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Test your basic knowledge |
FRM: Foundations Of Risk Management
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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. Hazard - Financial - Operational - Strategic
Solvency-related metrics
Risk types addressed by ERM
Probability of ruin
Ways risk can be mismeasured
2. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
APT in active portfolio management
Firms becoming more sensitive to changes(bank deregulation)
Nonparametric VaR
Risk
3. Losses due to market activities ex. Interest rate changes or defaults
Zero- beta CAPM (two factor model)
Correlation coefficient effect on diversification
Allied Irish Bank
Financial risks
4. 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)
Expected return of two assets
Valuation vs. Risk management
Roles of risk management
5. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Basis risk
Settlement risk
Treynor measure
VaR - Value at Risk
6. The lower (closer to - 1) - the higher the payoff from diversification
Business risks
Basic Market risk
Correlation coefficient effect on diversification
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
7. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Efficient frontier
Security (primary vs secondary)
Risk types addressed by ERM
Effect of non- price- taking behavior on CAPM
8. The uses of debt to fall into a lower tax rate
CAPM assumption for EMH
Solvency-related metrics
Differences in financial risk management for financial companies vs industrial companies
Tax shield
9. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Morningstar Rating System
Formula for covariance
Business risks
Financial risks
10. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Performance- related metrics
Credit event
VaR - Value at Risk
Nonparametric VaR
11. Rp = XaRa + XbRb
Zero- beta CAPM (two factor model)
Expected return of two assets
VaR - Value at Risk
Probability of ruin
12. 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 -
Traits of ERM
Source of need for risk management
Where is risk coming from
Multi- period version of CAPM
13. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Volatility Market risk
Effect of heterogeneous expectations on CAPM
Parametric VaR
Solvency-related metrics
14. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Three main reasons for financial disasters
Ways firms can fail to account for risks
Differences in financial risk management for financial companies vs industrial companies
Parametric VaR
15. Occurs the day when two parties exchange payments same day
Debt overhang
Firms becoming more sensitive to changes(bank deregulation)
Correlation coefficient effect on diversification
Settlement risk
16. Curve must be concave - Straight line connecting any two points must be under the curve
Risk
Effect of heterogeneous expectations on CAPM
Shape of portfolio possibilities curve
Forms of Market risk
17. Prices of risk are common factors and do not change - Sensitivities can change
APT (equation and assumptions)
Prices of risk vs sensitivity
Operational risk
Ri = Rz + (gamma)(beta)
18. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Ways firms can fail to account for risks
CAPM with taxes included (equation)
3 main types of operational risk
Risk
19. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Valuation vs. Risk management
Traits of ERM
Risk Management Irrelevance Proposition
RAR = relative return of portfolio (RRp)
20. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Performance- related metrics
Debt overhang
Financial risks
Ri = Rz + (gamma)(beta)
21. 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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22. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Formula for covariance
Sovereign risk
Business risks
LTCM
23. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Practical considerations related to ERM implementatio
Multi- period version of CAPM
Jensen's alpha
Where is risk coming from
24. CAPM requires the strong form of the Efficient Market Hypothesis = private information
CAPM assumption for EMH
Forms of Market risk
Prices of risk vs sensitivity
CAPM with taxes included (equation)
25. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Risk
Settlement risk
Basis
Solvency-related metrics
26. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Source of need for risk management
Contango
Models used in ERM framework
Options motivation on volatility
27. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
What lead to the exponential growth to derivatives mkt?
CAPM with taxes included (equation)
Contango
Zero- beta CAPM (two factor model)
28. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Market imperfections that can create value
Jensen's alpha
APT for passive portfolio management
Prices of risk vs sensitivity
29. Probability distribution is unknown (ex. A terrorist attack)
RAR = relative return of portfolio (RRp)
APT in active portfolio management
Treynor measure
Uncertainty
30. Concave function that extends from minimum variance portfolio to maximum return portfolio
Risk
Importance of communication for risk managers
BTR - Below Target Risk
Efficient frontier
31. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Nonmarketable asset impact on CAPM
Source of need for risk management
Performance- related metrics
APT in active portfolio management
32. 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
Probability of ruin
Differences in financial risk management for financial companies vs industrial companies
Risks excluded from operational risk
Basic Market risk
33. Returns on any stock are linearly related to a set of indexes
Ri = ai + bi1l1 + bi2l2....+ei
Treynor measure
Shape of portfolio possibilities curve
Risk Management Irrelevance Proposition
34. 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
Business Risk
Derivative contract
APT for passive portfolio management
Risks excluded from operational risk
35. Cannot exit position in market due to size of the position
Asset liquidity risk
Exposure
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Treynor measure
36. Modeling approach is typically between statistical analytic models and structural simulation models
Performance- related metrics
Models used in ERM framework
Risk
Risk types addressed by ERM
37. Strategic risk - Business risk - Reputational risk
Banker's Trust
Risks excluded from operational risk
Allied Irish Bank
Differences in financial risk management for financial companies vs industrial companies
38. Quantile of an empirical distribution
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Nonparametric VaR
EPD or ECOR - Expected Policyholder Deficit (EPD)
Efficient frontier
39. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Funding liquidity risk
Basis
Correlation coefficient effect on diversification
CAPM (formula)
40. Potential amount that can be lost
Exposure
Capital market line (CML)
Asset liquidity risk
Kidder Peabody
41. Market risk - Liquidity risk - Credit risk - Operational risk
Roles of risk management
Prices of risk vs sensitivity
3 main types of operational risk
Four major types of risk
42. 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
Exposure
Debt overhang
Settlement risk
Ten assumptions underlying CAPM
43. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Risk- adjusted performance measure (RAP)
Business risks
Capital market line (CML)
VaR- based analysis (formula)
44. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Differences in financial risk management for financial companies vs industrial companies
CAPM with taxes included (equation)
Allied Irish Bank
Tax shield
45. Derives value from an underlying asset - rate - or index - Derives value from a security
Sovereign risk
VaR- based analysis (formula)
Derivative contract
Treynor measure
46. Both probability and cost of tail events are considered
Tail VaR or TCE - Tail Conditional Expectation(TCE)
APT in active portfolio management
Barings
Basis risk
47. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
CAPM with taxes included (equation)
Multi- period version of CAPM
Zero- beta CAPM (two factor model)
Debt overhang
48. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Effect of heterogeneous expectations on CAPM
Solve for minimum variance portfolio
Allied Irish Bank
Financial Risk
49. 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
Barings
Security (primary vs secondary)
Risks excluded from operational risk
Valuation vs. Risk management
50. Expected value of unfavorable deviations of a random variable from a specified target level
BTR - Below Target Risk
Formula for covariance
Operational risk
Financial risks