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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.
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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. 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
Information ratio
Kidder Peabody
Roles of risk management
3 main types of operational risk
2. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Operational risk
CAPM with taxes included (equation)
VaR - Value at Risk
Effect of heterogeneous expectations on CAPM
3. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Traits of ERM
Carry- backs and carry- forwards
BTR - Below Target Risk
Solvency-related metrics
4. Law of one price - Homogeneous expectations - Security returns process
Sovereign risk
Volatility Market risk
Shape of portfolio possibilities curve
APT (equation and assumptions)
5. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Options motivation on volatility
Effect of heterogeneous expectations on CAPM
Shape of portfolio possibilities curve
Treynor measure
6. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
3 main types of operational risk
Traits of ERM
Derivative contract
Carry- backs and carry- forwards
7. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Capital market line (CML)
Nonmarketable asset impact on CAPM
VaR - Value at Risk
Practical considerations related to ERM implementatio
8. 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)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
VaR - Value at Risk
Shortcomings of risk metrics
9. Changes in vol - implied or actual
Options motivation on volatility
Volatility Market risk
Allied Irish Bank
Risks excluded from operational 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
Roles of risk management
Banker's Trust
Drysdale Securities (Chase Manhattan)
Ways risk can be mismeasured
11. Occurs the day when two parties exchange payments same day
Expected return of two assets
Information ratio
What lead to the exponential growth to derivatives mkt?
Settlement risk
12. Wrong distribution - Historical sample may not apply
Financial risks
Ways risk can be mismeasured
Four major types of risk
Basis
13. Concave function that extends from minimum variance portfolio to maximum return portfolio
Risk
Derivative contract
Nonmarketable asset impact on CAPM
Efficient frontier
14. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Treynor measure
Derivative contract
Liquidity risk
Three main reasons for financial disasters
15. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Where is risk coming from
Options motivation on volatility
Carry- backs and carry- forwards
Ways firms can fail to account for risks
16. 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
Sharpe measure
Exposure
Sortino ratio
17. Modeling approach is typically between statistical analytic models and structural simulation models
Firms becoming more sensitive to changes(bank deregulation)
Formula for covariance
Models used in ERM framework
Treynor measure
18. 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
Where is risk coming from
Traits of ERM
Capital market line (CML)
Basis
19. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Shortfall risk
Settlement risk
Importance of communication for risk managers
Solve for minimum variance portfolio
20. Potential amount that can be lost
Exposure
Recovery rate
Four major types of risk
Basic Market risk
21. Quantile of an empirical distribution
What lead to the exponential growth to derivatives mkt?
Nonparametric VaR
Risk
VaR- based analysis (formula)
22. Strategic risk - Business risk - Reputational risk
Risks excluded from operational risk
Uncertainty
Sharpe measure
Market imperfections that can create value
23. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Sortino ratio
APT (equation and assumptions)
CAPM with taxes included (equation)
Solve for minimum variance portfolio
24. Asses firm risks - Communicate risks - Manage and monitor risks
Differences in financial risk management for financial companies vs industrial companies
Tax shield
Roles of risk management
Traits of ERM
25. 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
Risk
Nonparametric VaR
Derivative contract
Probability of ruin
26. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Effect of heterogeneous expectations on CAPM
Roles of risk management
What lead to the exponential growth to derivatives mkt?
Nonmarketable asset impact on CAPM
27. 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
APT for passive portfolio management
Performance- related metrics
Ri = ai + bi1l1 + bi2l2....+ei
Operational risk
28. 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
LTCM
Volatility Market risk
Traits of ERM
Security (primary vs secondary)
29. Volatility of unexpected outcomes
CAPM (formula)
Asset liquidity risk
Sharpe measure
Risk
30. The lower (closer to - 1) - the higher the payoff from diversification
Security (primary vs secondary)
Operational risk
Correlation coefficient effect on diversification
Formula for covariance
31. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Tax shield
Ri = Rz + (gamma)(beta)
Volatility Market risk
Morningstar Rating System
32. Risk of loses owing to movements in level or volatility of market prices
Market risk
Efficient frontier
Asset liquidity risk
Morningstar Rating System
33. 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
Efficient frontier
Sovereign risk
Practical considerations related to ERM implementatio
Sortino ratio
34. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Standard deviation of two assets
Risk- adjusted performance measure (RAP)
Effect of heterogeneous expectations on CAPM
Debt overhang
35. Unanticipated movements in relative prices of assets in hedged position
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Correlation coefficient effect on diversification
Allied Irish Bank
Basic Market risk
36. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Sharpe measure
Settlement risk
Uncertainty
Asset transformers
37. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
CAPM assumption for EMH
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Carry- backs and carry- forwards
Options motivation on volatility
38. 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
Practical considerations related to ERM implementatio
Allied Irish Bank
Where is risk coming from
Expected return of two assets
39. Quantile of a statistical distribution
Ways risk can be mismeasured
Sovereign risk
Parametric VaR
Information ratio
40. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Sovereign risk
Differences in financial risk management for financial companies vs industrial companies
Business risks
CAPM with taxes included (equation)
41. Returns on any stock are linearly related to a set of indexes
Volatility Market risk
Contango
Ri = ai + bi1l1 + bi2l2....+ei
RAR = relative return of portfolio (RRp)
42. Cannot exit position in market due to size of the position
Asset liquidity risk
Solvency-related metrics
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Nonparametric VaR
43. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
EPD or ECOR - Expected Policyholder Deficit (EPD)
What lead to the exponential growth to derivatives mkt?
Debt overhang
Operational risk
44. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
VaR- based analysis (formula)
Morningstar Rating System
Nonmarketable asset impact on CAPM
BTR - Below Target Risk
45. Firms became multinational - - >watched xchange rates more - deregulation and globalization
CAPM assumption for EMH
Solve for minimum variance portfolio
Source of need for risk management
Firms becoming more sensitive to changes(bank deregulation)
46. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Barings
Basis
Allied Irish Bank
Drysdale Securities (Chase Manhattan)
47. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Ri = ai + bi1l1 + bi2l2....+ei
Basis
Information ratio
Risk- adjusted performance measure (RAP)
48. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Capital market line (CML)
CAPM assumption for EMH
Parametric VaR
Banker's Trust
49. 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
Recovery rate
Kidder Peabody
Shortfall risk
50. Market risk - Liquidity risk - Credit risk - Operational risk
Four major types of risk
Multi- period version of CAPM
APT in active portfolio management
Financial risks