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Test your basic knowledge |
FRM: Foundations Of Risk Management
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certifications
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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. Volatility of unexpected outcomes
Risk
Security (primary vs secondary)
Shape of portfolio possibilities curve
Basis risk
2. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Basis risk
Banker's Trust
Market imperfections that can create value
Nonparametric VaR
3. 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
Ten assumptions underlying CAPM
Shortfall risk
3 main types of operational risk
Shortcomings of risk metrics
4. Asses firm risks - Communicate risks - Manage and monitor risks
Operational risk
Roles of risk management
Financial Risk
Ten assumptions underlying CAPM
5. 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
Security (primary vs secondary)
Valuation vs. Risk management
Credit event
Effect of heterogeneous expectations on CAPM
6. Return is linearly related to growth rate in consumption
Financial Risk
Multi- period version of CAPM
Morningstar Rating System
Ten assumptions underlying CAPM
7. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Options motivation on volatility
What lead to the exponential growth to derivatives mkt?
Ways risk can be mismeasured
Sovereign risk
8. Asset-liability/market-liquidity risk
Expected return of two assets
Liquidity risk
Risk
Basis
9. Concave function that extends from minimum variance portfolio to maximum return portfolio
APT (equation and assumptions)
Ri = ai + bi1l1 + bi2l2....+ei
Probability of ruin
Efficient frontier
10. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Differences in financial risk management for financial companies vs industrial companies
Risk
Ri = Rz + (gamma)(beta)
Performance- related metrics
11. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Liquidity risk
Importance of communication for risk managers
BTR - Below Target Risk
Effect of non- price- taking behavior on CAPM
12. Losses due to market activities ex. Interest rate changes or defaults
BTR - Below Target Risk
Financial risks
Settlement risk
Multi- period version of CAPM
13. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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14. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Nonparametric VaR
APT in active portfolio management
Solve for minimum variance portfolio
Effect of heterogeneous expectations on CAPM
15. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
CAPM with taxes included (equation)
Shortfall risk
Options motivation on volatility
APT in active portfolio management
16. 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
Practical considerations related to ERM implementatio
Kidder Peabody
Drysdale Securities (Chase Manhattan)
Banker's Trust
17. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Liquidity risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Contango
Risk- adjusted performance measure (RAP)
18. Multibeta CAPM Ri - Rf =
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Debt overhang
Effect of non- price- taking behavior on CAPM
Differences in financial risk management for financial companies vs industrial companies
19. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Ten assumptions underlying CAPM
Barings
Liquidity risk
Tracking error
20. The uses of debt to fall into a lower tax rate
Nonparametric VaR
Importance of communication for risk managers
Tax shield
Efficient frontier
21. Hazard - Financial - Operational - Strategic
Risk types addressed by ERM
Contango
3 main types of operational risk
Treynor measure
22. 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
Settlement risk
Risk types addressed by ERM
Morningstar Rating System
Probability of ruin
23. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Business risks
Risk- adjusted performance measure (RAP)
Contango
Barings
24. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
VaR - Value at Risk
Practical considerations related to ERM implementatio
Where is risk coming from
Ten assumptions underlying CAPM
25. Both probability and cost of tail events are considered
Nonmarketable asset impact on CAPM
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Banker's Trust
Valuation vs. Risk management
26. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Sovereign risk
Solvency-related metrics
Options motivation on volatility
Basis risk
27. Occurs the day when two parties exchange payments same day
Ways risk can be mismeasured
Differences in financial risk management for financial companies vs industrial companies
Settlement risk
Financial risks
28. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Risk- adjusted performance measure (RAP)
Models used in ERM framework
3 main types of operational risk
Effect of non- price- taking behavior on CAPM
29. Inability to make payment obligations (ex. Margin calls)
Funding liquidity risk
Firms becoming more sensitive to changes(bank deregulation)
Source of need for risk management
Financial Risk
30. 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
Debt overhang
Firms becoming more sensitive to changes(bank deregulation)
Three main reasons for financial disasters
Shortcomings of risk metrics
31. 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
Traits of ERM
Ri = Rz + (gamma)(beta)
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Expected return of two assets
32. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Roles of risk management
Asset transformers
Zero- beta CAPM (two factor model)
Morningstar Rating System
33. Risk of loses owing to movements in level or volatility of market prices
Market risk
Business risks
Roles of risk management
Valuation vs. Risk management
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
Tracking error
APT for passive portfolio management
Solve for minimum variance portfolio
Multi- period version of CAPM
35. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
LTCM
Zero- beta CAPM (two factor model)
Asset transformers
Traits of ERM
36. 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
Three main reasons for financial disasters
Efficient frontier
Prices of risk vs sensitivity
Barings
37. Law of one price - Homogeneous expectations - Security returns process
Derivative contract
APT (equation and assumptions)
Banker's Trust
Volatility Market risk
38. Future price is greater than the spot price
Contango
LTCM
Differences in financial risk management for financial companies vs industrial companies
Settlement risk
39. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Contango
Ten assumptions underlying CAPM
Shape of portfolio possibilities curve
Debt overhang
40. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Sortino ratio
Where is risk coming from
VaR- based analysis (formula)
Efficient frontier
41. 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
Information ratio
VaR - Value at Risk
LTCM
Ways firms can fail to account for risks
42. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Sortino ratio
Drysdale Securities (Chase Manhattan)
APT for passive portfolio management
Differences in financial risk management for financial companies vs industrial companies
43. Curve must be concave - Straight line connecting any two points must be under the curve
Correlation coefficient effect on diversification
Traits of ERM
Shape of portfolio possibilities curve
Basis
44. 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
Traits of ERM
CAPM with taxes included (equation)
Three main reasons for financial disasters
45. 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)
Banker's Trust
Correlation coefficient effect on diversification
Security (primary vs secondary)
46. Potential amount that can be lost
Liquidity risk
APT for passive portfolio management
Banker's Trust
Exposure
47. Cannot exit position in market due to size of the position
Risks excluded from operational risk
Asset liquidity risk
Expected return of two assets
Market risk
48. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Practical considerations related to ERM implementatio
RAR = relative return of portfolio (RRp)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Zero- beta CAPM (two factor model)
49. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Drysdale Securities (Chase Manhattan)
Derivative contract
Probability of ruin
Market imperfections that can create value
50. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Where is risk coming from
Funding liquidity risk
Jensen's alpha
Sharpe measure