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Test your basic knowledge |
FRM: Foundations Of Risk Management
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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. 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
Drysdale Securities (Chase Manhattan)
Expected return of two assets
Exposure
Basic Market risk
2. 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.
Debt overhang
Recovery rate
Nonmarketable asset impact on CAPM
Risk Management Irrelevance Proposition
3. Interest rate movements - derivatives - defaults
Financial Risk
Uncertainty
Barings
Security (primary vs secondary)
4. 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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5. Unanticipated movements in relative prices of assets in hedged position
Probability of ruin
Basic Market risk
Expected return of two assets
Shortfall risk
6. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Recovery rate
Solvency-related metrics
Risk
Solve for minimum variance portfolio
7. Those which corporations assume whillingly to create competitive advantage/add shareholder value - Business Decisions: investment decisions - prod - dev choices - marketing strategies - organizational struct. - Business Environment: competitive and
Formula for covariance
Standard deviation of two assets
Market imperfections that can create value
Business Risk
8. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Correlation coefficient effect on diversification
Operational risk
3 main types of operational risk
RAR = relative return of portfolio (RRp)
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
RAR = relative return of portfolio (RRp)
Volatility Market risk
Settlement risk
Kidder Peabody
10. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Information ratio
Where is risk coming from
Risk- adjusted performance measure (RAP)
APT in active portfolio management
11. Return is linearly related to growth rate in consumption
Multi- period version of CAPM
Solve for minimum variance portfolio
Zero- beta CAPM (two factor model)
Kidder Peabody
12. Volatility of unexpected outcomes
Sharpe measure
Parametric VaR
Risk
Liquidity risk
13. When negative taxable income is moved to a different year to offset future or past taxable income
Tracking error
Business risks
Carry- backs and carry- forwards
Valuation vs. Risk management
14. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Differences in financial risk management for financial companies vs industrial companies
Volatility Market risk
Sovereign risk
Models used in ERM framework
15. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
APT (equation and assumptions)
VaR - Value at Risk
Nonparametric VaR
Efficient frontier
16. 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
Correlation coefficient effect on diversification
LTCM
Credit event
Tax shield
17. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Settlement risk
Recovery rate
Debt overhang
Tracking error
18. Potential amount that can be lost
Tracking error
Valuation vs. Risk management
Exposure
Shortfall risk
19. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Business risks
LTCM
What lead to the exponential growth to derivatives mkt?
CAPM (formula)
20. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Uncertainty
Credit event
Effect of heterogeneous expectations on CAPM
Operational risk
21. 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
Ways risk can be mismeasured
Allied Irish Bank
Expected return of two assets
Nonmarketable asset impact on CAPM
22. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Shortcomings of risk metrics
Market risk
CAPM with taxes included (equation)
Derivative contract
23. Occurs the day when two parties exchange payments same day
Debt overhang
Settlement risk
Risk
Barings
24. Prices of risk are common factors and do not change - Sensitivities can change
Volatility Market risk
Prices of risk vs sensitivity
Information ratio
Roles of risk management
25. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
APT in active portfolio management
Correlation coefficient effect on diversification
Basis risk
What lead to the exponential growth to derivatives mkt?
26. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Options motivation on volatility
Ways risk can be mismeasured
Firms becoming more sensitive to changes(bank deregulation)
Efficient frontier
27. Returns on any stock are linearly related to a set of indexes
Settlement risk
Ri = ai + bi1l1 + bi2l2....+ei
Capital market line (CML)
Four major types of risk
28. 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
Ten assumptions underlying CAPM
Volatility Market risk
Efficient frontier
APT for passive portfolio management
29. Market risk - Liquidity risk - Credit risk - Operational risk
Four major types of risk
Efficient frontier
Risk
Correlation coefficient effect on diversification
30. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Four major types of risk
Asset liquidity risk
CAPM assumption for EMH
Options motivation on volatility
31. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Risk
Basis risk
Shape of portfolio possibilities curve
Standard deviation of two assets
32. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Performance- related metrics
Shape of portfolio possibilities curve
Debt overhang
Morningstar Rating System
33. 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
Market risk
Barings
Security (primary vs secondary)
Probability of ruin
34. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Market imperfections that can create value
Solve for minimum variance portfolio
Funding liquidity risk
Ten assumptions underlying CAPM
35. Multibeta CAPM Ri - Rf =
Treynor measure
Business Risk
Market risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
36. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Firms becoming more sensitive to changes(bank deregulation)
Where is risk coming from
Operational risk
Ri = Rz + (gamma)(beta)
37. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Morningstar Rating System
Shortcomings of risk metrics
Probability of ruin
Where is risk coming from
38. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Allied Irish Bank
Source of need for risk management
Basis
Risk Management Irrelevance Proposition
39. Quantile of a statistical distribution
Capital market line (CML)
Parametric VaR
Morningstar Rating System
BTR - Below Target Risk
40. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Security (primary vs secondary)
Volatility Market risk
Solvency-related metrics
Ways firms can fail to account for risks
41. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Firms becoming more sensitive to changes(bank deregulation)
Expected return of two assets
APT (equation and assumptions)
Effect of non- price- taking behavior on CAPM
42. 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
Risk
Basic Market risk
Shortcomings of risk metrics
Sortino ratio
43. Future price is greater than the spot price
VaR - Value at Risk
What lead to the exponential growth to derivatives mkt?
Financial risks
Contango
44. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Efficient frontier
Jensen's alpha
Risk
RAR = relative return of portfolio (RRp)
45. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Recovery rate
Probability of ruin
Effect of heterogeneous expectations on CAPM
Forms of Market risk
46. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Tracking error
APT (equation and assumptions)
Ri = Rz + (gamma)(beta)
Ways risk can be mismeasured
47. The need to hedge against risks - for firms need to speculate.
What lead to the exponential growth to derivatives mkt?
Parametric VaR
Uncertainty
Basis
48. 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
Basic Market risk
Morningstar Rating System
Asset transformers
Traits of ERM
49. Losses due to market activities ex. Interest rate changes or defaults
Differences in financial risk management for financial companies vs industrial companies
Multi- period version of CAPM
Financial risks
Settlement risk
50. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Solve for minimum variance portfolio
Effect of heterogeneous expectations on CAPM
Contango
Efficient frontier