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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. 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
APT in active portfolio management
Basis
Shortcomings of risk metrics
VaR - Value at Risk
2. Unanticipated movements in relative prices of assets in hedged position
Asset transformers
Basic Market risk
Volatility Market risk
Shape of portfolio possibilities curve
3. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Uncertainty
Shape of portfolio possibilities curve
Solve for minimum variance portfolio
Asset transformers
4. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Recovery rate
Basis risk
Market imperfections that can create value
Carry- backs and carry- forwards
5. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Market risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
Business risks
Contango
6. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Sovereign risk
Capital market line (CML)
Derivative contract
Differences in financial risk management for financial companies vs industrial companies
7. Hazard - Financial - Operational - Strategic
Roles of risk management
Risk types addressed by ERM
Exposure
Differences in financial risk management for financial companies vs industrial companies
8. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Business Risk
Debt overhang
Volatility Market risk
Morningstar Rating System
9. 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
APT in active portfolio management
Sortino ratio
Kidder Peabody
CAPM assumption for EMH
10. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
RAR = relative return of portfolio (RRp)
Market imperfections that can create value
Performance- related metrics
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
11. Returns on any stock are linearly related to a set of indexes
Tax shield
Ri = ai + bi1l1 + bi2l2....+ei
Market risk
Shortcomings of risk metrics
12. Expected value of unfavorable deviations of a random variable from a specified target level
Traits of ERM
BTR - Below Target Risk
Practical considerations related to ERM implementatio
Performance- related metrics
13. 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
Ways risk can be mismeasured
Formula for covariance
Ten assumptions underlying CAPM
RAR = relative return of portfolio (RRp)
14. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Derivative contract
Carry- backs and carry- forwards
Treynor measure
Nonparametric VaR
15. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Tracking error
Valuation vs. Risk management
Effect of heterogeneous expectations on CAPM
CAPM assumption for EMH
16. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Where is risk coming from
Tracking error
Debt overhang
CAPM assumption for EMH
17. Losses due to market activities ex. Interest rate changes or defaults
Zero- beta CAPM (two factor model)
Financial risks
Roles of risk management
Ri = ai + bi1l1 + bi2l2....+ei
18. Interest rate movements - derivatives - defaults
Financial Risk
APT (equation and assumptions)
Operational risk
Risks excluded from operational risk
19. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Standard deviation of two assets
Tax shield
Morningstar Rating System
Risk Management Irrelevance Proposition
20. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Tracking error
Source of need for risk management
CAPM with taxes included (equation)
Options motivation on volatility
21. Covariance = correlation coefficient std dev(a) std dev(b)
Four major types of risk
CAPM assumption for EMH
Formula for covariance
Forms of Market risk
22. Derives value from an underlying asset - rate - or index - Derives value from a security
Traits of ERM
Derivative contract
VaR - Value at Risk
Capital market line (CML)
23. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Practical considerations related to ERM implementatio
Operational risk
Basic Market risk
Nonmarketable asset impact on CAPM
24. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Performance- related metrics
Sharpe measure
Formula for covariance
Ways risk can be mismeasured
25. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
VaR - Value at Risk
Morningstar Rating System
Sortino ratio
CAPM with taxes included (equation)
26. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Basis
Risk
Importance of communication for risk managers
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
27. 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.
Risk- adjusted performance measure (RAP)
Ways risk can be mismeasured
Risk Management Irrelevance Proposition
Solvency-related metrics
28. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
CAPM (formula)
Efficient frontier
Risk
Solvency-related metrics
29. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Drysdale Securities (Chase Manhattan)
Debt overhang
Valuation vs. Risk management
Risk types addressed by ERM
30. Rp = XaRa + XbRb
Forms of Market risk
Contango
Credit event
Expected return of two assets
31. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Barings
Forms of Market risk
Ri = Rz + (gamma)(beta)
Credit event
32. Strategic risk - Business risk - Reputational risk
Contango
Risks excluded from operational risk
Nonparametric VaR
Differences in financial risk management for financial companies vs industrial companies
33. Return is linearly related to growth rate in consumption
Forms of Market risk
Carry- backs and carry- forwards
Importance of communication for risk managers
Multi- period version of CAPM
34. Volatility of unexpected outcomes
BTR - Below Target Risk
Traits of ERM
Risk
Jensen's alpha
35. 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
Options motivation on volatility
Contango
Valuation vs. Risk management
Sortino ratio
36. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Firms becoming more sensitive to changes(bank deregulation)
VaR- based analysis (formula)
Liquidity risk
Market risk
37. Occurs the day when two parties exchange payments same day
Settlement risk
Source of need for risk management
Basis
Four major types of risk
38. 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 -
Risk
Probability of ruin
Financial Risk
Source of need for risk management
39. 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
CAPM assumption for EMH
Basis
Traits of ERM
Security (primary vs secondary)
40. Cannot exit position in market due to size of the position
Asset liquidity risk
Asset transformers
Forms of Market risk
Shape of portfolio possibilities curve
41. Both probability and cost of tail events are considered
Risks excluded from operational risk
Risk types addressed by ERM
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Effect of heterogeneous expectations on CAPM
42. 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
Ten assumptions underlying CAPM
BTR - Below Target Risk
Source of need for risk management
Drysdale Securities (Chase Manhattan)
43. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
CAPM with taxes included (equation)
APT (equation and assumptions)
Shape of portfolio possibilities curve
Probability of ruin
44. Modeling approach is typically between statistical analytic models and structural simulation models
BTR - Below Target Risk
Options motivation on volatility
Practical considerations related to ERM implementatio
Models used in ERM framework
45. Absolute and relative risk - direction and non-directional
Forms of Market risk
Sovereign risk
Business risks
Treynor measure
46. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Security (primary vs secondary)
CAPM with taxes included (equation)
Performance- related metrics
Market imperfections that can create value
47. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Market imperfections that can create value
Settlement risk
Sovereign risk
APT in active portfolio management
48. Relative portfolio risk (RRiskp) - Based on a one- month investment period
RAR = relative return of portfolio (RRp)
Traits of ERM
Source of need for risk management
Three main reasons for financial disasters
49. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Risk
Importance of communication for risk managers
Basis risk
Effect of non- price- taking behavior on CAPM
50. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Financial Risk
Options motivation on volatility
Four major types of risk
VaR - Value at Risk