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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.
If you are not ready to take this test, you can
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. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
CAPM assumption for EMH
Capital market line (CML)
Security (primary vs secondary)
Differences in financial risk management for financial companies vs industrial companies
2. Quantile of an empirical distribution
Nonparametric VaR
Performance- related metrics
Funding liquidity risk
Sortino ratio
3. Quantile of a statistical distribution
Parametric VaR
Three main reasons for financial disasters
Effect of non- price- taking behavior on CAPM
Recovery rate
4. 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
Multi- period version of CAPM
Uncertainty
Business Risk
Asset liquidity risk
5. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Credit event
Banker's Trust
Ri = Rz + (gamma)(beta)
APT for passive portfolio management
6. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Expected return of two assets
Drysdale Securities (Chase Manhattan)
VaR - Value at Risk
CAPM with taxes included (equation)
7. 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
Financial risks
Barings
Information ratio
Basic Market risk
8. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
VaR - Value at Risk
Sortino ratio
Recovery rate
Jensen's alpha
9. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
3 main types of operational risk
Where is risk coming from
Ways risk can be mismeasured
Credit event
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
Asset transformers
Firms becoming more sensitive to changes(bank deregulation)
Risks excluded from operational risk
Drysdale Securities (Chase Manhattan)
11. Rp = XaRa + XbRb
Tax shield
Expected return of two assets
Risks excluded from operational risk
Basic Market risk
12. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Zero- beta CAPM (two factor model)
Source of need for risk management
Options motivation on volatility
Traits of ERM
13. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
APT (equation and assumptions)
Models used in ERM framework
Ways firms can fail to account for risks
Tracking error
14. Return is linearly related to growth rate in consumption
Practical considerations related to ERM implementatio
Multi- period version of CAPM
Sovereign risk
VaR- based analysis (formula)
15. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
APT (equation and assumptions)
Risk
Market imperfections that can create value
Treynor measure
16. 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)
Sharpe measure
Forms of Market risk
Business Risk
17. Probability that a random variable falls below a specified threshold level
Derivative contract
Shortfall risk
VaR- based analysis (formula)
Ways risk can be mismeasured
18. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Expected return of two assets
Information ratio
Four major types of risk
Standard deviation of two assets
19. Hazard - Financial - Operational - Strategic
Debt overhang
Risk types addressed by ERM
Traits of ERM
APT (equation and assumptions)
20. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Parametric VaR
3 main types of operational risk
Basis
Risk
21. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Sortino ratio
Morningstar Rating System
Solvency-related metrics
Settlement risk
22. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Treynor measure
Security (primary vs secondary)
Options motivation on volatility
Shape of portfolio possibilities curve
23. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Standard deviation of two assets
Where is risk coming from
Differences in financial risk management for financial companies vs industrial companies
RAR = relative return of portfolio (RRp)
24. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Business risks
Risks excluded from operational risk
Exposure
Traits of ERM
25. 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
Drysdale Securities (Chase Manhattan)
Nonmarketable asset impact on CAPM
Kidder Peabody
Shortfall risk
26. Inability to make payment obligations (ex. Margin calls)
Basis risk
Four major types of risk
Basic Market risk
Funding liquidity risk
27. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Risk
Prices of risk vs sensitivity
Three main reasons for financial disasters
Performance- related metrics
28. 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
Risk
APT for passive portfolio management
Three main reasons for financial disasters
Jensen's alpha
29. Returns on any stock are linearly related to a set of indexes
Contango
Where is risk coming from
Correlation coefficient effect on diversification
Ri = ai + bi1l1 + bi2l2....+ei
30. The uses of debt to fall into a lower tax rate
Drysdale Securities (Chase Manhattan)
What lead to the exponential growth to derivatives mkt?
Business Risk
Tax shield
31. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Risk types addressed by ERM
Ways firms can fail to account for risks
Credit event
Effect of heterogeneous expectations on CAPM
32. 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
Market imperfections that can create value
CAPM assumption for EMH
Information ratio
Ways firms can fail to account for risks
33. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Contango
Firms becoming more sensitive to changes(bank deregulation)
Three main reasons for financial disasters
Effect of heterogeneous expectations on CAPM
34. 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
Practical considerations related to ERM implementatio
Zero- beta CAPM (two factor model)
Volatility Market risk
Risk
35. 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
Traits of ERM
Financial risks
Ten assumptions underlying CAPM
Kidder Peabody
36. Derives value from an underlying asset - rate - or index - Derives value from a security
Basis risk
Tax shield
Carry- backs and carry- forwards
Derivative contract
37. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Business Risk
Solvency-related metrics
Recovery rate
Multi- period version of CAPM
38. Potential amount that can be lost
LTCM
Risk Management Irrelevance Proposition
Nonmarketable asset impact on CAPM
Exposure
39. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Funding liquidity risk
CAPM assumption for EMH
Market imperfections that can create value
Operational risk
40. 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
Source of need for risk management
Risk types addressed by ERM
Valuation vs. Risk management
Parametric VaR
41. Market risk - Liquidity risk - Credit risk - Operational risk
Nonparametric VaR
Four major types of risk
Asset transformers
Carry- backs and carry- forwards
42. Both probability and cost of tail events are considered
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Security (primary vs secondary)
VaR- based analysis (formula)
Ri = ai + bi1l1 + bi2l2....+ei
43. Asset-liability/market-liquidity risk
Four major types of risk
Differences in financial risk management for financial companies vs industrial companies
Nonparametric VaR
Liquidity risk
44. 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
What lead to the exponential growth to derivatives mkt?
Expected return of two assets
Allied Irish Bank
Probability of ruin
45. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Nonparametric VaR
Multi- period version of CAPM
Differences in financial risk management for financial companies vs industrial companies
Sharpe measure
46. The need to hedge against risks - for firms need to speculate.
Practical considerations related to ERM implementatio
Traits of ERM
Uncertainty
What lead to the exponential growth to derivatives mkt?
47. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
EPD or ECOR - Expected Policyholder Deficit (EPD)
Basis
Ways risk can be mismeasured
Exposure
48. 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
Options motivation on volatility
Volatility Market risk
3 main types of operational risk
49. When two payments are exchanged the same day and one party may default after payment is made
Settlement risk
Shape of portfolio possibilities curve
Jensen's alpha
Probability of ruin
50. Volatility of unexpected outcomes
Models used in ERM framework
Risk
3 main types of operational risk
EPD or ECOR - Expected Policyholder Deficit (EPD)