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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. 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
APT in active portfolio management
Volatility Market risk
Business Risk
Solvency-related metrics
2. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Risk
Multi- period version of CAPM
Differences in financial risk management for financial companies vs industrial companies
CAPM (formula)
3. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Probability of ruin
Solvency-related metrics
Shape of portfolio possibilities curve
Options motivation on volatility
4. Return is linearly related to growth rate in consumption
Risk
Multi- period version of CAPM
Credit event
Forms of Market risk
5. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Roles of risk management
EPD or ECOR - Expected Policyholder Deficit (EPD)
Debt overhang
Tracking error
6. 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
Formula for covariance
Effect of heterogeneous expectations on CAPM
Shortcomings of risk metrics
Differences in financial risk management for financial companies vs industrial companies
7. When two payments are exchanged the same day and one party may default after payment is made
Settlement risk
Risk
Expected return of two assets
Effect of non- price- taking behavior on CAPM
8. RM cannot increase firm value when it costs the same to bear a risk w/in the firm or outside the firm - For RM to increase firm value it must be more expensive to bear risks internally than to pay capital markets to bear them.
Risks excluded from operational risk
LTCM
Market risk
Risk Management Irrelevance Proposition
9. Covariance = correlation coefficient std dev(a) std dev(b)
Information ratio
Banker's Trust
Traits of ERM
Formula for covariance
10. Inability to make payment obligations (ex. Margin calls)
Multi- period version of CAPM
Funding liquidity risk
Solve for minimum variance portfolio
RAR = relative return of portfolio (RRp)
11. 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
Importance of communication for risk managers
EPD or ECOR - Expected Policyholder Deficit (EPD)
Kidder Peabody
Solvency-related metrics
12. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Capital market line (CML)
Valuation vs. Risk management
VaR- based analysis (formula)
Sortino ratio
13. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Business risks
LTCM
CAPM assumption for EMH
CAPM with taxes included (equation)
14. Absolute and relative risk - direction and non-directional
Funding liquidity risk
Risks excluded from operational risk
Forms of Market risk
What lead to the exponential growth to derivatives mkt?
15. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Basic Market risk
Sovereign risk
Market imperfections that can create value
Efficient frontier
16. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Debt overhang
CAPM (formula)
Kidder Peabody
Three main reasons for financial disasters
17. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Solvency-related metrics
Contango
Morningstar Rating System
18. Probability that a random variable falls below a specified threshold level
Risk
Shortfall risk
Settlement risk
BTR - Below Target Risk
19. 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
CAPM (formula)
Allied Irish Bank
Exposure
Sharpe measure
20. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Solve for minimum variance portfolio
Three main reasons for financial disasters
EPD or ECOR - Expected Policyholder Deficit (EPD)
Multi- period version of CAPM
21. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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22. 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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23. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
RAR = relative return of portfolio (RRp)
APT in active portfolio management
Roles of risk management
Basis
24. Rp = XaRa + XbRb
Correlation coefficient effect on diversification
Differences in financial risk management for financial companies vs industrial companies
Debt overhang
Expected return of two assets
25. Quantile of a statistical distribution
Operational risk
Parametric VaR
Forms of Market risk
Credit event
26. Probability distribution is unknown (ex. A terrorist attack)
Operational risk
Risk
Effect of heterogeneous expectations on CAPM
Uncertainty
27. Strategic risk - Business risk - Reputational risk
Risks excluded from operational risk
Shape of portfolio possibilities curve
Solve for minimum variance portfolio
Probability of ruin
28. 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
Risk Management Irrelevance Proposition
Sharpe measure
Four major types of risk
Capital market line (CML)
29. Interest rate movements - derivatives - defaults
Financial Risk
Roles of risk management
Uncertainty
Risks excluded from operational risk
30. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Settlement risk
Performance- related metrics
Operational risk
Zero- beta CAPM (two factor model)
31. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Operational risk
Ten assumptions underlying CAPM
Source of need for risk management
Formula for covariance
32. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Probability of ruin
Risk
Recovery rate
Basis risk
33. Risk of loses owing to movements in level or volatility of market prices
Market risk
Valuation vs. Risk management
Risks excluded from operational risk
Firms becoming more sensitive to changes(bank deregulation)
34. Prices of risk are common factors and do not change - Sensitivities can change
Probability of ruin
Prices of risk vs sensitivity
Effect of heterogeneous expectations on CAPM
CAPM assumption for EMH
35. Occurs the day when two parties exchange payments same day
3 main types of operational risk
Banker's Trust
Settlement risk
Risk Management Irrelevance Proposition
36. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
VaR - Value at Risk
Four major types of risk
Market risk
37. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Tracking error
Market risk
Volatility Market risk
Asset liquidity risk
38. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Credit event
Sharpe measure
Treynor measure
Efficient frontier
39. Modeling approach is typically between statistical analytic models and structural simulation models
Models used in ERM framework
Forms of Market risk
Sharpe measure
Effect of heterogeneous expectations on CAPM
40. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Effect of heterogeneous expectations on CAPM
VaR- based analysis (formula)
Firms becoming more sensitive to changes(bank deregulation)
Source of need for risk management
41. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Effect of non- price- taking behavior on CAPM
Basis risk
Kidder Peabody
RAR = relative return of portfolio (RRp)
42. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Market imperfections that can create value
VaR - Value at Risk
Debt overhang
BTR - Below Target Risk
43. Concave function that extends from minimum variance portfolio to maximum return portfolio
Business risks
Basis risk
Valuation vs. Risk management
Efficient frontier
44. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Shape of portfolio possibilities curve
Volatility Market risk
Risk types addressed by ERM
Business risks
45. Long Term Capital Management - Renowned quants produced great returns with arbitrage- type trades - Unexpected and extreme events resulted in devaluation of Russian Rouble - resulting in a 3.65 billion dollar bailout - Failure to account for illiquid
LTCM
Risk
Ri = ai + bi1l1 + bi2l2....+ei
Exposure
46. 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 -
Treynor measure
Efficient frontier
Source of need for risk management
Uncertainty
47. 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
Derivative contract
Volatility Market risk
Drysdale Securities (Chase Manhattan)
Carry- backs and carry- forwards
48. Law of one price - Homogeneous expectations - Security returns process
Where is risk coming from
APT (equation and assumptions)
Probability of ruin
Three main reasons for financial disasters
49. 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 (equation and assumptions)
RAR = relative return of portfolio (RRp)
APT for passive portfolio management
Forms of Market risk
50. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Importance of communication for risk managers
Ten assumptions underlying CAPM
Roles of risk management
Nonmarketable asset impact on CAPM