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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. 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
Morningstar Rating System
Formula for covariance
Carry- backs and carry- forwards
Allied Irish Bank
2. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
APT in active portfolio management
Standard deviation of two assets
Zero- beta CAPM (two factor model)
Basis
3. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
EPD or ECOR - Expected Policyholder Deficit (EPD)
Tax shield
Effect of heterogeneous expectations on CAPM
Morningstar Rating System
4. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Morningstar Rating System
Market imperfections that can create value
CAPM (formula)
Risk
5. 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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6. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Morningstar Rating System
Multi- period version of CAPM
Prices of risk vs sensitivity
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
Volatility Market risk
Allied Irish Bank
Zero- beta CAPM (two factor model)
Business Risk
8. Hazard - Financial - Operational - Strategic
Efficient frontier
Risk types addressed by ERM
3 main types of operational risk
Roles of risk management
9. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Sharpe measure
Ten assumptions underlying CAPM
Operational risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
10. Occurs the day when two parties exchange payments same day
Zero- beta CAPM (two factor model)
Forms of Market risk
Settlement risk
Allied Irish Bank
11. Wrong distribution - Historical sample may not apply
Contango
Correlation coefficient effect on diversification
RAR = relative return of portfolio (RRp)
Ways risk can be mismeasured
12. Return is linearly related to growth rate in consumption
Multi- period version of CAPM
Funding liquidity risk
LTCM
Asset transformers
13. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Information ratio
Sovereign risk
Market imperfections that can create value
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
14. Probability distribution is unknown (ex. A terrorist attack)
Uncertainty
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Banker's Trust
15. 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
Tax shield
CAPM (formula)
Probability of ruin
Shortfall risk
16. Expected value of unfavorable deviations of a random variable from a specified target level
Risk types addressed by ERM
BTR - Below Target Risk
Three main reasons for financial disasters
Practical considerations related to ERM implementatio
17. 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
Performance- related metrics
CAPM with taxes included (equation)
Operational risk
18. Losses due to market activities ex. Interest rate changes or defaults
Probability of ruin
Risk Management Irrelevance Proposition
Carry- backs and carry- forwards
Financial risks
19. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Solvency-related metrics
Firms becoming more sensitive to changes(bank deregulation)
Exposure
Correlation coefficient effect on diversification
20. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Effect of non- price- taking behavior on CAPM
Firms becoming more sensitive to changes(bank deregulation)
Credit event
Nonparametric VaR
21. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Solvency-related metrics
APT for passive portfolio management
Nonparametric VaR
3 main types of operational risk
22. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Traits of ERM
Roles of risk management
Effect of heterogeneous expectations on CAPM
Settlement risk
23. 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
Ways firms can fail to account for risks
Probability of ruin
Funding liquidity risk
Risk types addressed by ERM
24. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Financial risks
Differences in financial risk management for financial companies vs industrial companies
Risk
Three main reasons for financial disasters
25. When two payments are exchanged the same day and one party may default after payment is made
Probability of ruin
Importance of communication for risk managers
Kidder Peabody
Settlement risk
26. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Carry- backs and carry- forwards
Importance of communication for risk managers
Debt overhang
Zero- beta CAPM (two factor model)
27. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Risk types addressed by ERM
Settlement risk
Market imperfections that can create value
Solve for minimum variance portfolio
28. Probability that a random variable falls below a specified threshold level
Business Risk
Financial risks
Shortfall risk
Credit event
29. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Sortino ratio
Sharpe measure
Business Risk
Prices of risk vs sensitivity
30. The uses of debt to fall into a lower tax rate
LTCM
Nonparametric VaR
Tax shield
Sharpe measure
31. 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
Practical considerations related to ERM implementatio
BTR - Below Target Risk
Four major types of risk
CAPM with taxes included (equation)
32. 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 -
Financial Risk
RAR = relative return of portfolio (RRp)
Nonmarketable asset impact on CAPM
Source of need for risk management
33. Both probability and cost of tail events are considered
Treynor measure
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Expected return of two assets
Firms becoming more sensitive to changes(bank deregulation)
34. Interest rate movements - derivatives - defaults
Financial Risk
APT (equation and assumptions)
Debt overhang
Correlation coefficient effect on diversification
35. Need to assess risk and tell management so they can determine which risks to take on
Firms becoming more sensitive to changes(bank deregulation)
Importance of communication for risk managers
Sharpe measure
Risk types addressed by ERM
36. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Sovereign risk
Business risks
Contango
Sharpe measure
37. Strategic risk - Business risk - Reputational risk
Risks excluded from operational risk
Formula for covariance
Settlement risk
CAPM assumption for EMH
38. Volatility of unexpected outcomes
Valuation vs. Risk management
Risk
Source of need for risk management
LTCM
39. Covariance = correlation coefficient std dev(a) std dev(b)
Formula for covariance
Traits of ERM
CAPM (formula)
Market risk
40. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Performance- related metrics
Standard deviation of two assets
Security (primary vs secondary)
Risk- adjusted performance measure (RAP)
41. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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42. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Sovereign risk
Shape of portfolio possibilities curve
RAR = relative return of portfolio (RRp)
Zero- beta CAPM (two factor model)
43. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
3 main types of operational risk
Risk- adjusted performance measure (RAP)
Nonmarketable asset impact on CAPM
Ri = Rz + (gamma)(beta)
44. Potential amount that can be lost
Exposure
Ways risk can be mismeasured
Security (primary vs secondary)
Derivative contract
45. Cannot exit position in market due to size of the position
Ten assumptions underlying CAPM
Differences in financial risk management for financial companies vs industrial companies
Asset liquidity risk
Debt overhang
46. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Nonparametric VaR
Importance of communication for risk managers
VaR - Value at Risk
Probability of ruin
47. Derives value from an underlying asset - rate - or index - Derives value from a security
Credit event
VaR - Value at Risk
Derivative contract
Kidder Peabody
48. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Asset liquidity risk
Basis risk
Shortfall risk
Banker's Trust
49. Multibeta CAPM Ri - Rf =
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Ri = ai + bi1l1 + bi2l2....+ei
Nonparametric VaR
APT in active portfolio management
50. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Sortino ratio
LTCM
Firms becoming more sensitive to changes(bank deregulation)
Ri = Rz + (gamma)(beta)