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Test your basic knowledge |
FRM: Foundations Of Risk Management
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Subjects
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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. 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
Drysdale Securities (Chase Manhattan)
Recovery rate
Operational risk
APT for passive portfolio management
2. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Sharpe measure
Information ratio
Importance of communication for risk managers
Barings
3. 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
Tracking error
Volatility Market risk
Shortfall risk
4. Wrong distribution - Historical sample may not apply
Traits of ERM
Jensen's alpha
Nonmarketable asset impact on CAPM
Ways risk can be mismeasured
5. Modeling approach is typically between statistical analytic models and structural simulation models
Models used in ERM framework
Multi- period version of CAPM
Settlement risk
Shortfall risk
6. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Risk- adjusted performance measure (RAP)
Zero- beta CAPM (two factor model)
Tax shield
Options motivation on volatility
7. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Security (primary vs secondary)
Effect of heterogeneous expectations on CAPM
Models used in ERM framework
Performance- related metrics
8. Cannot exit position in market due to size of the position
Standard deviation of two assets
Jensen's alpha
Asset liquidity risk
Security (primary vs secondary)
9. Need to assess risk and tell management so they can determine which risks to take on
Traits of ERM
Risk
Importance of communication for risk managers
Forms of Market risk
10. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
EPD or ECOR - Expected Policyholder Deficit (EPD)
Asset transformers
CAPM (formula)
Solve for minimum variance portfolio
11. Quantile of a statistical distribution
Banker's Trust
Market imperfections that can create value
Parametric VaR
CAPM (formula)
12. Occurs the day when two parties exchange payments same day
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Settlement risk
Banker's Trust
Business Risk
13. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Treynor measure
Recovery rate
Differences in financial risk management for financial companies vs industrial companies
CAPM (formula)
14. Market risk - Liquidity risk - Credit risk - Operational risk
Risk
Four major types of risk
Probability of ruin
EPD or ECOR - Expected Policyholder Deficit (EPD)
15. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Sovereign risk
Solvency-related metrics
Traits of ERM
Effect of non- price- taking behavior on CAPM
16. 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
Basis
Risk Management Irrelevance Proposition
Tax shield
Practical considerations related to ERM implementatio
17. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Risks excluded from operational risk
Multi- period version of CAPM
Sortino ratio
Sovereign risk
18. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Ri = Rz + (gamma)(beta)
Risks excluded from operational risk
Credit event
Differences in financial risk management for financial companies vs industrial companies
19. Risk of loses owing to movements in level or volatility of market prices
Market risk
Basic Market risk
Shape of portfolio possibilities curve
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
20. Return is linearly related to growth rate in consumption
Carry- backs and carry- forwards
Multi- period version of CAPM
APT (equation and assumptions)
Ri = ai + bi1l1 + bi2l2....+ei
21. Concave function that extends from minimum variance portfolio to maximum return portfolio
Efficient frontier
RAR = relative return of portfolio (RRp)
Risk- adjusted performance measure (RAP)
Tracking error
22. Future price is greater than the spot price
Three main reasons for financial disasters
Business Risk
Sortino ratio
Contango
23. 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)
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Differences in financial risk management for financial companies vs industrial companies
Market risk
24. The lower (closer to - 1) - the higher the payoff from diversification
Credit event
Banker's Trust
Barings
Correlation coefficient effect on diversification
25. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Risk
Settlement risk
Security (primary vs secondary)
Uncertainty
26. 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
Business risks
Risk
Expected return of two assets
Barings
27. Prices of risk are common factors and do not change - Sensitivities can change
APT (equation and assumptions)
Prices of risk vs sensitivity
3 main types of operational risk
Shortcomings of risk metrics
28. Inability to make payment obligations (ex. Margin calls)
CAPM with taxes included (equation)
Funding liquidity risk
Ways firms can fail to account for risks
Risk Management Irrelevance Proposition
29. 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
VaR - Value at Risk
Probability of ruin
Risks excluded from operational risk
Zero- beta CAPM (two factor model)
30. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Recovery rate
Uncertainty
Valuation vs. Risk management
CAPM assumption for EMH
31. Interest rate movements - derivatives - defaults
Financial Risk
Expected return of two assets
VaR- based analysis (formula)
Allied Irish Bank
32. Quantile of an empirical distribution
Nonparametric VaR
What lead to the exponential growth to derivatives mkt?
Kidder Peabody
Risk
33. CAPM requires the strong form of the Efficient Market Hypothesis = private information
CAPM assumption for EMH
Financial Risk
Drysdale Securities (Chase Manhattan)
Carry- backs and carry- forwards
34. Law of one price - Homogeneous expectations - Security returns process
Debt overhang
Practical considerations related to ERM implementatio
Multi- period version of CAPM
APT (equation and assumptions)
35. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
CAPM assumption for EMH
Credit event
Where is risk coming from
Nonparametric VaR
36. Covariance = correlation coefficient std dev(a) std dev(b)
What lead to the exponential growth to derivatives mkt?
Formula for covariance
Settlement risk
Debt overhang
37. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Security (primary vs secondary)
Effect of heterogeneous expectations on CAPM
Sovereign risk
Asset liquidity risk
38. Asset-liability/market-liquidity risk
Liquidity risk
Basis
Carry- backs and carry- forwards
CAPM assumption for EMH
39. When negative taxable income is moved to a different year to offset future or past taxable income
Models used in ERM framework
Valuation vs. Risk management
APT in active portfolio management
Carry- backs and carry- forwards
40. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Volatility Market risk
Tracking error
Debt overhang
VaR - Value at Risk
41. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Jensen's alpha
Valuation vs. Risk management
Formula for covariance
Where is risk coming from
42. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Ten assumptions underlying CAPM
Drysdale Securities (Chase Manhattan)
Financial risks
Zero- beta CAPM (two factor model)
43. Multibeta CAPM Ri - Rf =
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Financial risks
Derivative contract
Ten assumptions underlying CAPM
44. 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
Risk Management Irrelevance Proposition
Models used in ERM framework
Source of need for risk management
Ten assumptions underlying CAPM
45. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Risk
Four major types of risk
Sharpe measure
Solvency-related metrics
46. 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
Risks excluded from operational risk
Source of need for risk management
Valuation vs. Risk management
Credit event
47. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Efficient frontier
Source of need for risk management
Basis
Recovery rate
48. Probability distribution is unknown (ex. A terrorist attack)
Uncertainty
Probability of ruin
Ten assumptions underlying CAPM
Settlement risk
49. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Efficient frontier
Correlation coefficient effect on diversification
Practical considerations related to ERM implementatio
Firms becoming more sensitive to changes(bank deregulation)
50. 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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