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Test your basic knowledge |
FRM: Foundations Of Risk Management
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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. Multibeta CAPM Ri - Rf =
CAPM (formula)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Probability of ruin
Options motivation on volatility
2. CAPM requires the strong form of the Efficient Market Hypothesis = private information
BTR - Below Target Risk
CAPM assumption for EMH
Risk
Asset liquidity risk
3. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Shortcomings of risk metrics
Funding liquidity risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
Volatility Market risk
4. When negative taxable income is moved to a different year to offset future or past taxable income
Carry- backs and carry- forwards
APT (equation and assumptions)
Nonmarketable asset impact on CAPM
Ri = Rz + (gamma)(beta)
5. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Risks excluded from operational risk
Valuation vs. Risk management
Efficient frontier
Basis risk
6. Expected value of unfavorable deviations of a random variable from a specified target level
Risk
Performance- related metrics
BTR - Below Target Risk
Debt overhang
7. Changes in vol - implied or actual
Nonmarketable asset impact on CAPM
Volatility Market risk
Roles of risk management
Expected return of two assets
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.
Risk Management Irrelevance Proposition
Financial risks
Options motivation on volatility
Traits of ERM
9. 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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10. 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
Derivative contract
Practical considerations related to ERM implementatio
Carry- backs and carry- forwards
Risk
11. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Basic Market risk
Barings
Parametric VaR
Three main reasons for financial disasters
12. Return is linearly related to growth rate in consumption
Tracking error
Business Risk
Recovery rate
Multi- period version of CAPM
13. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Market imperfections that can create value
Settlement risk
Differences in financial risk management for financial companies vs industrial companies
Credit event
14. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Ways firms can fail to account for risks
Performance- related metrics
Multi- period version of CAPM
Probability of ruin
15. Losses due to market activities ex. Interest rate changes or defaults
Sharpe measure
Expected return of two assets
Efficient frontier
Financial risks
16. 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
Where is risk coming from
Debt overhang
APT for passive portfolio management
Multi- period version of CAPM
17. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Solvency-related metrics
CAPM assumption for EMH
Multi- period version of CAPM
Tracking error
18. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Standard deviation of two assets
Source of need for risk management
CAPM (formula)
Forms of Market risk
19. 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
3 main types of operational risk
Models used in ERM framework
Security (primary vs secondary)
Shortcomings of risk metrics
20. 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)
Four major types of risk
Risk- adjusted performance measure (RAP)
Formula for covariance
21. Covariance = correlation coefficient std dev(a) std dev(b)
Importance of communication for risk managers
Formula for covariance
Risk types addressed by ERM
Ways risk can be mismeasured
22. Risk of loses owing to movements in level or volatility of market prices
Security (primary vs secondary)
Recovery rate
Ten assumptions underlying CAPM
Market risk
23. Absolute and relative risk - direction and non-directional
Nonmarketable asset impact on CAPM
Forms of Market risk
Risk
Debt overhang
24. Need to assess risk and tell management so they can determine which risks to take on
Importance of communication for risk managers
Treynor measure
Settlement risk
Practical considerations related to ERM implementatio
25. Modeling approach is typically between statistical analytic models and structural simulation models
Security (primary vs secondary)
Prices of risk vs sensitivity
Models used in ERM framework
CAPM assumption for EMH
26. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Derivative contract
Security (primary vs secondary)
Ri = ai + bi1l1 + bi2l2....+ei
Financial risks
27. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Effect of heterogeneous expectations on CAPM
Risk types addressed by ERM
Three main reasons for financial disasters
Differences in financial risk management for financial companies vs industrial companies
28. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Financial risks
BTR - Below Target Risk
Business risks
Source of need for risk management
29. When two payments are exchanged the same day and one party may default after payment is made
Correlation coefficient effect on diversification
Sortino ratio
Volatility Market risk
Settlement risk
30. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Standard deviation of two assets
CAPM with taxes included (equation)
Four major types of risk
Contango
31. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Sharpe measure
Morningstar Rating System
Ways firms can fail to account for risks
Ways risk can be mismeasured
32. Volatility of unexpected outcomes
Risk
Capital market line (CML)
Carry- backs and carry- forwards
Tax shield
33. Returns on any stock are linearly related to a set of indexes
Valuation vs. Risk management
CAPM (formula)
Ri = ai + bi1l1 + bi2l2....+ei
Settlement risk
34. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Risk- adjusted performance measure (RAP)
Ri = Rz + (gamma)(beta)
Firms becoming more sensitive to changes(bank deregulation)
Sovereign risk
35. 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
Barings
Risks excluded from operational risk
Valuation vs. Risk management
Basis
36. Country specific - Foreign exchange controls that prohibit counterparty's obligations
3 main types of operational risk
VaR - Value at Risk
Sovereign risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
37. Law of one price - Homogeneous expectations - Security returns process
APT (equation and assumptions)
Where is risk coming from
Solve for minimum variance portfolio
Parametric VaR
38. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Zero- beta CAPM (two factor model)
Credit event
CAPM (formula)
Standard deviation of two assets
39. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Practical considerations related to ERM implementatio
Debt overhang
Ten assumptions underlying CAPM
Exposure
40. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Three main reasons for financial disasters
Morningstar Rating System
Performance- related metrics
Risks excluded from operational risk
41. Occurs the day when two parties exchange payments same day
Shape of portfolio possibilities curve
Settlement risk
Roles of risk management
Performance- related metrics
42. Both probability and cost of tail events are considered
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Barings
Valuation vs. Risk management
Debt overhang
43. 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
Roles of risk management
Business Risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
Traits of ERM
44. The uses of debt to fall into a lower tax rate
Sharpe measure
Tax shield
Uncertainty
Ways firms can fail to account for risks
45. Derives value from an underlying asset - rate - or index - Derives value from a security
Jensen's alpha
Financial risks
Tax shield
Derivative contract
46. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Volatility Market risk
3 main types of operational risk
Sharpe measure
Risks excluded from operational risk
47. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Valuation vs. Risk management
Liquidity risk
Debt overhang
VaR- based analysis (formula)
48. Concave function that extends from minimum variance portfolio to maximum return portfolio
Recovery rate
Security (primary vs secondary)
Business risks
Efficient frontier
49. Strategic risk - Business risk - Reputational risk
Sovereign risk
Derivative contract
Risks excluded from operational risk
Debt overhang
50. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Credit event
Debt overhang
Recovery rate
Roles of risk management