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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. 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
Performance- related metrics
BTR - Below Target Risk
Valuation vs. Risk management
Allied Irish Bank
2. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
CAPM (formula)
Debt overhang
Banker's Trust
Volatility Market risk
3. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Tracking error
CAPM assumption for EMH
Drysdale Securities (Chase Manhattan)
Banker's Trust
4. 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
Risk
Forms of Market risk
Importance of communication for risk managers
Probability of ruin
5. Cannot exit position in market due to size of the position
Drysdale Securities (Chase Manhattan)
Asset liquidity risk
Kidder Peabody
LTCM
6. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Importance of communication for risk managers
Risk
RAR = relative return of portfolio (RRp)
Business Risk
7. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Sortino ratio
Debt overhang
Security (primary vs secondary)
Basis
8. Multibeta CAPM Ri - Rf =
Exposure
Operational risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Ri = ai + bi1l1 + bi2l2....+ei
9. Absolute and relative risk - direction and non-directional
Market imperfections that can create value
Credit event
VaR - Value at Risk
Forms of Market risk
10. 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)
Parametric VaR
Risk types addressed by ERM
Solvency-related metrics
11. 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
Practical considerations related to ERM implementatio
CAPM assumption for EMH
Differences in financial risk management for financial companies vs industrial companies
Business Risk
12. Market risk - Liquidity risk - Credit risk - Operational risk
Carry- backs and carry- forwards
Four major types of risk
Settlement risk
Probability of ruin
13. Asses firm risks - Communicate risks - Manage and monitor risks
Roles of risk management
Risk
Parametric VaR
Sovereign risk
14. Derives value from an underlying asset - rate - or index - Derives value from a security
Derivative contract
Credit event
Standard deviation of two assets
Basic Market risk
15. 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
Uncertainty
Drysdale Securities (Chase Manhattan)
Shortcomings of risk metrics
VaR - Value at Risk
16. Wrong distribution - Historical sample may not apply
Forms of Market risk
Effect of heterogeneous expectations on CAPM
Ways risk can be mismeasured
Tail VaR or TCE - Tail Conditional Expectation(TCE)
17. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Zero- beta CAPM (two factor model)
Financial Risk
Effect of non- price- taking behavior on CAPM
Basis risk
18. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Financial risks
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Sharpe measure
VaR - Value at Risk
19. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Effect of heterogeneous expectations on CAPM
Risk
Security (primary vs secondary)
Formula for covariance
20. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
3 main types of operational risk
Zero- beta CAPM (two factor model)
Tax shield
Security (primary vs secondary)
21. 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
Credit event
Settlement risk
Operational risk
22. Potential amount that can be lost
Exposure
LTCM
Security (primary vs secondary)
VaR- based analysis (formula)
23. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Exposure
Sovereign risk
Ways risk can be mismeasured
Firms becoming more sensitive to changes(bank deregulation)
24. 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
Basic Market risk
Barings
Asset transformers
25. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Options motivation on volatility
Standard deviation of two assets
Business risks
Credit event
26. When two payments are exchanged the same day and one party may default after payment is made
Barings
Shape of portfolio possibilities curve
Nonmarketable asset impact on CAPM
Settlement risk
27. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Ri = Rz + (gamma)(beta)
Where is risk coming from
Information ratio
Solvency-related metrics
28. Strategic risk - Business risk - Reputational risk
Risks excluded from operational risk
Formula for covariance
Market risk
Risk
29. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Performance- related metrics
Four major types of risk
RAR = relative return of portfolio (RRp)
Three main reasons for financial disasters
30. Prices of risk are common factors and do not change - Sensitivities can change
Efficient frontier
VaR- based analysis (formula)
Prices of risk vs sensitivity
Performance- related metrics
31. 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
32. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Banker's Trust
Shortfall risk
Firms becoming more sensitive to changes(bank deregulation)
Debt overhang
33. Both probability and cost of tail events are considered
APT in active portfolio management
Three main reasons for financial disasters
Formula for covariance
Tail VaR or TCE - Tail Conditional Expectation(TCE)
34. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Expected return of two assets
Business risks
Solvency-related metrics
Treynor measure
35. Occurs the day when two parties exchange payments same day
Sortino ratio
Traits of ERM
Settlement risk
Derivative contract
36. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Shortcomings of risk metrics
Ri = Rz + (gamma)(beta)
Ways firms can fail to account for risks
Market imperfections that can create value
37. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Ten assumptions underlying CAPM
Treynor measure
Differences in financial risk management for financial companies vs industrial companies
Liquidity risk
38. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Asset transformers
Valuation vs. Risk management
Parametric VaR
Models used in ERM framework
39. Need to assess risk and tell management so they can determine which risks to take on
Solvency-related metrics
Importance of communication for risk managers
Capital market line (CML)
Risks excluded from operational risk
40. Unanticipated movements in relative prices of assets in hedged position
Basic Market risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
Basis risk
Firms becoming more sensitive to changes(bank deregulation)
41. 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
Recovery rate
Four major types of risk
Jensen's alpha
42. 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
Roles of risk management
Capital market line (CML)
Practical considerations related to ERM implementatio
APT (equation and assumptions)
43. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Roles of risk management
Traits of ERM
Funding liquidity risk
Options motivation on volatility
44. Covariance = correlation coefficient std dev(a) std dev(b)
Formula for covariance
Jensen's alpha
Zero- beta CAPM (two factor model)
Recovery rate
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
Shortcomings of risk metrics
Roles of risk management
Basis
APT for passive portfolio management
46. 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
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Nonparametric VaR
Prices of risk vs sensitivity
47. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Market imperfections that can create value
VaR- based analysis (formula)
Kidder Peabody
What lead to the exponential growth to derivatives mkt?
48. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Liquidity risk
APT in active portfolio management
Market imperfections that can create value
Risks excluded from operational risk
49. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Drysdale Securities (Chase Manhattan)
Treynor measure
Morningstar Rating System
VaR- based analysis (formula)
50. Relative portfolio risk (RRiskp) - Based on a one- month investment period
RAR = relative return of portfolio (RRp)
Tax shield
Basis
Where is risk coming from