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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. Quantile of a statistical distribution
Debt overhang
Ri = ai + bi1l1 + bi2l2....+ei
Parametric VaR
EPD or ECOR - Expected Policyholder Deficit (EPD)
2. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Efficient frontier
Tracking error
Zero- beta CAPM (two factor model)
Options motivation on volatility
3. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Barings
Ri = Rz + (gamma)(beta)
Performance- related metrics
Four major types of risk
4. Quantile of an empirical distribution
Correlation coefficient effect on diversification
Nonparametric VaR
Liquidity risk
Basis risk
5. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Firms becoming more sensitive to changes(bank deregulation)
Carry- backs and carry- forwards
VaR - Value at Risk
Four major types of risk
6. Derives value from an underlying asset - rate - or index - Derives value from a security
Derivative contract
Traits of ERM
Operational risk
Parametric VaR
7. Concave function that extends from minimum variance portfolio to maximum return portfolio
APT (equation and assumptions)
Ways risk can be mismeasured
Efficient frontier
Sortino ratio
8. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
APT (equation and assumptions)
Importance of communication for risk managers
Information ratio
Drysdale Securities (Chase Manhattan)
9. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Three main reasons for financial disasters
Security (primary vs secondary)
Firms becoming more sensitive to changes(bank deregulation)
Uncertainty
10. 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
Source of need for risk management
Asset liquidity risk
Ways firms can fail to account for risks
Practical considerations related to ERM implementatio
11. Volatility of unexpected outcomes
Risk
Basis
Capital market line (CML)
Market risk
12. The need to hedge against risks - for firms need to speculate.
Valuation vs. Risk management
Kidder Peabody
What lead to the exponential growth to derivatives mkt?
Practical considerations related to ERM implementatio
13. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Source of need for risk management
Drysdale Securities (Chase Manhattan)
Effect of non- price- taking behavior on CAPM
Recovery rate
14. 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
Risks excluded from operational risk
Funding liquidity risk
Financial risks
Kidder Peabody
15. 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
Risks excluded from operational risk
Sharpe measure
APT (equation and assumptions)
16. 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 -
Correlation coefficient effect on diversification
Debt overhang
Standard deviation of two assets
Source of need for risk management
17. Inability to make payment obligations (ex. Margin calls)
Source of need for risk management
Shortcomings of risk metrics
APT for passive portfolio management
Funding liquidity risk
18. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Practical considerations related to ERM implementatio
Formula for covariance
Recovery rate
Allied Irish Bank
19. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
CAPM assumption for EMH
Solve for minimum variance portfolio
Standard deviation of two assets
Banker's Trust
20. 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
Models used in ERM framework
Sortino ratio
Business Risk
Ri = Rz + (gamma)(beta)
21. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
APT for passive portfolio management
Morningstar Rating System
Information ratio
Roles of risk management
22. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Debt overhang
Formula for covariance
Treynor measure
Traits of ERM
23. Both probability and cost of tail events are considered
Risk
Debt overhang
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Probability of ruin
24. Occurs the day when two parties exchange payments same day
Sortino ratio
Uncertainty
Settlement risk
Security (primary vs secondary)
25. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Four major types of risk
Expected return of two assets
Asset liquidity risk
Asset transformers
26. Rp = XaRa + XbRb
Ri = Rz + (gamma)(beta)
Expected return of two assets
RAR = relative return of portfolio (RRp)
Recovery rate
27. Future price is greater than the spot price
Shape of portfolio possibilities curve
Asset transformers
Contango
APT (equation and assumptions)
28. Prices of risk are common factors and do not change - Sensitivities can change
Jensen's alpha
Market imperfections that can create value
Prices of risk vs sensitivity
Basis
29. 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
Effect of non- price- taking behavior on CAPM
Where is risk coming from
Information ratio
APT for passive portfolio management
30. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Options motivation on volatility
Solvency-related metrics
Jensen's alpha
Risk- adjusted performance measure (RAP)
31. When negative taxable income is moved to a different year to offset future or past taxable income
Standard deviation of two assets
Carry- backs and carry- forwards
Ways firms can fail to account for risks
Shortfall risk
32. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Basis risk
Ways firms can fail to account for risks
Drysdale Securities (Chase Manhattan)
Risks excluded from operational risk
33. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
APT for passive portfolio management
CAPM with taxes included (equation)
Models used in ERM framework
Security (primary vs secondary)
34. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Credit event
Options motivation on volatility
Shortfall risk
Tracking error
35. The uses of debt to fall into a lower tax rate
Volatility Market risk
Barings
Risk types addressed by ERM
Tax shield
36. 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
Market risk
LTCM
Uncertainty
Liquidity risk
37. Potential amount that can be lost
Allied Irish Bank
CAPM with taxes included (equation)
Exposure
Options motivation on volatility
38. Modeling approach is typically between statistical analytic models and structural simulation models
VaR- based analysis (formula)
Models used in ERM framework
Exposure
What lead to the exponential growth to derivatives mkt?
39. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Risk- adjusted performance measure (RAP)
Tracking error
Source of need for risk management
Ri = ai + bi1l1 + bi2l2....+ei
40. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
VaR - Value at Risk
Ten assumptions underlying CAPM
Risk
Market risk
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
Basis risk
APT for passive portfolio management
Drysdale Securities (Chase Manhattan)
Carry- backs and carry- forwards
42. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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43. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Derivative contract
Traits of ERM
Zero- beta CAPM (two factor model)
Business risks
44. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Sortino ratio
Importance of communication for risk managers
Where is risk coming from
Differences in financial risk management for financial companies vs industrial companies
45. Wrong distribution - Historical sample may not apply
Firms becoming more sensitive to changes(bank deregulation)
Treynor measure
Ways risk can be mismeasured
Four major types of risk
46. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Contango
CAPM (formula)
APT (equation and assumptions)
Valuation vs. Risk management
47. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Effect of heterogeneous expectations on CAPM
What lead to the exponential growth to derivatives mkt?
Capital market line (CML)
Allied Irish Bank
48. Expected value of unfavorable deviations of a random variable from a specified target level
Credit event
BTR - Below Target Risk
Volatility Market risk
Business Risk
49. Probability distribution is unknown (ex. A terrorist attack)
Shortcomings of risk metrics
3 main types of operational risk
Financial Risk
Uncertainty
50. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Importance of communication for risk managers
Basis
Treynor measure
Differences in financial risk management for financial companies vs industrial companies