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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 an empirical distribution
Liquidity risk
Nonparametric VaR
Models used in ERM framework
Risk
2. 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
Tracking error
Valuation vs. Risk management
Ways firms can fail to account for risks
Shortfall risk
3. Quantile of a statistical distribution
Sovereign risk
Basis risk
Sharpe measure
Parametric VaR
4. The uses of debt to fall into a lower tax rate
Firms becoming more sensitive to changes(bank deregulation)
Tax shield
Volatility Market risk
Traits of ERM
5. Returns on any stock are linearly related to a set of indexes
BTR - Below Target Risk
Treynor measure
Ri = ai + bi1l1 + bi2l2....+ei
Operational risk
6. 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
Ten assumptions underlying CAPM
Basis risk
Drysdale Securities (Chase Manhattan)
Asset liquidity risk
7. 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
Shortcomings of risk metrics
Asset liquidity risk
Business Risk
What lead to the exponential growth to derivatives mkt?
8. Interest rate movements - derivatives - defaults
Models used in ERM framework
Financial Risk
Basic Market risk
Credit event
9. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
RAR = relative return of portfolio (RRp)
Practical considerations related to ERM implementatio
Business risks
Asset liquidity risk
10. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Ten assumptions underlying CAPM
VaR - Value at Risk
CAPM with taxes included (equation)
Models used in ERM framework
11. 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
Solvency-related metrics
Ri = ai + bi1l1 + bi2l2....+ei
Practical considerations related to ERM implementatio
Tail VaR or TCE - Tail Conditional Expectation(TCE)
12. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Capital market line (CML)
LTCM
Importance of communication for risk managers
Debt overhang
13. 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 -
Source of need for risk management
Ways firms can fail to account for risks
Risk
Carry- backs and carry- forwards
14. Expected value of unfavorable deviations of a random variable from a specified target level
Multi- period version of CAPM
Basis risk
BTR - Below Target Risk
CAPM assumption for EMH
15. Inability to make payment obligations (ex. Margin calls)
RAR = relative return of portfolio (RRp)
Settlement risk
APT in active portfolio management
Funding liquidity risk
16. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Multi- period version of CAPM
EPD or ECOR - Expected Policyholder Deficit (EPD)
CAPM with taxes included (equation)
Shortfall risk
17. Future price is greater than the spot price
Risks excluded from operational risk
Probability of ruin
Derivative contract
Contango
18. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Ten assumptions underlying CAPM
Basic Market risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
Asset liquidity risk
19. Prices of risk are common factors and do not change - Sensitivities can change
Prices of risk vs sensitivity
Debt overhang
RAR = relative return of portfolio (RRp)
Standard deviation of two assets
20. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Standard deviation of two assets
Jensen's alpha
Differences in financial risk management for financial companies vs industrial companies
Prices of risk vs sensitivity
21. 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
Shortcomings of risk metrics
Ways firms can fail to account for risks
Sharpe measure
Security (primary vs secondary)
22. 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
Business risks
Performance- related metrics
Sharpe measure
Drysdale Securities (Chase Manhattan)
23. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Treynor measure
Financial Risk
Business risks
Sovereign risk
24. 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
Traits of ERM
Basis risk
Source of need for risk management
Performance- related metrics
25. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Forms of Market risk
Financial risks
Differences in financial risk management for financial companies vs industrial companies
CAPM (formula)
26. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Asset transformers
Carry- backs and carry- forwards
Financial Risk
Efficient frontier
27. Rp = XaRa + XbRb
RAR = relative return of portfolio (RRp)
Settlement risk
Where is risk coming from
Expected return of two assets
28. Hazard - Financial - Operational - Strategic
CAPM assumption for EMH
Contango
Risk types addressed by ERM
Valuation vs. Risk management
29. Potential amount that can be lost
Exposure
Funding liquidity risk
Where is risk coming from
Risk types addressed by ERM
30. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Debt overhang
Risk Management Irrelevance Proposition
Options motivation on volatility
Settlement risk
31. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Source of need for risk management
Correlation coefficient effect on diversification
RAR = relative return of portfolio (RRp)
VaR - Value at Risk
32. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Four major types of risk
Risk
Banker's Trust
Security (primary vs secondary)
33. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Risk- adjusted performance measure (RAP)
Business risks
Ten assumptions underlying CAPM
Settlement risk
34. Market risk - Liquidity risk - Credit risk - Operational risk
Information ratio
Solvency-related metrics
Four major types of risk
Roles of risk management
35. Probability that a random variable falls below a specified threshold level
Shortfall risk
Zero- beta CAPM (two factor model)
APT (equation and assumptions)
Differences in financial risk management for financial companies vs industrial companies
36. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Market imperfections that can create value
Efficient frontier
Formula for covariance
Sovereign risk
37. 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
Solve for minimum variance portfolio
Jensen's alpha
Information ratio
38. Unanticipated movements in relative prices of assets in hedged position
Exposure
Efficient frontier
Basic Market risk
APT for passive portfolio management
39. Probability distribution is unknown (ex. A terrorist attack)
3 main types of operational risk
Derivative contract
Uncertainty
APT (equation and assumptions)
40. Absolute and relative risk - direction and non-directional
Information ratio
Where is risk coming from
Solvency-related metrics
Forms of Market risk
41. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Asset liquidity risk
Risks excluded from operational risk
Practical considerations related to ERM implementatio
Recovery rate
42. Losses due to market activities ex. Interest rate changes or defaults
Financial risks
Kidder Peabody
Where is risk coming from
Jensen's alpha
43. Law of one price - Homogeneous expectations - Security returns process
Asset transformers
APT (equation and assumptions)
Market risk
Tracking error
44. Derives value from an underlying asset - rate - or index - Derives value from a security
Risk
Derivative contract
Nonparametric VaR
Basis risk
45. 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
Ways risk can be mismeasured
Market imperfections that can create value
Allied Irish Bank
APT (equation and assumptions)
46. Wrong distribution - Historical sample may not apply
Ways risk can be mismeasured
Treynor measure
Risk
Financial risks
47. Long Term Capital Management - Renowned quants produced great returns with arbitrage- type trades - Unexpected and extreme events resulted in devaluation of Russian Rouble - resulting in a 3.65 billion dollar bailout - Failure to account for illiquid
LTCM
Risk
Ri = ai + bi1l1 + bi2l2....+ei
Nonparametric VaR
48. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Forms of Market risk
Operational risk
Four major types of risk
Nonparametric VaR
49. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Zero- beta CAPM (two factor model)
Standard deviation of two assets
Debt overhang
CAPM (formula)
50. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Firms becoming more sensitive to changes(bank deregulation)
Nonmarketable asset impact on CAPM
Credit event
Risk- adjusted performance measure (RAP)