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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.
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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. Return is linearly related to growth rate in consumption
APT in active portfolio management
Carry- backs and carry- forwards
3 main types of operational risk
Multi- period version of CAPM
2. 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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3. The uses of debt to fall into a lower tax rate
Tax shield
Tail VaR or TCE - Tail Conditional Expectation(TCE)
APT in active portfolio management
CAPM assumption for EMH
4. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Source of need for risk management
Operational risk
Security (primary vs secondary)
Business Risk
5. Inability to make payment obligations (ex. Margin calls)
Effect of heterogeneous expectations on CAPM
Uncertainty
Carry- backs and carry- forwards
Funding liquidity risk
6. When negative taxable income is moved to a different year to offset future or past taxable income
Solve for minimum variance portfolio
Nonparametric VaR
Roles of risk management
Carry- backs and carry- forwards
7. Multibeta CAPM Ri - Rf =
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Ri = ai + bi1l1 + bi2l2....+ei
Contango
Formula for covariance
8. 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
3 main types of operational risk
Multi- period version of CAPM
Ways firms can fail to account for risks
Source of need for risk management
9. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Roles of risk management
Nonparametric VaR
Zero- beta CAPM (two factor model)
Risk
10. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Sortino ratio
Information ratio
Asset transformers
VaR- based analysis (formula)
11. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Probability of ruin
Liquidity risk
Differences in financial risk management for financial companies vs industrial companies
Treynor measure
12. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Morningstar Rating System
CAPM with taxes included (equation)
BTR - Below Target Risk
Asset transformers
13. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Tax shield
CAPM assumption for EMH
Risks excluded from operational risk
Jensen's alpha
14. 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
Barings
Solvency-related metrics
Allied Irish Bank
Basic Market risk
15. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Risk types addressed by ERM
CAPM (formula)
Source of need for risk management
Risk- adjusted performance measure (RAP)
16. 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
Differences in financial risk management for financial companies vs industrial companies
Ten assumptions underlying CAPM
Volatility Market risk
17. Losses due to market activities ex. Interest rate changes or defaults
Financial risks
APT for passive portfolio management
Firms becoming more sensitive to changes(bank deregulation)
Uncertainty
18. Volatility of unexpected outcomes
BTR - Below Target Risk
Risk
Sortino ratio
Jensen's alpha
19. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Options motivation on volatility
Source of need for risk management
Efficient frontier
Zero- beta CAPM (two factor model)
20. Need to assess risk and tell management so they can determine which risks to take on
APT in active portfolio management
Importance of communication for risk managers
VaR- based analysis (formula)
Ways risk can be mismeasured
21. Potential amount that can be lost
Settlement risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Four major types of risk
Exposure
22. Probability distribution is unknown (ex. A terrorist attack)
Tracking error
Asset liquidity risk
Uncertainty
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
23. 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.
Standard deviation of two assets
Credit event
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Risk Management Irrelevance Proposition
24. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Effect of heterogeneous expectations on CAPM
Tracking error
Standard deviation of two assets
Tail VaR or TCE - Tail Conditional Expectation(TCE)
25. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
APT for passive portfolio management
Basis
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Liquidity risk
26. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Firms becoming more sensitive to changes(bank deregulation)
Financial Risk
Market imperfections that can create value
Sovereign risk
27. Hazard - Financial - Operational - Strategic
Risks excluded from operational risk
Risk types addressed by ERM
Jensen's alpha
Formula for covariance
28. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Asset liquidity risk
Risks excluded from operational risk
Risk- adjusted performance measure (RAP)
Expected return of two assets
29. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Where is risk coming from
Four major types of risk
Valuation vs. Risk management
Financial Risk
30. Covariance = correlation coefficient std dev(a) std dev(b)
Practical considerations related to ERM implementatio
Formula for covariance
Sovereign risk
VaR - Value at Risk
31. 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
APT in active portfolio management
Basis risk
Basic Market risk
Ten assumptions underlying CAPM
32. Absolute and relative risk - direction and non-directional
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Forms of Market risk
Settlement risk
Allied Irish Bank
33. 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
Risk- adjusted performance measure (RAP)
BTR - Below Target Risk
Carry- backs and carry- forwards
Drysdale Securities (Chase Manhattan)
34. When two payments are exchanged the same day and one party may default after payment is made
Financial risks
Settlement risk
Models used in ERM framework
Volatility Market risk
35. Future price is greater than the spot price
Parametric VaR
Contango
Funding liquidity risk
3 main types of operational risk
36. Curve must be concave - Straight line connecting any two points must be under the curve
BTR - Below Target Risk
Shape of portfolio possibilities curve
Exposure
LTCM
37. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Risks excluded from operational risk
Credit event
Firms becoming more sensitive to changes(bank deregulation)
Asset transformers
38. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Volatility Market risk
Risks excluded from operational risk
Drysdale Securities (Chase Manhattan)
Three main reasons for financial disasters
39. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Tracking error
Liquidity risk
3 main types of operational risk
VaR - Value at Risk
40. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
APT for passive portfolio management
Prices of risk vs sensitivity
Sortino ratio
Ten assumptions underlying CAPM
41. 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
Risk Management Irrelevance Proposition
Morningstar Rating System
42. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Importance of communication for risk managers
Risk types addressed by ERM
Settlement risk
Debt overhang
43. 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
Sharpe measure
Business Risk
Solve for minimum variance portfolio
Allied Irish Bank
44. Strategic risk - Business risk - Reputational risk
What lead to the exponential growth to derivatives mkt?
Information ratio
Derivative contract
Risks excluded from operational risk
45. 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 -
Capital market line (CML)
Basis
Source of need for risk management
Risk Management Irrelevance Proposition
46. 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
Asset transformers
Kidder Peabody
LTCM
Sharpe measure
47. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
APT for passive portfolio management
Financial Risk
APT (equation and assumptions)
Asset transformers
48. Concave function that extends from minimum variance portfolio to maximum return portfolio
Settlement risk
Efficient frontier
BTR - Below Target Risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
49. Quantile of an empirical distribution
Basic Market risk
Nonparametric VaR
Tax shield
Expected return of two assets
50. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Capital market line (CML)
Sharpe measure
Operational risk
APT for passive portfolio management