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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. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Performance- related metrics
Financial Risk
Tracking error
Morningstar Rating System
2. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Shortcomings of risk metrics
Funding liquidity risk
Debt overhang
Carry- backs and carry- forwards
3. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Uncertainty
CAPM assumption for EMH
Debt overhang
Formula for covariance
4. The need to hedge against risks - for firms need to speculate.
Information ratio
Recovery rate
Effect of non- price- taking behavior on CAPM
What lead to the exponential growth to derivatives mkt?
5. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
RAR = relative return of portfolio (RRp)
Standard deviation of two assets
Business Risk
Asset transformers
6. 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
Jensen's alpha
Solvency-related metrics
Risk types addressed by ERM
Ways firms can fail to account for risks
7. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Performance- related metrics
Options motivation on volatility
Three main reasons for financial disasters
EPD or ECOR - Expected Policyholder Deficit (EPD)
8. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Shortfall risk
Sharpe measure
Importance of communication for risk managers
Barings
9. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Ri = Rz + (gamma)(beta)
Efficient frontier
Allied Irish Bank
Operational risk
10. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
BTR - Below Target Risk
Treynor measure
Risk- adjusted performance measure (RAP)
Parametric VaR
11. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Settlement risk
Options motivation on volatility
Ways firms can fail to account for risks
Security (primary vs secondary)
12. Efficient frontier with inclusion of risk free rate - Straight line with formula Rc = Rf + ((Ra - Rf)/std dev(a))*std dev(c) - c is the total portfolio - a is the risky asset
Performance- related metrics
Probability of ruin
APT in active portfolio management
Capital market line (CML)
13. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Operational risk
Four major types of risk
Effect of non- price- taking behavior on CAPM
Nonparametric VaR
14. Quantile of an empirical distribution
Nonparametric VaR
Basic Market risk
Importance of communication for risk managers
Ri = Rz + (gamma)(beta)
15. 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 -
Effect of heterogeneous expectations on CAPM
Basis risk
Source of need for risk management
Market imperfections that can create value
16. Quantile of a statistical distribution
Parametric VaR
Debt overhang
Sovereign risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
17. Prices of risk are common factors and do not change - Sensitivities can change
Debt overhang
APT for passive portfolio management
Prices of risk vs sensitivity
Treynor measure
18. 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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19. Probability distribution is unknown (ex. A terrorist attack)
Shortfall risk
Ways risk can be mismeasured
Uncertainty
CAPM with taxes included (equation)
20. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Credit event
Liquidity risk
Options motivation on volatility
Risk- adjusted performance measure (RAP)
21. Need to assess risk and tell management so they can determine which risks to take on
Liquidity risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
Jensen's alpha
Importance of communication for risk managers
22. Future price is greater than the spot price
Contango
Kidder Peabody
Shortfall risk
Four major types of risk
23. Modeling approach is typically between statistical analytic models and structural simulation models
Risks excluded from operational risk
CAPM assumption for EMH
Models used in ERM framework
Ways firms can fail to account for risks
24. 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
Parametric VaR
Drysdale Securities (Chase Manhattan)
Debt overhang
Kidder Peabody
25. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Solve for minimum variance portfolio
Multi- period version of CAPM
APT in active portfolio management
Performance- related metrics
26. Curve must be concave - Straight line connecting any two points must be under the curve
Morningstar Rating System
Contango
Debt overhang
Shape of portfolio possibilities curve
27. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Ri = Rz + (gamma)(beta)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Zero- beta CAPM (two factor model)
Ri = ai + bi1l1 + bi2l2....+ei
28. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Efficient frontier
Jensen's alpha
Morningstar Rating System
Risk- adjusted performance measure (RAP)
29. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
CAPM with taxes included (equation)
Performance- related metrics
Tax shield
Standard deviation of two assets
30. When negative taxable income is moved to a different year to offset future or past taxable income
Carry- backs and carry- forwards
Traits of ERM
Market risk
APT in active portfolio management
31. 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
Allied Irish Bank
Ri = Rz + (gamma)(beta)
Four major types of risk
Business Risk
32. 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
Ri = ai + bi1l1 + bi2l2....+ei
Importance of communication for risk managers
Ten assumptions underlying CAPM
Traits of ERM
33. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Kidder Peabody
Ri = ai + bi1l1 + bi2l2....+ei
Market imperfections that can create value
Solvency-related metrics
34. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Firms becoming more sensitive to changes(bank deregulation)
Asset transformers
Parametric VaR
Basis risk
35. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
APT in active portfolio management
Treynor measure
Three main reasons for financial disasters
Carry- backs and carry- forwards
36. Risk of loses owing to movements in level or volatility of market prices
Market risk
Banker's Trust
Standard deviation of two assets
Ten assumptions underlying CAPM
37. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Treynor measure
Basis risk
RAR = relative return of portfolio (RRp)
Sortino ratio
38. Absolute and relative risk - direction and non-directional
Forms of Market risk
Barings
Risks excluded from operational risk
Effect of non- price- taking behavior on CAPM
39. Volatility of unexpected outcomes
Risk
Where is risk coming from
Formula for covariance
Operational risk
40. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Debt overhang
Practical considerations related to ERM implementatio
Traits of ERM
Business Risk
41. Concave function that extends from minimum variance portfolio to maximum return portfolio
Information ratio
Barings
Efficient frontier
APT (equation and assumptions)
42. Asset-liability/market-liquidity risk
Liquidity risk
Business Risk
RAR = relative return of portfolio (RRp)
Nonmarketable asset impact on CAPM
43. 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
Recovery rate
Three main reasons for financial disasters
Shortcomings of risk metrics
Ri = Rz + (gamma)(beta)
44. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Funding liquidity risk
Ways firms can fail to account for risks
3 main types of operational risk
Tracking error
45. When two payments are exchanged the same day and one party may default after payment is made
Nonparametric VaR
Morningstar Rating System
LTCM
Settlement risk
46. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Sharpe measure
Shortcomings of risk metrics
Debt overhang
CAPM (formula)
47. Law of one price - Homogeneous expectations - Security returns process
Source of need for risk management
Traits of ERM
APT (equation and assumptions)
Uncertainty
48. 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
Derivative contract
Solvency-related metrics
Banker's Trust
49. Probability that a random variable falls below a specified threshold level
Firms becoming more sensitive to changes(bank deregulation)
Recovery rate
Risk
Shortfall risk
50. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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