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Test your basic knowledge |
FRM: Foundations Of Risk Management
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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. Quantile of a statistical distribution
CAPM assumption for EMH
Parametric VaR
Settlement risk
Standard deviation of two assets
2. Occurs the day when two parties exchange payments same day
Settlement risk
BTR - Below Target Risk
Morningstar Rating System
Effect of non- price- taking behavior on CAPM
3. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Risk
Ri = Rz + (gamma)(beta)
Where is risk coming from
Volatility Market risk
4. Expected value of unfavorable deviations of a random variable from a specified target level
Capital market line (CML)
Standard deviation of two assets
What lead to the exponential growth to derivatives mkt?
BTR - Below Target Risk
5. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Correlation coefficient effect on diversification
Standard deviation of two assets
Nonmarketable asset impact on CAPM
Traits of ERM
6. Return is linearly related to growth rate in consumption
RAR = relative return of portfolio (RRp)
VaR- based analysis (formula)
Multi- period version of CAPM
Basis
7. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Financial risks
Risk types addressed by ERM
Effect of heterogeneous expectations on CAPM
Morningstar Rating System
8. Probability that a random variable falls below a specified threshold level
Shortfall risk
Asset transformers
What lead to the exponential growth to derivatives mkt?
Tracking error
9. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Financial Risk
Shortcomings of risk metrics
EPD or ECOR - Expected Policyholder Deficit (EPD)
Basis
10. Multibeta CAPM Ri - Rf =
Basic Market risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Business risks
Ways firms can fail to account for risks
11. Modeling approach is typically between statistical analytic models and structural simulation models
Options motivation on volatility
Models used in ERM framework
Market imperfections that can create value
Prices of risk vs sensitivity
12. 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
Business Risk
Jensen's alpha
Risk
Performance- related metrics
13. 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
Settlement risk
Shortcomings of risk metrics
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Performance- related metrics
14. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Where is risk coming from
Recovery rate
Risks excluded from operational risk
Nonparametric VaR
15. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Debt overhang
Risks excluded from operational risk
Funding liquidity risk
Three main reasons for financial disasters
16. Law of one price - Homogeneous expectations - Security returns process
Three main reasons for financial disasters
APT (equation and assumptions)
Source of need for risk management
Multi- period version of CAPM
17. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
VaR- based analysis (formula)
LTCM
Where is risk coming from
Market imperfections that can create value
18. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Sharpe measure
Funding liquidity risk
Effect of non- price- taking behavior on CAPM
Valuation vs. Risk management
19. 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
Nonmarketable asset impact on CAPM
Morningstar Rating System
CAPM with taxes included (equation)
20. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Four major types of risk
Sharpe measure
BTR - Below Target Risk
Sovereign risk
21. Covariance = correlation coefficient std dev(a) std dev(b)
Morningstar Rating System
Debt overhang
Asset liquidity risk
Formula for covariance
22. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Credit event
Sortino ratio
Basis
Ways firms can fail to account for risks
23. Hazard - Financial - Operational - Strategic
Firms becoming more sensitive to changes(bank deregulation)
Treynor measure
Barings
Risk types addressed by ERM
24. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Tracking error
APT in active portfolio management
Business Risk
Market risk
25. Concave function that extends from minimum variance portfolio to maximum return portfolio
CAPM assumption for EMH
Efficient frontier
Nonmarketable asset impact on CAPM
Solve for minimum variance portfolio
26. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Basic Market risk
Roles of risk management
Kidder Peabody
CAPM assumption for EMH
27. 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
Multi- period version of CAPM
Risk Management Irrelevance Proposition
Ten assumptions underlying CAPM
Settlement risk
28. 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
Parametric VaR
Three main reasons for financial disasters
Barings
Market imperfections that can create value
29. Probability distribution is unknown (ex. A terrorist attack)
CAPM (formula)
Uncertainty
Options motivation on volatility
Ri = Rz + (gamma)(beta)
30. Rp = XaRa + XbRb
Expected return of two assets
Risk
Ri = Rz + (gamma)(beta)
Uncertainty
31. Strategic risk - Business risk - Reputational risk
APT (equation and assumptions)
Risks excluded from operational risk
Effect of non- price- taking behavior on CAPM
Tail VaR or TCE - Tail Conditional Expectation(TCE)
32. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Ways risk can be mismeasured
EPD or ECOR - Expected Policyholder Deficit (EPD)
Three main reasons for financial disasters
Jensen's alpha
33. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Liquidity risk
Importance of communication for risk managers
Nonmarketable asset impact on CAPM
Zero- beta CAPM (two factor model)
34. 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
APT (equation and assumptions)
Probability of ruin
Settlement risk
Asset transformers
35. 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
Allied Irish Bank
Ri = ai + bi1l1 + bi2l2....+ei
Nonparametric VaR
Uncertainty
36. 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
Debt overhang
Risks excluded from operational risk
APT for passive portfolio management
Sharpe measure
37. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Standard deviation of two assets
Ways risk can be mismeasured
RAR = relative return of portfolio (RRp)
Shortcomings of risk metrics
38. Need to assess risk and tell management so they can determine which risks to take on
Sharpe measure
Valuation vs. Risk management
What lead to the exponential growth to derivatives mkt?
Importance of communication for risk managers
39. 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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40. 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
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Valuation vs. Risk management
Ri = Rz + (gamma)(beta)
Morningstar Rating System
41. 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
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Market imperfections that can create value
Drysdale Securities (Chase Manhattan)
42. The need to hedge against risks - for firms need to speculate.
What lead to the exponential growth to derivatives mkt?
Basis risk
APT for passive portfolio management
Business risks
43. Efficient frontier with inclusion of risk free rate - Straight line with formula Rc = Rf + ((Ra - Rf)/std dev(a))*std dev(c) - c is the total portfolio - a is the risky asset
Valuation vs. Risk management
Barings
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Capital market line (CML)
44. Absolute and relative risk - direction and non-directional
Forms of Market risk
Risk
Ways firms can fail to account for risks
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
45. Wrong distribution - Historical sample may not apply
Carry- backs and carry- forwards
Ten assumptions underlying CAPM
Source of need for risk management
Ways risk can be mismeasured
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
Kidder Peabody
Sharpe measure
Parametric VaR
3 main types of operational risk
47. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Four major types of risk
Ten assumptions underlying CAPM
Risk
Basis risk
48. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
CAPM with taxes included (equation)
Risk- adjusted performance measure (RAP)
Information ratio
Tax shield
49. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Sovereign risk
Asset transformers
Three main reasons for financial disasters
Debt overhang
50. When two payments are exchanged the same day and one party may default after payment is made
Settlement risk
Nonmarketable asset impact on CAPM
Basis risk
Debt overhang