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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. Quantile of a statistical distribution
Importance of communication for risk managers
Parametric VaR
Liquidity risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
2. The need to hedge against risks - for firms need to speculate.
Formula for covariance
Settlement risk
LTCM
What lead to the exponential growth to derivatives mkt?
3. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Solvency-related metrics
RAR = relative return of portfolio (RRp)
APT in active portfolio management
Four major types of risk
4. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Security (primary vs secondary)
Models used in ERM framework
CAPM assumption for EMH
Firms becoming more sensitive to changes(bank deregulation)
5. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Solvency-related metrics
Capital market line (CML)
Debt overhang
Ri = Rz + (gamma)(beta)
6. Curve must be concave - Straight line connecting any two points must be under the curve
Derivative contract
Settlement risk
Shape of portfolio possibilities curve
EPD or ECOR - Expected Policyholder Deficit (EPD)
7. Prices of risk are common factors and do not change - Sensitivities can change
Risk types addressed by ERM
Prices of risk vs sensitivity
Funding liquidity risk
Basic Market risk
8. Risk of loses owing to movements in level or volatility of market prices
Market risk
Ri = ai + bi1l1 + bi2l2....+ei
Funding liquidity risk
Solve for minimum variance portfolio
9. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Sharpe measure
RAR = relative return of portfolio (RRp)
Zero- beta CAPM (two factor model)
Liquidity risk
10. Interest rate movements - derivatives - defaults
Asset liquidity risk
Treynor measure
Allied Irish Bank
Financial Risk
11. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Risk
Nonmarketable asset impact on CAPM
Risk- adjusted performance measure (RAP)
Practical considerations related to ERM implementatio
12. Potential amount that can be lost
Nonmarketable asset impact on CAPM
Exposure
CAPM (formula)
Financial risks
13. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Importance of communication for risk managers
Risk- adjusted performance measure (RAP)
Sovereign risk
Security (primary vs secondary)
14. Multibeta CAPM Ri - Rf =
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Ways risk can be mismeasured
Information ratio
Settlement risk
15. Losses due to market activities ex. Interest rate changes or defaults
Financial risks
Morningstar Rating System
Volatility Market risk
Multi- period version of CAPM
16. Inability to make payment obligations (ex. Margin calls)
Recovery rate
Allied Irish Bank
Funding liquidity risk
Security (primary vs secondary)
17. 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
Settlement risk
Allied Irish Bank
Options motivation on volatility
Effect of non- price- taking behavior on CAPM
18. Probability that a random variable falls below a specified threshold level
Market risk
Shortfall risk
Valuation vs. Risk management
Sovereign risk
19. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
VaR - Value at Risk
Information ratio
Ri = Rz + (gamma)(beta)
Settlement risk
20. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Market imperfections that can create value
Firms becoming more sensitive to changes(bank deregulation)
CAPM assumption for EMH
Performance- related metrics
21. Covariance = correlation coefficient std dev(a) std dev(b)
Derivative contract
Formula for covariance
Efficient frontier
Traits of ERM
22. 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
Models used in ERM framework
EPD or ECOR - Expected Policyholder Deficit (EPD)
Financial Risk
Business Risk
23. 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
Drysdale Securities (Chase Manhattan)
Exposure
Nonmarketable asset impact on CAPM
Ten assumptions underlying CAPM
24. Market risk - Liquidity risk - Credit risk - Operational risk
Ways firms can fail to account for risks
Four major types of risk
CAPM with taxes included (equation)
Uncertainty
25. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Financial Risk
Financial risks
VaR - Value at Risk
Contango
26. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Three main reasons for financial disasters
Basis
Derivative contract
Funding liquidity risk
27. 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
Probability of ruin
Multi- period version of CAPM
Standard deviation of two assets
Carry- backs and carry- forwards
28. Quantile of an empirical distribution
Nonparametric VaR
Sortino ratio
VaR - Value at Risk
Risk Management Irrelevance Proposition
29. When two payments are exchanged the same day and one party may default after payment is made
Where is risk coming from
Settlement risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Ri = Rz + (gamma)(beta)
30. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Ri = Rz + (gamma)(beta)
Settlement risk
Debt overhang
Formula for covariance
31. Modeling approach is typically between statistical analytic models and structural simulation models
Models used in ERM framework
Risk Management Irrelevance Proposition
Shape of portfolio possibilities curve
Zero- beta CAPM (two factor model)
32. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Morningstar Rating System
Differences in financial risk management for financial companies vs industrial companies
Effect of non- price- taking behavior on CAPM
Security (primary vs secondary)
33. Changes in vol - implied or actual
Recovery rate
Volatility Market risk
LTCM
Barings
34. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Solve for minimum variance portfolio
Settlement risk
Exposure
Parametric VaR
35. Cannot exit position in market due to size of the position
Source of need for risk management
Asset liquidity risk
Risk
Three main reasons for financial disasters
36. 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)
Ten assumptions underlying CAPM
Basic Market risk
Forms of Market risk
37. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Market imperfections that can create value
Where is risk coming from
Contango
Ways firms can fail to account for risks
38. Returns on any stock are linearly related to a set of indexes
Sovereign risk
Ri = ai + bi1l1 + bi2l2....+ei
Prices of risk vs sensitivity
Firms becoming more sensitive to changes(bank deregulation)
39. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Ri = Rz + (gamma)(beta)
Shape of portfolio possibilities curve
Nonparametric VaR
Differences in financial risk management for financial companies vs industrial companies
40. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
EPD or ECOR - Expected Policyholder Deficit (EPD)
Solve for minimum variance portfolio
Zero- beta CAPM (two factor model)
Tracking error
41. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Operational risk
Carry- backs and carry- forwards
Basis risk
Differences in financial risk management for financial companies vs industrial companies
42. Probability distribution is unknown (ex. A terrorist attack)
Zero- beta CAPM (two factor model)
Uncertainty
Probability of ruin
Funding liquidity risk
43. The uses of debt to fall into a lower tax rate
Tax shield
Derivative contract
Business Risk
CAPM assumption for EMH
44. When negative taxable income is moved to a different year to offset future or past taxable income
Risks excluded from operational risk
Nonparametric VaR
Capital market line (CML)
Carry- backs and carry- forwards
45. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Debt overhang
Risks excluded from operational risk
CAPM (formula)
Morningstar Rating System
46. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
3 main types of operational risk
Differences in financial risk management for financial companies vs industrial companies
Debt overhang
Capital market line (CML)
47. 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
What lead to the exponential growth to derivatives mkt?
Kidder Peabody
Ways risk can be mismeasured
Zero- beta CAPM (two factor model)
48. The lower (closer to - 1) - the higher the payoff from diversification
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
CAPM with taxes included (equation)
Correlation coefficient effect on diversification
Shortcomings of risk metrics
49. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Where is risk coming from
Risk
Market imperfections that can create value
Nonmarketable asset impact on CAPM
50. Asset-liability/market-liquidity risk
Source of need for risk management
Risk types addressed by ERM
Formula for covariance
Liquidity risk