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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.
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. 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
Ways firms can fail to account for risks
Market risk
Tax shield
Traits of ERM
2. The need to hedge against risks - for firms need to speculate.
Traits of ERM
Information ratio
What lead to the exponential growth to derivatives mkt?
Business Risk
3. Derives value from an underlying asset - rate - or index - Derives value from a security
Sortino ratio
Derivative contract
Zero- beta CAPM (two factor model)
Ways firms can fail to account for risks
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
Traits of ERM
Sovereign risk
Prices of risk vs sensitivity
Kidder Peabody
5. Probability distribution is unknown (ex. A terrorist attack)
Barings
Uncertainty
EPD or ECOR - Expected Policyholder Deficit (EPD)
Risk types addressed by ERM
6. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Market imperfections that can create value
Derivative contract
Asset transformers
Carry- backs and carry- forwards
7. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Sovereign risk
CAPM assumption for EMH
Sortino ratio
Financial risks
8. 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
Valuation vs. Risk management
Sortino ratio
Formula for covariance
Probability of ruin
9. Returns on any stock are linearly related to a set of indexes
Ri = ai + bi1l1 + bi2l2....+ei
Exposure
Source of need for risk management
APT (equation and assumptions)
10. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Recovery rate
Asset transformers
What lead to the exponential growth to derivatives mkt?
Credit event
11. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Treynor measure
Shortfall risk
Nonparametric VaR
Debt overhang
12. Law of one price - Homogeneous expectations - Security returns process
Debt overhang
Four major types of risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
APT (equation and assumptions)
13. 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
Nonparametric VaR
Uncertainty
Allied Irish Bank
APT in active portfolio management
14. The uses of debt to fall into a lower tax rate
Tax shield
Expected return of two assets
Morningstar Rating System
Ten assumptions underlying CAPM
15. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Risks excluded from operational risk
Standard deviation of two assets
APT in active portfolio management
Ways risk can be mismeasured
16. Prices of risk are common factors and do not change - Sensitivities can change
Risk Management Irrelevance Proposition
Where is risk coming from
Differences in financial risk management for financial companies vs industrial companies
Prices of risk vs sensitivity
17. Both probability and cost of tail events are considered
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Volatility Market risk
Models used in ERM framework
Tracking error
18. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
EPD or ECOR - Expected Policyholder Deficit (EPD)
Models used in ERM framework
Ten assumptions underlying CAPM
Information ratio
19. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Basis risk
Solvency-related metrics
Ri = ai + bi1l1 + bi2l2....+ei
Business risks
20. Concave function that extends from minimum variance portfolio to maximum return portfolio
APT (equation and assumptions)
APT in active portfolio management
Effect of heterogeneous expectations on CAPM
Efficient frontier
21. Expected value of unfavorable deviations of a random variable from a specified target level
BTR - Below Target Risk
VaR- based analysis (formula)
Risk Management Irrelevance Proposition
Prices of risk vs sensitivity
22. Return is linearly related to growth rate in consumption
Risks excluded from operational risk
Traits of ERM
Multi- period version of CAPM
Risk types addressed by ERM
23. Changes in vol - implied or actual
Volatility Market risk
Traits of ERM
Barings
Correlation coefficient effect on diversification
24. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Allied Irish Bank
Firms becoming more sensitive to changes(bank deregulation)
Basis risk
CAPM with taxes included (equation)
25. 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
Kidder Peabody
Allied Irish Bank
3 main types of operational risk
Capital market line (CML)
26. Wrong distribution - Historical sample may not apply
Ways firms can fail to account for risks
Ways risk can be mismeasured
What lead to the exponential growth to derivatives mkt?
Multi- period version of CAPM
27. Absolute and relative risk - direction and non-directional
Credit event
Forms of Market risk
Information ratio
Contango
28. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Solve for minimum variance portfolio
Market risk
Zero- beta CAPM (two factor model)
Risk types addressed by ERM
29. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Solve for minimum variance portfolio
Formula for covariance
Operational risk
30. Hazard - Financial - Operational - Strategic
Banker's Trust
Risk types addressed by ERM
Correlation coefficient effect on diversification
Financial risks
31. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Expected return of two assets
Financial risks
Business Risk
VaR- based analysis (formula)
32. Modeling approach is typically between statistical analytic models and structural simulation models
Importance of communication for risk managers
Expected return of two assets
Risk Management Irrelevance Proposition
Models used in ERM framework
33. 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
Ten assumptions underlying CAPM
LTCM
CAPM (formula)
Information ratio
34. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Sovereign risk
Operational risk
Efficient frontier
VaR- based analysis (formula)
35. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Firms becoming more sensitive to changes(bank deregulation)
Shortfall risk
Standard deviation of two assets
Risks excluded from operational risk
36. Potential amount that can be lost
Banker's Trust
Risk- adjusted performance measure (RAP)
Probability of ruin
Exposure
37. Quantile of an empirical distribution
Expected return of two assets
Nonparametric VaR
Carry- backs and carry- forwards
Practical considerations related to ERM implementatio
38. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
CAPM (formula)
Operational risk
Shortcomings of risk metrics
CAPM with taxes included (equation)
39. Market risk - Liquidity risk - Credit risk - Operational risk
Ways firms can fail to account for risks
Four major types of risk
Where is risk coming from
Business Risk
40. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Importance of communication for risk managers
APT (equation and assumptions)
Asset transformers
Zero- beta CAPM (two factor model)
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
Volatility Market risk
Drysdale Securities (Chase Manhattan)
Standard deviation of two assets
Debt overhang
42. Probability that a random variable falls below a specified threshold level
Shortfall risk
Risk
Formula for covariance
3 main types of operational risk
43. 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
Asset liquidity risk
APT for passive portfolio management
Security (primary vs secondary)
44. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Forms of Market risk
Sovereign risk
CAPM (formula)
Ri = Rz + (gamma)(beta)
45. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Multi- period version of CAPM
Security (primary vs secondary)
Risk
Solve for minimum variance portfolio
46. Asses firm risks - Communicate risks - Manage and monitor risks
Solve for minimum variance portfolio
Security (primary vs secondary)
Roles of risk management
Sharpe measure
47. Multibeta CAPM Ri - Rf =
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Basis
VaR - Value at Risk
Valuation vs. Risk management
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
Zero- beta CAPM (two factor model)
Barings
Basic Market risk
Settlement risk
49. Future price is greater than the spot price
Capital market line (CML)
LTCM
Contango
Practical considerations related to ERM implementatio
50. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Three main reasons for financial disasters
Nonmarketable asset impact on CAPM
Treynor measure
CAPM (formula)