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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. Returns on any stock are linearly related to a set of indexes
Ri = ai + bi1l1 + bi2l2....+ei
Morningstar Rating System
Solvency-related metrics
Debt overhang
2. Volatility of unexpected outcomes
CAPM (formula)
Risk
Traits of ERM
Business Risk
3. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Effect of heterogeneous expectations on CAPM
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Information ratio
Financial Risk
4. Absolute and relative risk - direction and non-directional
Business risks
Ten assumptions underlying CAPM
Volatility Market risk
Forms of Market risk
5. When two payments are exchanged the same day and one party may default after payment is made
Market imperfections that can create value
Source of need for risk management
Settlement risk
Parametric VaR
6. 1971: Fixed Exchange rate system broke down and was replaced by more volatile floating rate - 1973: Oil price shocks - - >high inflation - - >interest rate swings - 1987: Black Monday - OCt 19 - mkt fell 23% - 1989: Japanese stock price bubble -
Source of need for risk management
CAPM (formula)
VaR - Value at Risk
Effect of heterogeneous expectations on CAPM
7. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Tracking error
VaR - Value at Risk
Expected return of two assets
Debt overhang
8. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Credit event
Market imperfections that can create value
Risk- adjusted performance measure (RAP)
Ri = ai + bi1l1 + bi2l2....+ei
9. 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
CAPM assumption for EMH
Jensen's alpha
Valuation vs. Risk management
Recovery rate
10. 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
RAR = relative return of portfolio (RRp)
Financial Risk
Solve for minimum variance portfolio
11. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Solvency-related metrics
Ways risk can be mismeasured
Effect of non- price- taking behavior on CAPM
CAPM assumption for EMH
12. Quantile of an empirical distribution
Nonparametric VaR
Capital market line (CML)
Operational risk
Recovery rate
13. 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
Tax shield
Risk Management Irrelevance Proposition
Traits of ERM
Liquidity risk
14. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Market imperfections that can create value
Solve for minimum variance portfolio
Allied Irish Bank
Nonparametric VaR
15. Covariance = correlation coefficient std dev(a) std dev(b)
Formula for covariance
Financial Risk
Drysdale Securities (Chase Manhattan)
Risk Management Irrelevance Proposition
16. Modeling approach is typically between statistical analytic models and structural simulation models
Models used in ERM framework
Jensen's alpha
Tracking error
Settlement risk
17. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Differences in financial risk management for financial companies vs industrial companies
Solve for minimum variance portfolio
Forms of Market risk
Traits of ERM
18. Asset-liability/market-liquidity risk
Performance- related metrics
Importance of communication for risk managers
Information ratio
Liquidity risk
19. Market risk - Liquidity risk - Credit risk - Operational risk
Zero- beta CAPM (two factor model)
Risk
Valuation vs. Risk management
Four major types of risk
20. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Effect of non- price- taking behavior on CAPM
Zero- beta CAPM (two factor model)
Contango
Sovereign risk
21. 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
Tax shield
Business Risk
Funding liquidity risk
Financial Risk
22. 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
Differences in financial risk management for financial companies vs industrial companies
Credit event
Allied Irish Bank
Forms of Market risk
23. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Nonparametric VaR
CAPM assumption for EMH
VaR - Value at Risk
Risks excluded from operational risk
24. 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
Capital market line (CML)
Ten assumptions underlying CAPM
Basis risk
Sharpe measure
25. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Basis
Sortino ratio
3 main types of operational risk
Financial risks
26. 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
Traits of ERM
Asset transformers
Kidder Peabody
Importance of communication for risk managers
27. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Sharpe measure
CAPM (formula)
APT in active portfolio management
Nonmarketable asset impact on CAPM
28. 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
LTCM
Carry- backs and carry- forwards
Operational risk
29. Hazard - Financial - Operational - Strategic
VaR- based analysis (formula)
Business risks
Risk types addressed by ERM
Security (primary vs secondary)
30. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Risk
Sovereign risk
Business Risk
3 main types of operational risk
31. 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
Barings
Performance- related metrics
Drysdale Securities (Chase Manhattan)
Models used in ERM framework
32. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
VaR- based analysis (formula)
Debt overhang
Ten assumptions underlying CAPM
Roles of risk management
33. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Tracking error
CAPM with taxes included (equation)
Roles of risk management
Capital market line (CML)
34. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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35. Wrong distribution - Historical sample may not apply
Asset transformers
Ways risk can be mismeasured
Market imperfections that can create value
RAR = relative return of portfolio (RRp)
36. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Information ratio
Roles of risk management
Sortino ratio
Kidder Peabody
37. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Basis risk
Nonparametric VaR
Morningstar Rating System
Information ratio
38. Asses firm risks - Communicate risks - Manage and monitor risks
Roles of risk management
Risk
Parametric VaR
Shortcomings of risk metrics
39. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Basis risk
CAPM (formula)
Drysdale Securities (Chase Manhattan)
Firms becoming more sensitive to changes(bank deregulation)
40. Need to assess risk and tell management so they can determine which risks to take on
Importance of communication for risk managers
Business Risk
Ten assumptions underlying CAPM
Ri = Rz + (gamma)(beta)
41. 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
Roles of risk management
APT for passive portfolio management
Recovery rate
APT in active portfolio management
42. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Risk types addressed by ERM
CAPM assumption for EMH
EPD or ECOR - Expected Policyholder Deficit (EPD)
Prices of risk vs sensitivity
43. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
CAPM (formula)
Multi- period version of CAPM
Performance- related metrics
Risk
44. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Options motivation on volatility
What lead to the exponential growth to derivatives mkt?
Effect of non- price- taking behavior on CAPM
Where is risk coming from
45. Probability that a random variable falls below a specified threshold level
Market imperfections that can create value
APT in active portfolio management
Shortfall risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
46. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
CAPM with taxes included (equation)
Liquidity risk
Asset transformers
Risk types addressed by ERM
47. The uses of debt to fall into a lower tax rate
Risk- adjusted performance measure (RAP)
Tax shield
Basic Market risk
Settlement risk
48. Risk of loses owing to movements in level or volatility of market prices
Liquidity risk
Market risk
Funding liquidity risk
Nonmarketable asset impact on CAPM
49. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Multi- period version of CAPM
Capital market line (CML)
CAPM (formula)
Exposure
50. Both probability and cost of tail events are considered
Debt overhang
Tail VaR or TCE - Tail Conditional Expectation(TCE)
APT for passive portfolio management
Market imperfections that can create value