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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. The need to hedge against risks - for firms need to speculate.
Business risks
Differences in financial risk management for financial companies vs industrial companies
Expected return of two assets
What lead to the exponential growth to derivatives mkt?
2. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Risk Management Irrelevance Proposition
Financial risks
Sharpe measure
Exposure
3. Expected value of unfavorable deviations of a random variable from a specified target level
BTR - Below Target Risk
Settlement risk
What lead to the exponential growth to derivatives mkt?
Basic Market risk
4. 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
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Probability of ruin
Allied Irish Bank
Jensen's alpha
5. Inability to make payment obligations (ex. Margin calls)
Ten assumptions underlying CAPM
Volatility Market risk
3 main types of operational risk
Funding liquidity risk
6. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Asset transformers
Source of need for risk management
Sortino ratio
3 main types of operational risk
7. Asset-liability/market-liquidity risk
Liquidity risk
Nonmarketable asset impact on CAPM
Debt overhang
RAR = relative return of portfolio (RRp)
8. 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
Information ratio
Settlement risk
Exposure
Allied Irish Bank
9. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Models used in ERM framework
Asset transformers
Shape of portfolio possibilities curve
Risk Management Irrelevance Proposition
10. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Derivative contract
Security (primary vs secondary)
Sortino ratio
Standard deviation of two assets
11. Law of one price - Homogeneous expectations - Security returns process
APT (equation and assumptions)
Financial risks
Basis risk
Allied Irish Bank
12. 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
Business Risk
Morningstar Rating System
Differences in financial risk management for financial companies vs industrial companies
Risk- adjusted performance measure (RAP)
13. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
BTR - Below Target Risk
Ri = Rz + (gamma)(beta)
Ways firms can fail to account for risks
Capital market line (CML)
14. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Expected return of two assets
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Differences in financial risk management for financial companies vs industrial companies
Derivative contract
15. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Sortino ratio
Market imperfections that can create value
Volatility Market risk
Nonmarketable asset impact on CAPM
16. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Three main reasons for financial disasters
Source of need for risk management
Sortino ratio
3 main types of operational risk
17. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
VaR - Value at Risk
Settlement risk
APT for passive portfolio management
Traits of ERM
18. 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
Allied Irish Bank
Kidder Peabody
Source of need for risk management
Roles of risk management
19. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Nonmarketable asset impact on CAPM
Funding liquidity risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Shape of portfolio possibilities curve
20. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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21. Concave function that extends from minimum variance portfolio to maximum return portfolio
Effect of heterogeneous expectations on CAPM
Effect of non- price- taking behavior on CAPM
CAPM (formula)
Efficient frontier
22. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Importance of communication for risk managers
Solvency-related metrics
Practical considerations related to ERM implementatio
VaR - Value at Risk
23. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Options motivation on volatility
Debt overhang
Where is risk coming from
Ri = Rz + (gamma)(beta)
24. 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 -
Capital market line (CML)
Source of need for risk management
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Efficient frontier
25. Potential amount that can be lost
Solve for minimum variance portfolio
Exposure
Firms becoming more sensitive to changes(bank deregulation)
CAPM (formula)
26. Probability distribution is unknown (ex. A terrorist attack)
Practical considerations related to ERM implementatio
Roles of risk management
Uncertainty
Firms becoming more sensitive to changes(bank deregulation)
27. Modeling approach is typically between statistical analytic models and structural simulation models
Business risks
BTR - Below Target Risk
Risks excluded from operational risk
Models used in ERM framework
28. Market risk - Liquidity risk - Credit risk - Operational risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Four major types of risk
Performance- related metrics
Options motivation on volatility
29. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Source of need for risk management
CAPM assumption for EMH
Sortino ratio
Credit event
30. Strategic risk - Business risk - Reputational risk
Performance- related metrics
Sharpe measure
Risks excluded from operational risk
Risk
31. Losses due to market activities ex. Interest rate changes or defaults
Financial risks
APT in active portfolio management
Risk Management Irrelevance Proposition
Shortcomings of risk metrics
32. Cannot exit position in market due to size of the position
Shortcomings of risk metrics
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Solve for minimum variance portfolio
Asset liquidity risk
33. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Ten assumptions underlying CAPM
Formula for covariance
Debt overhang
34. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Business Risk
Options motivation on volatility
Barings
Allied Irish Bank
35. Return is linearly related to growth rate in consumption
Multi- period version of CAPM
Risk
Tax shield
Risk
36. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Risk types addressed by ERM
Shortfall risk
Ri = ai + bi1l1 + bi2l2....+ei
Recovery rate
37. When two payments are exchanged the same day and one party may default after payment is made
Standard deviation of two assets
Risks excluded from operational risk
Asset liquidity risk
Settlement risk
38. 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
Tax shield
APT in active portfolio management
Valuation vs. Risk management
Risk- adjusted performance measure (RAP)
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
Ten assumptions underlying CAPM
Asset liquidity risk
BTR - Below Target Risk
Traits of ERM
40. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Market risk
Capital market line (CML)
Effect of heterogeneous expectations on CAPM
Shape of portfolio possibilities curve
41. Both probability and cost of tail events are considered
Jensen's alpha
Financial Risk
VaR- based analysis (formula)
Tail VaR or TCE - Tail Conditional Expectation(TCE)
42. 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
Information ratio
Capital market line (CML)
Treynor measure
Credit event
43. 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
Barings
What lead to the exponential growth to derivatives mkt?
Credit event
Parametric VaR
44. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Tax shield
Ways risk can be mismeasured
Credit event
3 main types of operational risk
45. Curve must be concave - Straight line connecting any two points must be under the curve
Expected return of two assets
Shape of portfolio possibilities curve
Where is risk coming from
Four major types of risk
46. 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
Volatility Market risk
Jensen's alpha
Risk types addressed by ERM
47. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Ways firms can fail to account for risks
Risk
Risk- adjusted performance measure (RAP)
Debt overhang
48. Derives value from an underlying asset - rate - or index - Derives value from a security
Derivative contract
Risk
Debt overhang
Roles of risk management
49. Probability that a random variable falls below a specified threshold level
Shortfall risk
Source of need for risk management
Shortcomings of risk metrics
Debt overhang
50. Hazard - Financial - Operational - Strategic
Ten assumptions underlying CAPM
Information ratio
Expected return of two assets
Risk types addressed by ERM