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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. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Where is risk coming from
Sovereign risk
Basic Market risk
Contango
2. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Operational risk
Contango
Models used in ERM framework
Market imperfections that can create value
3. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Barings
Ways risk can be mismeasured
Contango
CAPM assumption for EMH
4. Interest rate movements - derivatives - defaults
Financial Risk
Business risks
Effect of heterogeneous expectations on CAPM
Settlement risk
5. Future price is greater than the spot price
Recovery rate
Contango
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Ways risk can be mismeasured
6. Need to assess risk and tell management so they can determine which risks to take on
Importance of communication for risk managers
Multi- period version of CAPM
Prices of risk vs sensitivity
Business Risk
7. The uses of debt to fall into a lower tax rate
Ri = Rz + (gamma)(beta)
Kidder Peabody
Tax shield
VaR - Value at Risk
8. Both probability and cost of tail events are considered
Market risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Settlement risk
Correlation coefficient effect on diversification
9. 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
Basic Market risk
Prices of risk vs sensitivity
Treynor measure
Shortcomings of risk metrics
10. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Uncertainty
CAPM assumption for EMH
Sharpe measure
Risks excluded from operational risk
11. 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
Capital market line (CML)
Nonmarketable asset impact on CAPM
Treynor measure
Sortino ratio
12. Potential amount that can be lost
Forms of Market risk
Expected return of two assets
Exposure
Models used in ERM framework
13. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Performance- related metrics
Allied Irish Bank
Valuation vs. Risk management
Tracking error
14. 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.
Traits of ERM
Risk Management Irrelevance Proposition
Allied Irish Bank
Source of need for risk management
15. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Shape of portfolio possibilities curve
Differences in financial risk management for financial companies vs industrial companies
Liquidity risk
Drysdale Securities (Chase Manhattan)
16. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Basis risk
Jensen's alpha
Sovereign risk
Operational risk
17. Volatility of unexpected outcomes
Basis
Capital market line (CML)
VaR - Value at Risk
Risk
18. Asses firm risks - Communicate risks - Manage and monitor risks
Four major types of risk
Basic Market risk
Roles of risk management
Financial Risk
19. 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
Forms of Market risk
Settlement risk
Valuation vs. Risk management
Settlement risk
20. 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
Sovereign risk
Market imperfections that can create value
Probability of ruin
Financial risks
21. Covariance = correlation coefficient std dev(a) std dev(b)
Formula for covariance
What lead to the exponential growth to derivatives mkt?
Sortino ratio
Morningstar Rating System
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
Banker's Trust
CAPM assumption for EMH
Financial Risk
Barings
23. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Basis risk
Market risk
Uncertainty
Options motivation on volatility
24. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Effect of non- price- taking behavior on CAPM
Credit event
CAPM with taxes included (equation)
Valuation vs. Risk management
25. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Tracking error
Basis
Nonmarketable asset impact on CAPM
Risks excluded from operational risk
26. Cannot exit position in market due to size of the position
Funding liquidity risk
Asset liquidity risk
CAPM assumption for EMH
Sharpe measure
27. 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
APT for passive portfolio management
Solvency-related metrics
Tax shield
3 main types of operational risk
28. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Nonparametric VaR
3 main types of operational risk
Where is risk coming from
Debt overhang
29. Law of one price - Homogeneous expectations - Security returns process
Settlement risk
RAR = relative return of portfolio (RRp)
APT (equation and assumptions)
Prices of risk vs sensitivity
30. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Treynor measure
Prices of risk vs sensitivity
Options motivation on volatility
Information ratio
31. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Business risks
Risk
Formula for covariance
Asset transformers
32. 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
Information ratio
Asset liquidity risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
33. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Source of need for risk management
Prices of risk vs sensitivity
Basic Market risk
Morningstar Rating System
34. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Exposure
Solvency-related metrics
Zero- beta CAPM (two factor model)
Roles of risk management
35. Multibeta CAPM Ri - Rf =
Jensen's alpha
RAR = relative return of portfolio (RRp)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Risk
36. Rp = XaRa + XbRb
Expected return of two assets
Ways risk can be mismeasured
Traits of ERM
Multi- period version of CAPM
37. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Sovereign risk
Valuation vs. Risk management
Probability of ruin
EPD or ECOR - Expected Policyholder Deficit (EPD)
38. Return is linearly related to growth rate in consumption
Effect of non- price- taking behavior on CAPM
Sovereign risk
Multi- period version of CAPM
Four major types of risk
39. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Nonparametric VaR
Formula for covariance
What lead to the exponential growth to derivatives mkt?
APT in active portfolio management
40. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Ri = Rz + (gamma)(beta)
Where is risk coming from
Debt overhang
Shortfall risk
41. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Differences in financial risk management for financial companies vs industrial companies
Risk
Treynor measure
What lead to the exponential growth to derivatives mkt?
42. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
APT for passive portfolio management
Market risk
Recovery rate
Four major types of risk
43. Quantile of an empirical distribution
Shape of portfolio possibilities curve
Nonparametric VaR
Where is risk coming from
Firms becoming more sensitive to changes(bank deregulation)
44. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Exposure
Source of need for risk management
Treynor measure
Ways risk can be mismeasured
45. The need to hedge against risks - for firms need to speculate.
Security (primary vs secondary)
BTR - Below Target Risk
What lead to the exponential growth to derivatives mkt?
Funding liquidity risk
46. Prices of risk are common factors and do not change - Sensitivities can change
Allied Irish Bank
Prices of risk vs sensitivity
Derivative contract
Expected return of two assets
47. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Operational risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
Basis
Performance- related metrics
48. 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
Four major types of risk
Business Risk
Sharpe measure
Performance- related metrics
49. Occurs the day when two parties exchange payments same day
Barings
Sovereign risk
Basis risk
Settlement risk
50. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Shortcomings of risk metrics
Settlement risk
Risk- adjusted performance measure (RAP)
Barings