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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. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Jensen's alpha
Credit event
Risk types addressed by ERM
Operational risk
2. Losses due to market activities ex. Interest rate changes or defaults
Kidder Peabody
Financial risks
Effect of heterogeneous expectations on CAPM
Expected return of two assets
3. Covariance = correlation coefficient std dev(a) std dev(b)
APT in active portfolio management
Effect of heterogeneous expectations on CAPM
Formula for covariance
Where is risk coming from
4. Absolute and relative risk - direction and non-directional
Forms of Market risk
Expected return of two assets
Nonmarketable asset impact on CAPM
Banker's Trust
5. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
VaR - Value at Risk
Risk
APT (equation and assumptions)
APT for passive portfolio management
6. 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
Firms becoming more sensitive to changes(bank deregulation)
APT for passive portfolio management
Banker's Trust
Correlation coefficient effect on diversification
7. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
CAPM (formula)
Ways firms can fail to account for risks
Basis risk
Valuation vs. Risk management
8. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Performance- related metrics
Morningstar Rating System
Financial risks
APT in active portfolio management
9. Multibeta CAPM Ri - Rf =
Risk
Operational risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
EPD or ECOR - Expected Policyholder Deficit (EPD)
10. Quantile of a statistical distribution
Tax shield
Asset liquidity risk
Parametric VaR
VaR - Value at Risk
11. Risk of loses owing to movements in level or volatility of market prices
Uncertainty
Financial risks
Market risk
Barings
12. Law of one price - Homogeneous expectations - Security returns process
APT (equation and assumptions)
Ri = ai + bi1l1 + bi2l2....+ei
Firms becoming more sensitive to changes(bank deregulation)
Barings
13. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Practical considerations related to ERM implementatio
Parametric VaR
Traits of ERM
CAPM with taxes included (equation)
14. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Performance- related metrics
Risk types addressed by ERM
Firms becoming more sensitive to changes(bank deregulation)
Standard deviation of two assets
15. Future price is greater than the spot price
Contango
Business risks
Probability of ruin
Expected return of two assets
16. Relative portfolio risk (RRiskp) - Based on a one- month investment period
RAR = relative return of portfolio (RRp)
Models used in ERM framework
Debt overhang
Three main reasons for financial disasters
17. 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
Capital market line (CML)
Debt overhang
Zero- beta CAPM (two factor model)
Sovereign risk
18. CAPM requires the strong form of the Efficient Market Hypothesis = private information
CAPM assumption for EMH
BTR - Below Target Risk
Operational risk
Effect of non- price- taking behavior on CAPM
19. Interest rate movements - derivatives - defaults
Allied Irish Bank
APT for passive portfolio management
LTCM
Financial Risk
20. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Financial risks
Solvency-related metrics
VaR- based analysis (formula)
Settlement risk
21. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
LTCM
Basis risk
Asset transformers
3 main types of operational risk
22. 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 -
Volatility Market risk
Source of need for risk management
Shortfall risk
Three main reasons for financial disasters
23. Concave function that extends from minimum variance portfolio to maximum return portfolio
Efficient frontier
Morningstar Rating System
Shortfall risk
Expected return of two assets
24. Potential amount that can be lost
Four major types of risk
Derivative contract
Ways firms can fail to account for risks
Exposure
25. 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
Credit event
Allied Irish Bank
Risk
Asset liquidity risk
26. Cannot exit position in market due to size of the position
Derivative contract
Shortfall risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Asset liquidity risk
27. Asset-liability/market-liquidity risk
Performance- related metrics
Liquidity risk
Exposure
EPD or ECOR - Expected Policyholder Deficit (EPD)
28. Capital structure (financial distress) - Taxes - Agency and information asymmetries
CAPM with taxes included (equation)
Treynor measure
Market imperfections that can create value
Business Risk
29. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Financial Risk
Tracking error
Forms of Market risk
Ri = ai + bi1l1 + bi2l2....+ei
30. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Sovereign risk
Nonparametric VaR
Practical considerations related to ERM implementatio
Information ratio
31. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
VaR - Value at Risk
Tax shield
Operational risk
Security (primary vs secondary)
32. Derives value from an underlying asset - rate - or index - Derives value from a security
Tracking error
Probability of ruin
Derivative contract
Liquidity risk
33. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
CAPM assumption for EMH
Where is risk coming from
Uncertainty
Morningstar Rating System
34. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Nonmarketable asset impact on CAPM
Asset transformers
Treynor measure
Differences in financial risk management for financial companies vs industrial companies
35. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Source of need for risk management
Three main reasons for financial disasters
Funding liquidity risk
Solvency-related metrics
36. 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)
Four major types of risk
Carry- backs and carry- forwards
RAR = relative return of portfolio (RRp)
37. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Information ratio
Three main reasons for financial disasters
Shortfall risk
Expected return of two assets
38. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Debt overhang
Morningstar Rating System
CAPM with taxes included (equation)
Credit event
39. Inability to make payment obligations (ex. Margin calls)
Operational risk
Shortfall risk
Funding liquidity risk
Valuation vs. Risk management
40. The uses of debt to fall into a lower tax rate
Standard deviation of two assets
Tax shield
Roles of risk management
Models used in ERM framework
41. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
CAPM assumption for EMH
Debt overhang
Ways risk can be mismeasured
Carry- backs and carry- forwards
42. Wrong distribution - Historical sample may not apply
Zero- beta CAPM (two factor model)
Sortino ratio
Efficient frontier
Ways risk can be mismeasured
43. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Risk
Security (primary vs secondary)
Recovery rate
Nonmarketable asset impact on CAPM
44. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Asset transformers
Performance- related metrics
Valuation vs. Risk management
Banker's Trust
45. Curve must be concave - Straight line connecting any two points must be under the curve
BTR - Below Target Risk
Shape of portfolio possibilities curve
Traits of ERM
Correlation coefficient effect on diversification
46. Returns on any stock are linearly related to a set of indexes
Shortcomings of risk metrics
Source of need for risk management
Ri = ai + bi1l1 + bi2l2....+ei
Nonmarketable asset impact on CAPM
47. When two payments are exchanged the same day and one party may default after payment is made
Four major types of risk
Operational risk
BTR - Below Target Risk
Settlement risk
48. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Asset liquidity risk
Allied Irish Bank
Differences in financial risk management for financial companies vs industrial companies
Derivative contract
49. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
CAPM (formula)
Drysdale Securities (Chase Manhattan)
Where is risk coming from
Performance- related metrics
50. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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