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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. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Source of need for risk management
CAPM (formula)
Risk
Basis risk
2. The need to hedge against risks - for firms need to speculate.
Risk- adjusted performance measure (RAP)
What lead to the exponential growth to derivatives mkt?
BTR - Below Target Risk
Roles of risk management
3. 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
Morningstar Rating System
VaR- based analysis (formula)
RAR = relative return of portfolio (RRp)
Business Risk
4. Modeling approach is typically between statistical analytic models and structural simulation models
Models used in ERM framework
Valuation vs. Risk management
Capital market line (CML)
Tax shield
5. Strategic risk - Business risk - Reputational risk
Risks excluded from operational risk
Risk types addressed by ERM
Financial risks
Shortcomings of risk metrics
6. 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)
Probability of ruin
Forms of Market risk
Risk types addressed by ERM
7. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Financial risks
Differences in financial risk management for financial companies vs industrial companies
Prices of risk vs sensitivity
What lead to the exponential growth to derivatives mkt?
8. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Recovery rate
Operational risk
Shortfall risk
Sharpe measure
9. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Ways risk can be mismeasured
CAPM assumption for EMH
3 main types of operational risk
Risks excluded from operational risk
10. Derives value from an underlying asset - rate - or index - Derives value from a security
Banker's Trust
Solve for minimum variance portfolio
Debt overhang
Derivative contract
11. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Sovereign risk
Importance of communication for risk managers
Credit event
Operational risk
12. Quantile of a statistical distribution
Exposure
Correlation coefficient effect on diversification
Debt overhang
Parametric VaR
13. 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
Sovereign risk
Barings
Importance of communication for risk managers
Practical considerations related to ERM implementatio
14. Hazard - Financial - Operational - Strategic
Valuation vs. Risk management
Differences in financial risk management for financial companies vs industrial companies
Risk types addressed by ERM
Allied Irish Bank
15. 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
Kidder Peabody
Market risk
Roles of risk management
Models used in ERM framework
16. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
CAPM (formula)
Correlation coefficient effect on diversification
Barings
Allied Irish Bank
17. Changes in vol - implied or actual
Risk types addressed by ERM
Volatility Market risk
Allied Irish Bank
Security (primary vs secondary)
18. Multibeta CAPM Ri - Rf =
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
VaR - Value at Risk
CAPM (formula)
Shortcomings of risk metrics
19. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
APT in active portfolio management
Valuation vs. Risk management
Volatility Market risk
CAPM with taxes included (equation)
20. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Debt overhang
Models used in ERM framework
Options motivation on volatility
Risk
21. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
APT in active portfolio management
Solvency-related metrics
Basis risk
Business risks
22. 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
Liquidity risk
Basis risk
Barings
Forms of Market risk
23. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Basic Market risk
Business risks
Source of need for risk management
CAPM assumption for EMH
24. Returns on any stock are linearly related to a set of indexes
Liquidity risk
Business Risk
APT in active portfolio management
Ri = ai + bi1l1 + bi2l2....+ei
25. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Settlement risk
Recovery rate
Information ratio
Solve for minimum variance portfolio
26. 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 -
Standard deviation of two assets
RAR = relative return of portfolio (RRp)
Source of need for risk management
Shortfall 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
Asset liquidity risk
Probability of ruin
Expected return of two assets
Market risk
28. Interest rate movements - derivatives - defaults
Risk types addressed by ERM
Financial Risk
Risk
LTCM
29. 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)
Four major types of risk
Sovereign risk
CAPM with taxes included (equation)
30. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Sharpe measure
Sortino ratio
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Performance- related metrics
31. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Nonmarketable asset impact on CAPM
EPD or ECOR - Expected Policyholder Deficit (EPD)
CAPM assumption for EMH
Performance- related metrics
32. Asses firm risks - Communicate risks - Manage and monitor risks
Risk types addressed by ERM
Roles of risk management
Four major types of risk
3 main types of operational risk
33. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Sortino ratio
Where is risk coming from
3 main types of operational risk
Uncertainty
34. 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
Financial Risk
LTCM
3 main types of operational risk
VaR - Value at Risk
35. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Tracking error
Practical considerations related to ERM implementatio
Information ratio
Standard deviation of two assets
36. Occurs the day when two parties exchange payments same day
3 main types of operational risk
APT in active portfolio management
Four major types of risk
Settlement risk
37. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Standard deviation of two assets
VaR- based analysis (formula)
Risk types addressed by ERM
38. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Models used in ERM framework
BTR - Below Target Risk
Risk- adjusted performance measure (RAP)
39. Curve must be concave - Straight line connecting any two points must be under the curve
Shape of portfolio possibilities curve
LTCM
Prices of risk vs sensitivity
Business risks
40. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Source of need for risk management
Roles of risk management
Carry- backs and carry- forwards
Recovery rate
41. Market risk - Liquidity risk - Credit risk - Operational risk
Volatility Market risk
Financial Risk
Four major types of risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
42. Future price is greater than the spot price
Models used in ERM framework
Business risks
Contango
Financial Risk
43. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Ri = Rz + (gamma)(beta)
Sortino ratio
Morningstar Rating System
RAR = relative return of portfolio (RRp)
44. Risk of loses owing to movements in level or volatility of market prices
Debt overhang
Business Risk
Market risk
Roles of risk management
45. 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
CAPM with taxes included (equation)
Effect of non- price- taking behavior on CAPM
Multi- period version of CAPM
46. Law of one price - Homogeneous expectations - Security returns process
Zero- beta CAPM (two factor model)
APT (equation and assumptions)
Business risks
Financial Risk
47. 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
Business Risk
Valuation vs. Risk management
Tax shield
Roles of risk management
48. Probability that a random variable falls below a specified threshold level
Shortfall risk
Solvency-related metrics
BTR - Below Target Risk
Importance of communication for risk managers
49. 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
Allied Irish Bank
Multi- period version of CAPM
Risks excluded from operational risk
Importance of communication for risk managers
50. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Morningstar Rating System
Firms becoming more sensitive to changes(bank deregulation)
VaR - Value at Risk
Expected return of two assets