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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. Hazard - Financial - Operational - Strategic
Risk types addressed by ERM
Nonmarketable asset impact on CAPM
Forms of Market risk
Shape of portfolio possibilities curve
2. Concave function that extends from minimum variance portfolio to maximum return portfolio
Sharpe measure
Risks excluded from operational risk
Efficient frontier
Four major types of risk
3. 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
Differences in financial risk management for financial companies vs industrial companies
Sovereign risk
APT in active portfolio management
APT for passive portfolio management
4. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Debt overhang
Shortfall risk
Barings
Correlation coefficient effect on diversification
5. Risk of loses owing to movements in level or volatility of market prices
BTR - Below Target Risk
Firms becoming more sensitive to changes(bank deregulation)
Effect of non- price- taking behavior on CAPM
Market risk
6. 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
Importance of communication for risk managers
Forms of Market risk
Exposure
LTCM
7. Market risk - Liquidity risk - Credit risk - Operational risk
Prices of risk vs sensitivity
What lead to the exponential growth to derivatives mkt?
Carry- backs and carry- forwards
Four major types of risk
8. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Operational risk
Basis
Risks excluded from operational risk
9. Changes in vol - implied or actual
Contango
Volatility Market risk
Security (primary vs secondary)
Risk types addressed by ERM
10. Unanticipated movements in relative prices of assets in hedged position
Carry- backs and carry- forwards
Treynor measure
Basic Market risk
VaR- based analysis (formula)
11. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Drysdale Securities (Chase Manhattan)
Differences in financial risk management for financial companies vs industrial companies
Effect of non- price- taking behavior on CAPM
Performance- related metrics
12. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
CAPM with taxes included (equation)
Sortino ratio
Shortcomings of risk metrics
APT (equation and assumptions)
13. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Financial risks
APT in active portfolio management
Multi- period version of CAPM
CAPM with taxes included (equation)
14. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Formula for covariance
Information ratio
Nonmarketable asset impact on CAPM
Basic Market risk
15. Strategic risk - Business risk - Reputational risk
Risks excluded from operational risk
Debt overhang
Basis
VaR- based analysis (formula)
16. Asset-liability/market-liquidity risk
Importance of communication for risk managers
Uncertainty
Risk Management Irrelevance Proposition
Liquidity risk
17. 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
Effect of heterogeneous expectations on CAPM
Roles of risk management
Differences in financial risk management for financial companies vs industrial companies
Allied Irish Bank
18. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Standard deviation of two assets
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Risk Management Irrelevance Proposition
Three main reasons for financial disasters
19. Quantile of a statistical distribution
Parametric VaR
APT for passive portfolio management
What lead to the exponential growth to derivatives mkt?
Effect of non- price- taking behavior on CAPM
20. Quantile of an empirical distribution
Nonparametric VaR
Solvency-related metrics
Source of need for risk management
Ways firms can fail to account for risks
21. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Carry- backs and carry- forwards
APT in active portfolio management
Source of need for risk management
Solvency-related metrics
22. Probability that a random variable falls below a specified threshold level
APT for passive portfolio management
Shortfall risk
Sortino ratio
LTCM
23. Occurs the day when two parties exchange payments same day
Shortfall risk
Settlement risk
Parametric VaR
Financial risks
24. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Recovery rate
Ri = Rz + (gamma)(beta)
Solvency-related metrics
Drysdale Securities (Chase Manhattan)
25. Rp = XaRa + XbRb
LTCM
Differences in financial risk management for financial companies vs industrial companies
Debt overhang
Expected return of two assets
26. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Sovereign risk
Business Risk
VaR- based analysis (formula)
Debt overhang
27. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Effect of non- price- taking behavior on CAPM
Business risks
Expected return of two assets
Basis
28. 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
Valuation vs. Risk management
APT (equation and assumptions)
Importance of communication for risk managers
BTR - Below Target Risk
29. Inability to make payment obligations (ex. Margin calls)
Market risk
Efficient frontier
Funding liquidity risk
Ways firms can fail to account for risks
30. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Morningstar Rating System
Efficient frontier
Business risks
Performance- related metrics
31. 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
Ways firms can fail to account for risks
EPD or ECOR - Expected Policyholder Deficit (EPD)
Settlement risk
Market risk
32. Cannot exit position in market due to size of the position
Asset liquidity risk
CAPM assumption for EMH
Debt overhang
Ten assumptions underlying CAPM
33. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Tracking error
Correlation coefficient effect on diversification
Differences in financial risk management for financial companies vs industrial companies
Business Risk
34. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Nonparametric VaR
Business risks
Performance- related metrics
Recovery rate
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
VaR- based analysis (formula)
Traits of ERM
Volatility Market risk
Sortino ratio
36. 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
Settlement risk
Ri = Rz + (gamma)(beta)
Differences in financial risk management for financial companies vs industrial companies
37. 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
Business Risk
Efficient frontier
Ways firms can fail to account for risks
Basis
38. 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
Carry- backs and carry- forwards
CAPM (formula)
Four major types of risk
Drysdale Securities (Chase Manhattan)
39. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Liquidity risk
APT for passive portfolio management
Basis risk
Risk Management Irrelevance Proposition
40. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Asset liquidity risk
Effect of non- price- taking behavior on CAPM
Allied Irish Bank
Differences in financial risk management for financial companies vs industrial companies
41. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Carry- backs and carry- forwards
Risks excluded from operational risk
Where is risk coming from
Barings
42. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Basic Market risk
Operational risk
Solve for minimum variance portfolio
Standard deviation of two assets
43. Absolute and relative risk - direction and non-directional
Forms of Market risk
Where is risk coming from
Funding liquidity risk
Basis
44. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Business risks
Carry- backs and carry- forwards
Business Risk
Debt overhang
45. Probability distribution is unknown (ex. A terrorist attack)
Uncertainty
RAR = relative return of portfolio (RRp)
Market imperfections that can create value
Financial risks
46. Return is linearly related to growth rate in consumption
Multi- period version of CAPM
APT in active portfolio management
Probability of ruin
Three main reasons for financial disasters
47. When two payments are exchanged the same day and one party may default after payment is made
Settlement risk
Forms of Market risk
Prices of risk vs sensitivity
Four major types of risk
48. Asses firm risks - Communicate risks - Manage and monitor risks
Where is risk coming from
Roles of risk management
Settlement risk
Asset liquidity risk
49. 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.
Ri = Rz + (gamma)(beta)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Sharpe measure
Risk Management Irrelevance Proposition
50. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Drysdale Securities (Chase Manhattan)
CAPM (formula)
Settlement risk
Multi- period version of CAPM