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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. Interest rate movements - derivatives - defaults
Formula for covariance
Risk
Carry- backs and carry- forwards
Financial Risk
2. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
APT in active portfolio management
Source of need for risk management
Sharpe measure
Operational risk
3. Quantile of a statistical distribution
Basic Market risk
Traits of ERM
Parametric VaR
Business Risk
4. 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
Ways risk can be mismeasured
BTR - Below Target Risk
Practical considerations related to ERM implementatio
Tracking error
5. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Debt overhang
Allied Irish Bank
Solve for minimum variance portfolio
Four major types of risk
6. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Risk types addressed by ERM
Formula for covariance
Sovereign risk
Zero- beta CAPM (two factor model)
7. Multibeta CAPM Ri - Rf =
Effect of heterogeneous expectations on CAPM
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Sortino ratio
Basis
8. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
RAR = relative return of portfolio (RRp)
Standard deviation of two assets
Prices of risk vs sensitivity
Solvency-related metrics
9. 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
RAR = relative return of portfolio (RRp)
Debt overhang
Business Risk
10. 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
Efficient frontier
Security (primary vs secondary)
Drysdale Securities (Chase Manhattan)
Information ratio
11. 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
LTCM
Correlation coefficient effect on diversification
Risk
12. Losses due to market activities ex. Interest rate changes or defaults
Financial risks
Valuation vs. Risk management
Effect of non- price- taking behavior on CAPM
Risk types addressed by ERM
13. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Settlement risk
Uncertainty
Debt overhang
Derivative contract
14. When negative taxable income is moved to a different year to offset future or past taxable income
What lead to the exponential growth to derivatives mkt?
CAPM with taxes included (equation)
Four major types of risk
Carry- backs and carry- forwards
15. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
3 main types of operational risk
Zero- beta CAPM (two factor model)
Market risk
VaR- based analysis (formula)
16. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Four major types of risk
APT for passive portfolio management
Risk- adjusted performance measure (RAP)
Prices of risk vs sensitivity
17. Changes in vol - implied or actual
Solvency-related metrics
Sharpe measure
Banker's Trust
Volatility Market risk
18. Market risk - Liquidity risk - Credit risk - Operational risk
Market risk
Options motivation on volatility
Four major types of risk
Importance of communication for risk managers
19. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Performance- related metrics
Probability of ruin
Asset transformers
Correlation coefficient effect on diversification
20. 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
Shortfall risk
Settlement risk
Traits of ERM
Risk types addressed by ERM
21. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Performance- related metrics
Traits of ERM
Asset liquidity risk
3 main types of operational risk
22. 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
Models used in ERM framework
APT for passive portfolio management
Ten assumptions underlying CAPM
Basic Market risk
23. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Ri = ai + bi1l1 + bi2l2....+ei
Firms becoming more sensitive to changes(bank deregulation)
Business Risk
Performance- related metrics
24. Expected value of unfavorable deviations of a random variable from a specified target level
Parametric VaR
VaR- based analysis (formula)
Risk- adjusted performance measure (RAP)
BTR - Below Target Risk
25. Asset-liability/market-liquidity risk
Exposure
Ri = Rz + (gamma)(beta)
Liquidity risk
Market imperfections that can create value
26. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
What lead to the exponential growth to derivatives mkt?
Shortcomings of risk metrics
Options motivation on volatility
Drysdale Securities (Chase Manhattan)
27. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Zero- beta CAPM (two factor model)
Performance- related metrics
Basic Market risk
Debt overhang
28. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Settlement risk
Morningstar Rating System
Nonparametric VaR
APT in active portfolio management
29. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
EPD or ECOR - Expected Policyholder Deficit (EPD)
Risk
Nonmarketable asset impact on CAPM
Risk Management Irrelevance Proposition
30. Percentile of the distribution corresponding to the point which capital is exhausted - Typically - a minimum acceptable probability of ruin is specified - and economic capital is derived from it
Asset liquidity risk
Probability of ruin
Derivative contract
Correlation coefficient effect on diversification
31. 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
Debt overhang
Drysdale Securities (Chase Manhattan)
Valuation vs. Risk management
3 main types of operational risk
32. 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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33. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
LTCM
Morningstar Rating System
Security (primary vs secondary)
Roles of risk management
34. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Standard deviation of two assets
Market imperfections that can create value
Debt overhang
VaR - Value at Risk
35. When two payments are exchanged the same day and one party may default after payment is made
Settlement risk
Source of need for risk management
APT for passive portfolio management
Business Risk
36. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Options motivation on volatility
Ri = Rz + (gamma)(beta)
Basic Market risk
Operational risk
37. Both probability and cost of tail events are considered
Efficient frontier
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Roles of risk management
APT (equation and assumptions)
38. Derives value from an underlying asset - rate - or index - Derives value from a security
Ways risk can be mismeasured
Basis
Derivative contract
Financial Risk
39. Return is linearly related to growth rate in consumption
Operational risk
Multi- period version of CAPM
Treynor measure
Ten assumptions underlying CAPM
40. Occurs the day when two parties exchange payments same day
Settlement risk
Capital market line (CML)
Exposure
Parametric VaR
41. 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
Basic Market risk
Basis risk
Business Risk
Exposure
42. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Basis risk
Nonparametric VaR
Basic Market risk
Exposure
43. Prices of risk are common factors and do not change - Sensitivities can change
Prices of risk vs sensitivity
Risk
Differences in financial risk management for financial companies vs industrial companies
Effect of heterogeneous expectations on CAPM
44. Probability that a random variable falls below a specified threshold level
Volatility Market risk
Shortfall risk
Capital market line (CML)
Valuation vs. Risk management
45. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Importance of communication for risk managers
Three main reasons for financial disasters
Where is risk coming from
Recovery rate
46. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Contango
Morningstar Rating System
Tracking error
Efficient frontier
47. Cannot exit position in market due to size of the position
Barings
Ri = Rz + (gamma)(beta)
Differences in financial risk management for financial companies vs industrial companies
Asset liquidity risk
48. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Standard deviation of two assets
Tail VaR or TCE - Tail Conditional Expectation(TCE)
VaR- based analysis (formula)
Business Risk
49. 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
Allied Irish Bank
3 main types of operational risk
Parametric VaR
What lead to the exponential growth to derivatives mkt?
50. Wrong distribution - Historical sample may not apply
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
RAR = relative return of portfolio (RRp)
Ways risk can be mismeasured
Nonparametric VaR