating System
Jensen's alpha
Practical considerations related to ERM implementatio
17. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
VaR- based analysis (formula)
Firms becoming more sensitive to changes(bank deregulation)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Sovereign risk
18. 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
Debt overhang
APT (equation and assumptions)
Drysdale Securities (Chase Manhattan)
Ways firms can fail to account for risks
19. Capital structure (financial distress) - Taxes - Agency and information asymmetries
VaR - Value at Risk
Standard deviation of two assets
Settlement risk
Market imperfections that can create value
20. 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
LTCM
Credit event
Traits of ERM
Source of need for risk management
21. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
VaR - Value at Risk
Probability of ruin
Kidder Peabody
Expected return of two assets
22. Asset-liability/market-liquidity risk
Debt overhang
Liquidity risk
Tracking error
Solvency-related metrics
23. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Financial Risk
Performance- related metrics
Drysdale Securities (Chase Manhattan)
Volatility Market risk
24. Law of one price - Homogeneous expectations - Security returns process
APT (equation and assumptions)
Prices of risk vs sensitivity
Funding liquidity risk
Risk
25. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Differences in financial risk management for financial companies vs industrial companies
Debt overhang
Volatility Market risk
Shape of portfolio possibilities curve
26. 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
Standard deviation of two assets
Business Risk
Probability of ruin
Multi- period version of CAPM
27. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Roles of risk management
Security (primary vs secondary)
Liquidity risk
Firms becoming more sensitive to changes(bank deregulation)
28. Return is linearly related to growth rate in consumption
Multi- period version of CAPM
LTCM
Effect of non- price- taking behavior on CAPM
Capital market line (CML)
29. Market risk - Liquidity risk - Credit risk - Operational risk
Four major types of risk
CAPM assumption for EMH
Tax shield
Asset transformers
30. Quantile of a statistical distribution
Information ratio
CAPM assumption for EMH
Parametric VaR
Banker's Trust
31. Inability to make payment obligations (ex. Margin calls)
Derivative contract
Funding liquidity risk
Shortcomings of risk metrics
Ten assumptions underlying CAPM
32. Probability distribution is unknown (ex. A terrorist attack)
Banker's Trust
CAPM assumption for EMH
Uncertainty
Performance- related metrics
33. Expected value of unfavorable deviations of a random variable from a specified target level
Risk- adjusted performance measure (RAP)
Efficient frontier
BTR - Below Target Risk
Ways firms can fail to account for risks
34. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Performance- related metrics
Zero- beta CAPM (two factor model)
Solve for minimum variance portfolio
Sovereign risk
35. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Options motivation on volatility
Treynor measure
Valuation vs. Risk management
Liquidity risk
36. Rp = XaRa + XbRb
Risk types addressed by ERM
Four major types of risk
Expected return of two assets
Kidder Peabody
37. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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38. 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
Financial risks
Risks excluded from operational risk
Ways firms can fail to account for risks
Options motivation on volatility
39. Covariance = correlation coefficient std dev(a) std dev(b)
Sovereign risk
Practical considerations related to ERM implementatio
Tracking error
Formula for covariance
40. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Ten assumptions underlying CAPM
Effect of heterogeneous expectations on CAPM
Solvency-related metrics
Settlement risk
41. When two payments are exchanged the same day and one party may default after payment is made
APT for passive portfolio management
Settlement risk
Shape of portfolio possibilities curve
Risks excluded from operational risk
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
Solvency-related metrics
Shortcomings of risk metrics
Sharpe measure
Kidder Peabody
43. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Asset transformers
Zero- beta CAPM (two factor model)
Three main reasons for financial disasters
Capital market line (CML)
44. Derives value from an underlying asset - rate - or index - Derives value from a security
Valuation vs. Risk management
What lead to the exponential growth to derivatives mkt?
Derivative contract
Carry- backs and carry- forwards
45. Concave function that extends from minimum variance portfolio to maximum return portfolio
Efficient frontier
Firms becoming more sensitive to changes(bank deregulation)
Formula for covariance
Financial Risk
46. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Probability of ruin
Prices of risk vs sensitivity
RAR = relative return of portfolio (RRp)
Morningstar Rating System
47. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Basis risk
Risk
Options motivation on volatility
Sharpe measure
48. 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
Business risks
Allied Irish Bank
Exposure
Volatility Market risk
49. 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 -
Financial Risk
Effect of heterogeneous expectations on CAPM
Source of need for risk management
CAPM (formula)
50. Changes in vol - implied or actual
Sortino ratio
Risk Management Irrelevance Proposition
Volatility Market risk
Correlation coefficient effect on diversification