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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. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Sharpe measure
Security (primary vs secondary)
Effect of non- price- taking behavior on CAPM
LTCM
2. 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
Solvency-related metrics
Security (primary vs secondary)
APT for passive portfolio management
Liquidity risk
3. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Models used in ERM framework
Risk
Debt overhang
Sovereign risk
4. Prices of risk are common factors and do not change - Sensitivities can change
Shortfall risk
Security (primary vs secondary)
Prices of risk vs sensitivity
CAPM (formula)
5. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Debt overhang
Business risks
Solvency-related metrics
6. Probability distribution is unknown (ex. A terrorist attack)
Performance- related metrics
Uncertainty
CAPM assumption for EMH
VaR - Value at Risk
7. Losses due to market activities ex. Interest rate changes or defaults
Ri = Rz + (gamma)(beta)
Financial risks
Effect of heterogeneous expectations on CAPM
LTCM
8. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
EPD or ECOR - Expected Policyholder Deficit (EPD)
Zero- beta CAPM (two factor model)
Information ratio
APT in active portfolio management
9. 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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10. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Effect of heterogeneous expectations on CAPM
Contango
Carry- backs and carry- forwards
Business risks
11. 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
Risk
Where is risk coming from
Solvency-related metrics
Kidder Peabody
12. CAPM requires the strong form of the Efficient Market Hypothesis = private information
LTCM
CAPM assumption for EMH
Asset liquidity risk
Market imperfections that can create value
13. Probability that a random variable falls below a specified threshold level
Kidder Peabody
Shortfall risk
Ways risk can be mismeasured
Derivative contract
14. Volatility of unexpected outcomes
Shortfall risk
Efficient frontier
Risk
CAPM (formula)
15. Curve must be concave - Straight line connecting any two points must be under the curve
Morningstar Rating System
Shape of portfolio possibilities curve
Business risks
Expected return of two assets
16. Multibeta CAPM Ri - Rf =
Forms of Market risk
Three main reasons for financial disasters
Nonmarketable asset impact on CAPM
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
17. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Multi- period version of CAPM
Four major types of risk
Solve for minimum variance portfolio
Three main reasons for financial disasters
18. Wrong distribution - Historical sample may not apply
RAR = relative return of portfolio (RRp)
Banker's Trust
Ways risk can be mismeasured
Nonparametric VaR
19. Interest rate movements - derivatives - defaults
Formula for covariance
Financial Risk
Multi- period version of CAPM
LTCM
20. Market risk - Liquidity risk - Credit risk - Operational risk
Four major types of risk
Importance of communication for risk managers
APT (equation and assumptions)
Operational risk
21. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Differences in financial risk management for financial companies vs industrial companies
Allied Irish Bank
CAPM with taxes included (equation)
Zero- beta CAPM (two factor model)
22. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Probability of ruin
Asset transformers
Three main reasons for financial disasters
Security (primary vs secondary)
23. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Basis risk
RAR = relative return of portfolio (RRp)
Correlation coefficient effect on diversification
Shortcomings of risk metrics
24. Cannot exit position in market due to size of the position
Asset liquidity risk
Effect of heterogeneous expectations on CAPM
3 main types of operational risk
Liquidity risk
25. The lower (closer to - 1) - the higher the payoff from diversification
Correlation coefficient effect on diversification
Capital market line (CML)
BTR - Below Target Risk
Valuation vs. Risk management
26. Potential amount that can be lost
Derivative contract
Treynor measure
Settlement risk
Exposure
27. Hazard - Financial - Operational - Strategic
Morningstar Rating System
Performance- related metrics
Probability of ruin
Risk types addressed by ERM
28. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Performance- related metrics
Debt overhang
Firms becoming more sensitive to changes(bank deregulation)
VaR- based analysis (formula)
29. The need to hedge against risks - for firms need to speculate.
Basis risk
What lead to the exponential growth to derivatives mkt?
Effect of heterogeneous expectations on CAPM
Performance- related metrics
30. 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
Basis risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Traits of ERM
Banker's Trust
31. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Credit event
Ways risk can be mismeasured
Parametric VaR
Kidder Peabody
32. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Operational risk
Ri = ai + bi1l1 + bi2l2....+ei
Nonmarketable asset impact on CAPM
Risk types addressed by ERM
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
Four major types of risk
Traits of ERM
Solvency-related metrics
Probability of ruin
34. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Risk- adjusted performance measure (RAP)
LTCM
Performance- related metrics
Prices of risk vs sensitivity
35. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Funding liquidity risk
Probability of ruin
Ri = Rz + (gamma)(beta)
Correlation coefficient effect on diversification
36. Returns on any stock are linearly related to a set of indexes
Practical considerations related to ERM implementatio
Shape of portfolio possibilities curve
Ri = ai + bi1l1 + bi2l2....+ei
Kidder Peabody
37. Occurs the day when two parties exchange payments same day
APT (equation and assumptions)
Settlement risk
Forms of Market risk
Basis risk
38. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
EPD or ECOR - Expected Policyholder Deficit (EPD)
Security (primary vs secondary)
Market imperfections that can create value
Risk
39. Asset-liability/market-liquidity risk
Firms becoming more sensitive to changes(bank deregulation)
Liquidity risk
Risk Management Irrelevance Proposition
RAR = relative return of portfolio (RRp)
40. Risk of loses owing to movements in level or volatility of market prices
Derivative contract
APT in active portfolio management
Forms of Market risk
Market risk
41. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Roles of risk management
Morningstar Rating System
Debt overhang
What lead to the exponential growth to derivatives mkt?
42. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
APT for passive portfolio management
Where is risk coming from
Roles of risk management
Information ratio
43. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Basis risk
Basis
Three main reasons for financial disasters
Financial Risk
44. 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
Multi- period version of CAPM
Practical considerations related to ERM implementatio
Ri = ai + bi1l1 + bi2l2....+ei
Effect of heterogeneous expectations on CAPM
45. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Three main reasons for financial disasters
Banker's Trust
3 main types of operational risk
APT (equation and assumptions)
46. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
APT in active portfolio management
Tax shield
Where is risk coming from
Basis risk
47. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Business risks
Sovereign risk
Ten assumptions underlying CAPM
Basis risk
48. 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
Roles of risk management
Barings
Basic Market risk
Sharpe measure
49. When negative taxable income is moved to a different year to offset future or past taxable income
Carry- backs and carry- forwards
Derivative contract
Multi- period version of CAPM
Risk- adjusted performance measure (RAP)
50. When two payments are exchanged the same day and one party may default after payment is made
Nonmarketable asset impact on CAPM
Market risk
Sovereign risk
Settlement risk