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Test your basic knowledge |
FRM: Foundations Of Risk Management
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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. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Uncertainty
Basic Market risk
Kidder Peabody
RAR = relative return of portfolio (RRp)
2. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Solvency-related metrics
Ri = Rz + (gamma)(beta)
Parametric VaR
Operational risk
3. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Forms of Market risk
APT for passive portfolio management
Performance- related metrics
Nonmarketable asset impact on CAPM
4. Occurs the day when two parties exchange payments same day
APT in active portfolio management
Tax shield
Settlement risk
CAPM (formula)
5. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Treynor measure
BTR - Below Target Risk
Standard deviation of two assets
CAPM assumption for EMH
6. The lower (closer to - 1) - the higher the payoff from diversification
Effect of heterogeneous expectations on CAPM
Correlation coefficient effect on diversification
LTCM
Three main reasons for financial disasters
7. Absolute and relative risk - direction and non-directional
Market risk
CAPM assumption for EMH
Contango
Forms of Market risk
8. Asset-liability/market-liquidity risk
Nonparametric VaR
Liquidity risk
Allied Irish Bank
Effect of non- price- taking behavior on CAPM
9. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Business risks
Source of need for risk management
Formula for covariance
Information ratio
10. Quantile of a statistical distribution
Parametric VaR
VaR - Value at Risk
Volatility Market risk
Risk- adjusted performance measure (RAP)
11. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Solve for minimum variance portfolio
Security (primary vs secondary)
APT in active portfolio management
Credit event
12. 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
Banker's Trust
Valuation vs. Risk management
Financial risks
Information ratio
13. 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
Uncertainty
Where is risk coming from
Probability of ruin
Basis risk
14. Potential amount that can be lost
VaR- based analysis (formula)
Risk
Shortfall risk
Exposure
15. 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)
Four major types of risk
Models used in ERM framework
Ten assumptions underlying CAPM
16. When two payments are exchanged the same day and one party may default after payment is made
Traits of ERM
What lead to the exponential growth to derivatives mkt?
Basic Market risk
Settlement risk
17. 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
Ways firms can fail to account for risks
3 main types of operational risk
Asset liquidity risk
18. The need to hedge against risks - for firms need to speculate.
Settlement risk
Operational risk
What lead to the exponential growth to derivatives mkt?
Expected return of two assets
19. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Zero- beta CAPM (two factor model)
Information ratio
Solvency-related metrics
Shortcomings of risk metrics
20. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Treynor measure
Kidder Peabody
Sharpe measure
Valuation vs. Risk management
21. Losses due to market activities ex. Interest rate changes or defaults
Financial risks
Efficient frontier
Sovereign risk
Forms of Market risk
22. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Exposure
Asset transformers
Settlement risk
Basis risk
23. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Debt overhang
Solvency-related metrics
Importance of communication for risk managers
Practical considerations related to ERM implementatio
24. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Sharpe measure
Settlement risk
Differences in financial risk management for financial companies vs industrial companies
Asset transformers
25. Strategic risk - Business risk - Reputational risk
Importance of communication for risk managers
Risks excluded from operational risk
3 main types of operational risk
Credit event
26. Returns on any stock are linearly related to a set of indexes
Ri = ai + bi1l1 + bi2l2....+ei
Solve for minimum variance portfolio
Security (primary vs secondary)
Operational risk
27. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Three main reasons for financial disasters
Kidder Peabody
Liquidity risk
Tax shield
28. 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
Sharpe measure
Risk
Carry- backs and carry- forwards
29. Quantile of an empirical distribution
Security (primary vs secondary)
Efficient frontier
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Nonparametric VaR
30. 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
Differences in financial risk management for financial companies vs industrial companies
CAPM (formula)
Performance- related metrics
Practical considerations related to ERM implementatio
31. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Effect of heterogeneous expectations on CAPM
Debt overhang
APT in active portfolio management
Ways risk can be mismeasured
32. 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
EPD or ECOR - Expected Policyholder Deficit (EPD)
Traits of ERM
Allied Irish Bank
Effect of non- price- taking behavior on CAPM
33. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Contango
Risk
Four major types of risk
Kidder Peabody
34. 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 (formula)
Sovereign risk
Ten assumptions underlying CAPM
APT in active portfolio management
35. Future price is greater than the spot price
Contango
Exposure
Correlation coefficient effect on diversification
Ways firms can fail to account for risks
36. Unanticipated movements in relative prices of assets in hedged position
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Basic Market risk
Shortfall risk
Shortcomings of risk metrics
37. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Business Risk
Correlation coefficient effect on diversification
3 main types of operational risk
Solve for minimum variance portfolio
38. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Probability of ruin
3 main types of operational risk
CAPM (formula)
39. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Ri = Rz + (gamma)(beta)
Basis
Correlation coefficient effect on diversification
Nonmarketable asset impact on CAPM
40. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Asset transformers
Allied Irish Bank
Business Risk
Market risk
41. Volatility of unexpected outcomes
Risks excluded from operational risk
Correlation coefficient effect on diversification
Risk
Carry- backs and carry- forwards
42. Concave function that extends from minimum variance portfolio to maximum return portfolio
Efficient frontier
Settlement risk
Market imperfections that can create value
Drysdale Securities (Chase Manhattan)
43. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
CAPM (formula)
Risk types addressed by ERM
Sortino ratio
EPD or ECOR - Expected Policyholder Deficit (EPD)
44. Derives value from an underlying asset - rate - or index - Derives value from a security
Derivative contract
Practical considerations related to ERM implementatio
Jensen's alpha
Multi- period version of CAPM
45. 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
Solve for minimum variance portfolio
Ways firms can fail to account for risks
Formula for covariance
Recovery rate
46. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Tax shield
Sovereign risk
Where is risk coming from
VaR- based analysis (formula)
47. Covariance = correlation coefficient std dev(a) std dev(b)
Firms becoming more sensitive to changes(bank deregulation)
Formula for covariance
Exposure
Expected return of two assets
48. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Ri = Rz + (gamma)(beta)
CAPM (formula)
Importance of communication for risk managers
Market imperfections that can create value
49. 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
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Security (primary vs secondary)
Information ratio
Kidder Peabody
50. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Solvency-related metrics
APT (equation and assumptions)
Basis
Volatility Market risk