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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.
If you are not ready to take this test, you can
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. Quantile of an empirical distribution
Nonparametric VaR
Tax shield
Shortcomings of risk metrics
Basis risk
2. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Differences in financial risk management for financial companies vs industrial companies
VaR- based analysis (formula)
Solve for minimum variance portfolio
Nonmarketable asset impact on CAPM
3. 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
Ri = ai + bi1l1 + bi2l2....+ei
Risk- adjusted performance measure (RAP)
Firms becoming more sensitive to changes(bank deregulation)
4. 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.
APT in active portfolio management
Risk Management Irrelevance Proposition
Standard deviation of two assets
Source of need for risk management
5. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Information ratio
Models used in ERM framework
3 main types of operational risk
Risk
6. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Business Risk
Options motivation on volatility
Basis
Uncertainty
7. 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
Effect of non- price- taking behavior on CAPM
Allied Irish Bank
Risks excluded from operational risk
Roles of risk management
8. Expected value of unfavorable deviations of a random variable from a specified target level
Shortcomings of risk metrics
BTR - Below Target Risk
Efficient frontier
Ri = ai + bi1l1 + bi2l2....+ei
9. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Debt overhang
Forms of Market risk
LTCM
Shape of portfolio possibilities curve
10. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Carry- backs and carry- forwards
Ri = Rz + (gamma)(beta)
Exposure
Recovery rate
11. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Firms becoming more sensitive to changes(bank deregulation)
Uncertainty
Probability of ruin
Correlation coefficient effect on diversification
12. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Where is risk coming from
Risk types addressed by ERM
Debt overhang
Banker's Trust
13. Interest rate movements - derivatives - defaults
Contango
Financial Risk
Standard deviation of two assets
APT in active portfolio management
14. The uses of debt to fall into a lower tax rate
Capital market line (CML)
Parametric VaR
Tax shield
Operational risk
15. Probability distribution is unknown (ex. A terrorist attack)
Expected return of two assets
Where is risk coming from
Uncertainty
CAPM (formula)
16. Changes in vol - implied or actual
Volatility Market risk
APT (equation and assumptions)
Allied Irish Bank
Market risk
17. Rp = XaRa + XbRb
Expected return of two assets
Information ratio
Market risk
Treynor measure
18. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Correlation coefficient effect on diversification
VaR- based analysis (formula)
APT in active portfolio management
LTCM
19. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Asset transformers
Sortino ratio
Carry- backs and carry- forwards
Correlation coefficient effect on diversification
20. 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
CAPM assumption for EMH
Tracking error
Ten assumptions underlying CAPM
Market imperfections that can create value
21. Need to assess risk and tell management so they can determine which risks to take on
Asset transformers
Importance of communication for risk managers
Sortino ratio
Risks excluded from operational risk
22. 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
Debt overhang
3 main types of operational risk
Derivative contract
Barings
23. 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
Carry- backs and carry- forwards
Sharpe measure
Traits of ERM
Market imperfections that can create value
24. The lower (closer to - 1) - the higher the payoff from diversification
CAPM assumption for EMH
Ri = Rz + (gamma)(beta)
Correlation coefficient effect on diversification
Recovery rate
25. 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
Expected return of two assets
Business Risk
Risk
Basis
26. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Shortcomings of risk metrics
Allied Irish Bank
Sovereign risk
Models used in ERM framework
27. Hazard - Financial - Operational - Strategic
Four major types of risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Risk types addressed by ERM
Barings
28. Potential amount that can be lost
Sharpe measure
Derivative contract
Uncertainty
Exposure
29. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Three main reasons for financial disasters
Operational risk
Shortcomings of risk metrics
Source of need for risk management
30. When negative taxable income is moved to a different year to offset future or past taxable income
Carry- backs and carry- forwards
Importance of communication for risk managers
Market risk
CAPM (formula)
31. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Solvency-related metrics
Operational risk
Drysdale Securities (Chase Manhattan)
Information ratio
32. Strategic risk - Business risk - Reputational risk
Risks excluded from operational risk
Sharpe measure
Debt overhang
Prices of risk vs sensitivity
33. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Business risks
What lead to the exponential growth to derivatives mkt?
Financial risks
Sharpe measure
34. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Operational risk
Shortfall risk
Expected return of two assets
Credit event
35. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Risk- adjusted performance measure (RAP)
Shortfall risk
Ri = ai + bi1l1 + bi2l2....+ei
Jensen's alpha
36. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
EPD or ECOR - Expected Policyholder Deficit (EPD)
Settlement risk
Security (primary vs secondary)
Where is risk coming from
37. Wrong distribution - Historical sample may not apply
Tax shield
Multi- period version of CAPM
Market risk
Ways risk can be mismeasured
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
Ways firms can fail to account for risks
Where is risk coming from
Barings
Asset liquidity risk
39. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Asset liquidity risk
Recovery rate
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
CAPM (formula)
40. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Basic Market risk
Treynor measure
Tracking error
Correlation coefficient effect on diversification
41. Quantile of a statistical distribution
Parametric VaR
Information ratio
Risks excluded from operational risk
Four major types of risk
42. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Standard deviation of two assets
Information ratio
Morningstar Rating System
Capital market line (CML)
43. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Standard deviation of two assets
RAR = relative return of portfolio (RRp)
Options motivation on volatility
Market imperfections that can create value
44. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Asset liquidity risk
Derivative contract
Basis risk
45. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Funding liquidity risk
Sharpe measure
Solve for minimum variance portfolio
APT in active portfolio management
46. Law of one price - Homogeneous expectations - Security returns process
APT (equation and assumptions)
Where is risk coming from
Models used in ERM framework
Firms becoming more sensitive to changes(bank deregulation)
47. Prices of risk are common factors and do not change - Sensitivities can change
Uncertainty
What lead to the exponential growth to derivatives mkt?
Prices of risk vs sensitivity
Treynor measure
48. Future price is greater than the spot price
Differences in financial risk management for financial companies vs industrial companies
Contango
Efficient frontier
Ri = Rz + (gamma)(beta)
49. Occurs the day when two parties exchange payments same day
Contango
CAPM with taxes included (equation)
Practical considerations related to ERM implementatio
Settlement risk
50. 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
Where is risk coming from
Probability of ruin
Financial risks
Multi- period version of CAPM