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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. Need to assess risk and tell management so they can determine which risks to take on
Sortino ratio
Importance of communication for risk managers
Kidder Peabody
What lead to the exponential growth to derivatives mkt?
2. 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
Banker's Trust
LTCM
Market imperfections that can create value
3. 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
Forms of Market risk
Asset transformers
Basis risk
4. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
EPD or ECOR - Expected Policyholder Deficit (EPD)
Effect of non- price- taking behavior on CAPM
Valuation vs. Risk management
VaR- based analysis (formula)
5. Interest rate movements - derivatives - defaults
Firms becoming more sensitive to changes(bank deregulation)
Debt overhang
What lead to the exponential growth to derivatives mkt?
Financial Risk
6. 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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7. Changes in vol - implied or actual
Business Risk
Volatility Market risk
Uncertainty
Correlation coefficient effect on diversification
8. 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
Uncertainty
Traits of ERM
Security (primary vs secondary)
Recovery rate
9. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Nonparametric VaR
Roles of risk management
VaR - Value at Risk
Risk- adjusted performance measure (RAP)
10. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
APT for passive portfolio management
Operational risk
Treynor measure
Basis risk
11. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Information ratio
What lead to the exponential growth to derivatives mkt?
VaR- based analysis (formula)
Kidder Peabody
12. Unanticipated movements in relative prices of assets in hedged position
Firms becoming more sensitive to changes(bank deregulation)
Effect of non- price- taking behavior on CAPM
Source of need for risk management
Basic Market risk
13. Quantile of a statistical distribution
Firms becoming more sensitive to changes(bank deregulation)
Parametric VaR
Risk types addressed by ERM
Liquidity risk
14. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Traits of ERM
CAPM (formula)
Shortcomings of risk metrics
Allied Irish Bank
15. 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 assumption for EMH
Correlation coefficient effect on diversification
RAR = relative return of portfolio (RRp)
16. Hazard - Financial - Operational - Strategic
Shape of portfolio possibilities curve
Risk types addressed by ERM
Valuation vs. Risk management
VaR - Value at Risk
17. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Three main reasons for financial disasters
VaR- based analysis (formula)
BTR - Below Target Risk
Business Risk
18. 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
Ri = Rz + (gamma)(beta)
CAPM (formula)
Practical considerations related to ERM implementatio
EPD or ECOR - Expected Policyholder Deficit (EPD)
19. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Volatility Market risk
Drysdale Securities (Chase Manhattan)
Exposure
Standard deviation of two assets
20. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Asset transformers
Basis
Risk types addressed by ERM
LTCM
21. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Where is risk coming from
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Risk- adjusted performance measure (RAP)
Market risk
22. Cannot exit position in market due to size of the position
Prices of risk vs sensitivity
Asset liquidity risk
Business Risk
Settlement risk
23. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Sharpe measure
Where is risk coming from
Risk- adjusted performance measure (RAP)
BTR - Below Target Risk
24. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Four major types of risk
Correlation coefficient effect on diversification
Recovery rate
Exposure
25. Asset-liability/market-liquidity risk
Liquidity risk
Risk- adjusted performance measure (RAP)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Standard deviation of two assets
26. Derives value from an underlying asset - rate - or index - Derives value from a security
Funding liquidity risk
Operational risk
Source of need for risk management
Derivative contract
27. 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
Sortino ratio
Shortfall risk
Capital market line (CML)
Ri = Rz + (gamma)(beta)
28. Law of one price - Homogeneous expectations - Security returns process
Firms becoming more sensitive to changes(bank deregulation)
Basis risk
APT (equation and assumptions)
Parametric VaR
29. Market risk - Liquidity risk - Credit risk - Operational risk
Tax shield
CAPM assumption for EMH
EPD or ECOR - Expected Policyholder Deficit (EPD)
Four major types of risk
30. Wrong distribution - Historical sample may not apply
Where is risk coming from
Basis
Debt overhang
Ways risk can be mismeasured
31. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Contango
Market risk
Zero- beta CAPM (two factor model)
Sortino ratio
32. Country specific - Foreign exchange controls that prohibit counterparty's obligations
RAR = relative return of portfolio (RRp)
Settlement risk
LTCM
Sovereign risk
33. 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
Standard deviation of two assets
Options motivation on volatility
Source of need for risk management
Drysdale Securities (Chase Manhattan)
34. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Barings
Asset transformers
Market imperfections that can create value
What lead to the exponential growth to derivatives mkt?
35. Return is linearly related to growth rate in consumption
CAPM with taxes included (equation)
LTCM
Zero- beta CAPM (two factor model)
Multi- period version of CAPM
36. 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
Models used in ERM framework
Valuation vs. Risk management
Shortcomings of risk metrics
Solvency-related metrics
37. The uses of debt to fall into a lower tax rate
Sharpe measure
Tax shield
Financial Risk
Liquidity risk
38. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Sharpe measure
Financial Risk
Operational risk
Market risk
39. 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
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Where is risk coming from
Probability of ruin
Asset liquidity risk
40. 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
Parametric VaR
Risk
Correlation coefficient effect on diversification
LTCM
41. Occurs the day when two parties exchange payments same day
Sovereign risk
Models used in ERM framework
Settlement risk
Shortfall risk
42. Modeling approach is typically between statistical analytic models and structural simulation models
Formula for covariance
CAPM (formula)
Models used in ERM framework
Sovereign risk
43. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Risks excluded from operational risk
VaR - Value at Risk
Effect of heterogeneous expectations on CAPM
Options motivation on volatility
44. 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
Traits of ERM
Solvency-related metrics
APT in active portfolio management
Ways firms can fail to account for risks
45. 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
Shortfall risk
Ways firms can fail to account for risks
Four major types of risk
46. Volatility of unexpected outcomes
Source of need for risk management
Debt overhang
CAPM with taxes included (equation)
Risk
47. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
3 main types of operational risk
Financial risks
Basis risk
Risk
48. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Uncertainty
Tracking error
Expected return of two assets
Risk
49. The need to hedge against risks - for firms need to speculate.
Roles of risk management
APT (equation and assumptions)
What lead to the exponential growth to derivatives mkt?
Importance of communication for risk managers
50. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Basis
Business risks
Risk
Models used in ERM framework