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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. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Models used in ERM framework
Debt overhang
Differences in financial risk management for financial companies vs industrial companies
Risk
2. Future price is greater than the spot price
Forms of Market risk
Treynor measure
Debt overhang
Contango
3. 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
Carry- backs and carry- forwards
Asset liquidity risk
Parametric VaR
4. Changes in vol - implied or actual
Sovereign risk
Uncertainty
Volatility Market risk
Roles of risk management
5. Risk of loses owing to movements in level or volatility of market prices
Risks excluded from operational risk
Ri = ai + bi1l1 + bi2l2....+ei
APT in active portfolio management
Market risk
6. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Security (primary vs secondary)
Models used in ERM framework
Multi- period version of CAPM
Solve for minimum variance portfolio
7. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
EPD or ECOR - Expected Policyholder Deficit (EPD)
Debt overhang
Settlement risk
Banker's Trust
8. 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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9. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Morningstar Rating System
Multi- period version of CAPM
Capital market line (CML)
Sortino ratio
10. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Derivative contract
Risk
Four major types of risk
Risk types addressed by ERM
11. Both probability and cost of tail events are considered
CAPM with taxes included (equation)
Allied Irish Bank
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Sovereign risk
12. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Roles of risk management
Solvency-related metrics
Tax shield
Sharpe measure
13. 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
Asset liquidity risk
CAPM with taxes included (equation)
Nonparametric VaR
14. Covariance = correlation coefficient std dev(a) std dev(b)
CAPM with taxes included (equation)
Formula for covariance
Volatility Market risk
CAPM (formula)
15. The uses of debt to fall into a lower tax rate
Tax shield
CAPM with taxes included (equation)
Shape of portfolio possibilities curve
Risk
16. Return is linearly related to growth rate in consumption
Settlement risk
Credit event
Multi- period version of CAPM
Drysdale Securities (Chase Manhattan)
17. Expected value of unfavorable deviations of a random variable from a specified target level
Morningstar Rating System
Carry- backs and carry- forwards
BTR - Below Target Risk
Nonparametric VaR
18. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
CAPM with taxes included (equation)
Security (primary vs secondary)
Where is risk coming from
Banker's Trust
19. Interest rate movements - derivatives - defaults
Contango
Capital market line (CML)
Solvency-related metrics
Financial Risk
20. 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 -
Market risk
Solve for minimum variance portfolio
Business Risk
Source of need for risk management
21. Hazard - Financial - Operational - Strategic
Risk types addressed by ERM
Correlation coefficient effect on diversification
Basis
Risk
22. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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23. Curve must be concave - Straight line connecting any two points must be under the curve
Shape of portfolio possibilities curve
VaR- based analysis (formula)
APT (equation and assumptions)
Capital market line (CML)
24. 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
Valuation vs. Risk management
Barings
Recovery rate
Risk- adjusted performance measure (RAP)
25. 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
Sortino ratio
Probability of ruin
VaR- based analysis (formula)
Drysdale Securities (Chase Manhattan)
26. Potential amount that can be lost
Probability of ruin
Where is risk coming from
Correlation coefficient effect on diversification
Exposure
27. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Formula for covariance
Risk
Solvency-related metrics
Performance- related metrics
28. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Practical considerations related to ERM implementatio
Risk
Solvency-related metrics
Differences in financial risk management for financial companies vs industrial companies
29. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Formula for covariance
3 main types of operational risk
VaR - Value at Risk
CAPM with taxes included (equation)
30. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Standard deviation of two assets
Treynor measure
Credit event
Market imperfections that can create value
31. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Banker's Trust
Derivative contract
Settlement risk
Asset transformers
32. Asset-liability/market-liquidity risk
Liquidity risk
Forms of Market risk
Shape of portfolio possibilities curve
Risk
33. Law of one price - Homogeneous expectations - Security returns process
VaR- based analysis (formula)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Derivative contract
APT (equation and assumptions)
34. Occurs the day when two parties exchange payments same day
Risks excluded from operational risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Basic Market risk
Settlement risk
35. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Zero- beta CAPM (two factor model)
Asset liquidity risk
Four major types of risk
Tracking error
36. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Market risk
Nonmarketable asset impact on CAPM
Basis
Security (primary vs secondary)
37. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Roles of risk management
Solve for minimum variance portfolio
Ri = ai + bi1l1 + bi2l2....+ei
CAPM assumption for EMH
38. 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)
Forms of Market risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Basis
39. 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
Operational risk
Ten assumptions underlying CAPM
BTR - Below Target Risk
VaR- based analysis (formula)
40. When two payments are exchanged the same day and one party may default after payment is made
Settlement risk
Standard deviation of two assets
Roles of risk management
Traits of ERM
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.
Forms of Market risk
Importance of communication for risk managers
Risk Management Irrelevance Proposition
Treynor measure
42. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Where is risk coming from
Kidder Peabody
Ways firms can fail to account for risks
Morningstar Rating System
43. Absolute and relative risk - direction and non-directional
Efficient frontier
Forms of Market risk
Morningstar Rating System
Kidder Peabody
44. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Financial Risk
Effect of heterogeneous expectations on CAPM
Asset transformers
VaR - Value at Risk
45. Firms became multinational - - >watched xchange rates more - deregulation and globalization
RAR = relative return of portfolio (RRp)
Firms becoming more sensitive to changes(bank deregulation)
Correlation coefficient effect on diversification
Volatility Market risk
46. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Risks excluded from operational risk
Performance- related metrics
What lead to the exponential growth to derivatives mkt?
Four major types of risk
47. When negative taxable income is moved to a different year to offset future or past taxable income
Liquidity risk
Carry- backs and carry- forwards
Derivative contract
Sortino ratio
48. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Treynor measure
Firms becoming more sensitive to changes(bank deregulation)
Ri = Rz + (gamma)(beta)
Sovereign risk
49. Asses firm risks - Communicate risks - Manage and monitor risks
Nonmarketable asset impact on CAPM
Roles of risk management
Asset liquidity risk
Practical considerations related to ERM implementatio
50. Derives value from an underlying asset - rate - or index - Derives value from a security
Carry- backs and carry- forwards
APT in active portfolio management
Financial Risk
Derivative contract