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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. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Liquidity risk
Three main reasons for financial disasters
Derivative contract
Operational risk
2. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
3 main types of operational risk
Carry- backs and carry- forwards
Financial risks
Debt overhang
3. Inability to make payment obligations (ex. Margin calls)
3 main types of operational risk
Risk Management Irrelevance Proposition
Funding liquidity risk
Ten assumptions underlying CAPM
4. 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
Ten assumptions underlying CAPM
Carry- backs and carry- forwards
Sortino ratio
5. Hazard - Financial - Operational - Strategic
Standard deviation of two assets
Jensen's alpha
Risk types addressed by ERM
Solve for minimum variance portfolio
6. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Sortino ratio
Risks excluded from operational risk
3 main types of operational risk
Risk types addressed by ERM
7. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Traits of ERM
Sovereign risk
Prices of risk vs sensitivity
Ri = Rz + (gamma)(beta)
8. 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
Drysdale Securities (Chase Manhattan)
Settlement risk
Risk
9. Covariance = correlation coefficient std dev(a) std dev(b)
Risk Management Irrelevance Proposition
Formula for covariance
Risk
APT for passive portfolio management
10. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
CAPM (formula)
Standard deviation of two assets
Sharpe measure
Four major types of risk
11. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Three main reasons for financial disasters
Recovery rate
Prices of risk vs sensitivity
12. Cannot exit position in market due to size of the position
Traits of ERM
Performance- related metrics
Asset liquidity risk
Practical considerations related to ERM implementatio
13. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Basis
APT (equation and assumptions)
Valuation vs. Risk management
Exposure
14. Strategic risk - Business risk - Reputational risk
Risks excluded from operational risk
Asset liquidity risk
Credit event
Uncertainty
15. 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
Shortcomings of risk metrics
Uncertainty
Barings
Valuation vs. Risk management
16. 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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17. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Debt overhang
Performance- related metrics
Liquidity risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
18. 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
Basic Market risk
Allied Irish Bank
Risks excluded from operational risk
Recovery rate
19. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Ways firms can fail to account for risks
Performance- related metrics
Derivative contract
Solve for minimum variance portfolio
20. 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
Barings
Risk types addressed by ERM
Tax shield
Basis
21. 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
Settlement risk
VaR- based analysis (formula)
APT in active portfolio management
22. Rp = XaRa + XbRb
Exposure
Settlement risk
Expected return of two assets
Settlement risk
23. Modeling approach is typically between statistical analytic models and structural simulation models
Probability of ruin
Models used in ERM framework
Risk Management Irrelevance Proposition
Solvency-related metrics
24. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Kidder Peabody
Debt overhang
Ri = Rz + (gamma)(beta)
Risk Management Irrelevance Proposition
25. Both probability and cost of tail events are considered
Prices of risk vs sensitivity
APT in active portfolio management
Tail VaR or TCE - Tail Conditional Expectation(TCE)
What lead to the exponential growth to derivatives mkt?
26. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
CAPM (formula)
Treynor measure
Risk Management Irrelevance Proposition
3 main types of operational risk
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
Financial risks
Volatility Market risk
Solve for minimum variance portfolio
Ten assumptions underlying CAPM
28. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Risk
BTR - Below Target Risk
Sovereign risk
Zero- beta CAPM (two factor model)
29. Unanticipated movements in relative prices of assets in hedged position
Three main reasons for financial disasters
Basic Market risk
Security (primary vs secondary)
Nonmarketable asset impact on CAPM
30. Quantile of an empirical distribution
Nonparametric VaR
Drysdale Securities (Chase Manhattan)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Options motivation on volatility
31. The uses of debt to fall into a lower tax rate
Tax shield
Risk
Importance of communication for risk managers
Practical considerations related to ERM implementatio
32. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Risk
Funding liquidity risk
Basis
Differences in financial risk management for financial companies vs industrial companies
33. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Risk
Business risks
Ways firms can fail to account for risks
Basis risk
34. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Settlement risk
Asset liquidity risk
Recovery rate
CAPM assumption for EMH
35. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Sharpe measure
Shortfall risk
3 main types of operational risk
Business risks
36. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Ways firms can fail to account for risks
CAPM (formula)
APT for passive portfolio management
Shape of portfolio possibilities curve
37. Need to assess risk and tell management so they can determine which risks to take on
Roles of risk management
VaR- based analysis (formula)
CAPM (formula)
Importance of communication for risk managers
38. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Risk types addressed by ERM
Practical considerations related to ERM implementatio
Differences in financial risk management for financial companies vs industrial companies
Effect of non- price- taking behavior on CAPM
39. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Allied Irish Bank
Correlation coefficient effect on diversification
Derivative contract
Information ratio
40. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
3 main types of operational risk
Treynor measure
Barings
Differences in financial risk management for financial companies vs industrial companies
41. 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.
Security (primary vs secondary)
Business Risk
Risk Management Irrelevance Proposition
Credit event
42. The need to hedge against risks - for firms need to speculate.
Settlement risk
Risk types addressed by ERM
Efficient frontier
What lead to the exponential growth to derivatives mkt?
43. When negative taxable income is moved to a different year to offset future or past taxable income
Carry- backs and carry- forwards
Efficient frontier
Capital market line (CML)
Source of need for risk management
44. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Where is risk coming from
Tax shield
Forms of Market risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
45. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Basis
APT (equation and assumptions)
Information ratio
Zero- beta CAPM (two factor model)
46. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Liquidity risk
Practical considerations related to ERM implementatio
Market imperfections that can create value
Security (primary vs secondary)
47. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Volatility Market risk
APT in active portfolio management
Funding liquidity risk
Correlation coefficient effect on diversification
48. Changes in vol - implied or actual
Roles of risk management
Risk
Capital market line (CML)
Volatility Market risk
49. Potential amount that can be lost
Settlement risk
Funding liquidity risk
APT (equation and assumptions)
Exposure
50. Future price is greater than the spot price
Jensen's alpha
Traits of ERM
Contango
Financial risks