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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.
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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. 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
Business risks
Credit event
Forms of Market risk
2. Both probability and cost of tail events are considered
Where is risk coming from
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Risk Management Irrelevance Proposition
Financial Risk
3. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Performance- related metrics
Differences in financial risk management for financial companies vs industrial companies
Risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
4. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
CAPM (formula)
Business risks
Ways firms can fail to account for risks
Traits of ERM
5. Quantile of an empirical distribution
Nonparametric VaR
Market imperfections that can create value
Debt overhang
Sortino ratio
6. Derives value from an underlying asset - rate - or index - Derives value from a security
Three main reasons for financial disasters
Tax shield
Derivative contract
Formula for covariance
7. Quantile of a statistical distribution
Sharpe measure
Parametric VaR
Standard deviation of two assets
Nonmarketable asset impact on CAPM
8. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Risks excluded from operational risk
Debt overhang
Roles of risk management
Tail VaR or TCE - Tail Conditional Expectation(TCE)
9. Potential amount that can be lost
Parametric VaR
Credit event
Security (primary vs secondary)
Exposure
10. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Ten assumptions underlying CAPM
Operational risk
Effect of heterogeneous expectations on CAPM
Sharpe measure
11. 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
Information ratio
Zero- beta CAPM (two factor model)
CAPM (formula)
12. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Effect of heterogeneous expectations on CAPM
CAPM with taxes included (equation)
Risks excluded from operational risk
Asset transformers
13. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Performance- related metrics
Ways firms can fail to account for risks
Credit event
Exposure
14. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Solvency-related metrics
Where is risk coming from
LTCM
Risk types addressed by ERM
15. Expected value of unfavorable deviations of a random variable from a specified target level
Basis risk
Valuation vs. Risk management
Tax shield
BTR - Below Target Risk
16. Inability to make payment obligations (ex. Margin calls)
Business risks
Funding liquidity risk
Zero- beta CAPM (two factor model)
Sovereign risk
17. Interest rate movements - derivatives - defaults
Tax shield
CAPM with taxes included (equation)
Nonmarketable asset impact on CAPM
Financial Risk
18. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Risk types addressed by ERM
Funding liquidity risk
Sovereign risk
Models used in ERM framework
19. 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
Recovery rate
CAPM with taxes included (equation)
Sharpe measure
20. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Traits of ERM
Settlement risk
Models used in ERM framework
Basis risk
21. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Capital market line (CML)
Roles of risk management
Risk- adjusted performance measure (RAP)
Basis
22. The need to hedge against risks - for firms need to speculate.
Capital market line (CML)
Ways firms can fail to account for risks
Tax shield
What lead to the exponential growth to derivatives mkt?
23. 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
Traits of ERM
Contango
Sharpe measure
24. 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)
Basis risk
Ri = Rz + (gamma)(beta)
Information ratio
25. Probability distribution is unknown (ex. A terrorist attack)
Uncertainty
Solve for minimum variance portfolio
Roles of risk management
Jensen's alpha
26. 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
Nonmarketable asset impact on CAPM
Contango
Allied Irish Bank
27. When two payments are exchanged the same day and one party may default after payment is made
Ways firms can fail to account for risks
Ri = ai + bi1l1 + bi2l2....+ei
What lead to the exponential growth to derivatives mkt?
Settlement risk
28. Prices of risk are common factors and do not change - Sensitivities can change
LTCM
Prices of risk vs sensitivity
Valuation vs. Risk management
VaR - Value at Risk
29. Curve must be concave - Straight line connecting any two points must be under the curve
EPD or ECOR - Expected Policyholder Deficit (EPD)
Treynor measure
Solvency-related metrics
Shape of portfolio possibilities curve
30. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Firms becoming more sensitive to changes(bank deregulation)
Parametric VaR
Barings
Prices of risk vs sensitivity
31. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Risk- adjusted performance measure (RAP)
Three main reasons for financial disasters
Effect of non- price- taking behavior on CAPM
Solvency-related metrics
32. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Tax shield
Multi- period version of CAPM
Banker's Trust
Debt overhang
33. Asses firm risks - Communicate risks - Manage and monitor risks
Roles of risk management
Debt overhang
Practical considerations related to ERM implementatio
Efficient frontier
34. Volatility of unexpected outcomes
Risk
Importance of communication for risk managers
Traits of ERM
Three main reasons for financial disasters
35. Returns on any stock are linearly related to a set of indexes
Operational risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Ri = ai + bi1l1 + bi2l2....+ei
APT for passive portfolio management
36. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Ways risk can be mismeasured
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Nonmarketable asset impact on CAPM
Standard deviation of two assets
37. Multibeta CAPM Ri - Rf =
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Parametric VaR
Basis
Probability of ruin
38. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Sortino ratio
Solve for minimum variance portfolio
Roles of risk management
APT for passive portfolio management
39. Future price is greater than the spot price
Business risks
Contango
Formula for covariance
Market risk
40. Risk of loses owing to movements in level or volatility of market prices
Shortcomings of risk metrics
Market risk
Differences in financial risk management for financial companies vs industrial companies
Recovery rate
41. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Market imperfections that can create value
Barings
Settlement risk
VaR - Value at Risk
42. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Standard deviation of two assets
Shortcomings of risk metrics
Basis
Funding liquidity risk
43. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
APT for passive portfolio management
Where is risk coming from
Zero- beta CAPM (two factor model)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
44. Asset-liability/market-liquidity risk
Performance- related metrics
APT (equation and assumptions)
Ways firms can fail to account for risks
Liquidity risk
45. 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
Contango
Financial Risk
Security (primary vs secondary)
Shortcomings of risk metrics
46. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
What lead to the exponential growth to derivatives mkt?
Risk
Nonmarketable asset impact on CAPM
Sovereign risk
47. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Efficient frontier
Treynor measure
Tracking error
Effect of heterogeneous expectations on CAPM
48. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Standard deviation of two assets
Roles of risk management
Basis
49. 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
Forms of Market risk
Settlement risk
Derivative contract
50. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Ri = Rz + (gamma)(beta)
Traits of ERM
Multi- period version of CAPM
Source of need for risk management