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Test your basic knowledge |
FRM: Foundations Of Risk Management
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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. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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2. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Risk
Kidder Peabody
Financial Risk
Three main reasons for financial disasters
3. Quantile of a statistical distribution
Parametric VaR
Expected return of two assets
Shortcomings of risk metrics
Asset liquidity risk
4. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Standard deviation of two assets
Basis
Expected return of two assets
Ri = Rz + (gamma)(beta)
5. When negative taxable income is moved to a different year to offset future or past taxable income
Differences in financial risk management for financial companies vs industrial companies
Carry- backs and carry- forwards
Firms becoming more sensitive to changes(bank deregulation)
CAPM assumption for EMH
6. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Risk Management Irrelevance Proposition
Zero- beta CAPM (two factor model)
Parametric VaR
Basis
7. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Exposure
Practical considerations related to ERM implementatio
Credit event
8. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
EPD or ECOR - Expected Policyholder Deficit (EPD)
APT (equation and assumptions)
Valuation vs. Risk management
Debt overhang
9. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Financial risks
Settlement risk
APT (equation and assumptions)
CAPM assumption for EMH
10. When two payments are exchanged the same day and one party may default after payment is made
Practical considerations related to ERM implementatio
Importance of communication for risk managers
Uncertainty
Settlement risk
11. Market risk - Liquidity risk - Credit risk - Operational risk
Solve for minimum variance portfolio
Where is risk coming from
Four major types of risk
Jensen's alpha
12. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Zero- beta CAPM (two factor model)
Differences in financial risk management for financial companies vs industrial companies
Valuation vs. Risk management
Performance- related metrics
13. 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
Operational risk
Capital market line (CML)
Tax shield
Kidder Peabody
14. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Basis risk
Effect of non- price- taking behavior on CAPM
Models used in ERM framework
Market risk
15. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Nonparametric VaR
Asset transformers
APT for passive portfolio management
Security (primary vs secondary)
16. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Where is risk coming from
Debt overhang
CAPM with taxes included (equation)
Financial Risk
17. The lower (closer to - 1) - the higher the payoff from diversification
Four major types of risk
Ten assumptions underlying CAPM
Shape of portfolio possibilities curve
Correlation coefficient effect on diversification
18. Multibeta CAPM Ri - Rf =
Ri = Rz + (gamma)(beta)
Correlation coefficient effect on diversification
Basic Market risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
19. Expected value of unfavorable deviations of a random variable from a specified target level
Where is risk coming from
Sharpe measure
Solvency-related metrics
BTR - Below Target Risk
20. Inability to make payment obligations (ex. Margin calls)
Funding liquidity risk
Jensen's alpha
Basis
Risks excluded from operational risk
21. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Zero- beta CAPM (two factor model)
Differences in financial risk management for financial companies vs industrial companies
Risk types addressed by ERM
CAPM assumption for EMH
22. Curve must be concave - Straight line connecting any two points must be under the curve
Shape of portfolio possibilities curve
Source of need for risk management
Effect of non- price- taking behavior on CAPM
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
23. Covariance = correlation coefficient std dev(a) std dev(b)
RAR = relative return of portfolio (RRp)
Jensen's alpha
VaR- based analysis (formula)
Formula for covariance
24. Modeling approach is typically between statistical analytic models and structural simulation models
Source of need for risk management
Capital market line (CML)
Models used in ERM framework
Forms of Market risk
25. 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.
Shape of portfolio possibilities curve
Risk Management Irrelevance Proposition
Basic Market risk
LTCM
26. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Shortfall risk
Treynor measure
Funding liquidity risk
What lead to the exponential growth to derivatives mkt?
27. 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
Probability of ruin
Ways risk can be mismeasured
Sharpe measure
Practical considerations related to ERM implementatio
28. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Volatility Market risk
Settlement risk
Firms becoming more sensitive to changes(bank deregulation)
VaR - Value at Risk
29. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Sortino ratio
Funding liquidity risk
Credit event
Three main reasons for financial disasters
30. Strategic risk - Business risk - Reputational risk
Financial Risk
Basis risk
Risks excluded from operational risk
Importance of communication for risk managers
31. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Ri = Rz + (gamma)(beta)
Market imperfections that can create value
Risk types addressed by ERM
Asset liquidity risk
32. 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
Forms of Market risk
Drysdale Securities (Chase Manhattan)
Basis
Kidder Peabody
33. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Forms of Market risk
Effect of heterogeneous expectations on CAPM
Options motivation on volatility
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
34. Both probability and cost of tail events are considered
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Morningstar Rating System
APT for passive portfolio management
Importance of communication for risk managers
35. Potential amount that can be lost
Shortcomings of risk metrics
Options motivation on volatility
Shape of portfolio possibilities curve
Exposure
36. Need to assess risk and tell management so they can determine which risks to take on
Importance of communication for risk managers
Morningstar Rating System
Probability of ruin
Tracking error
37. Probability that a random variable falls below a specified threshold level
Shortfall risk
Tracking error
Ri = Rz + (gamma)(beta)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
38. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
3 main types of operational risk
Operational risk
Valuation vs. Risk management
Forms of Market risk
39. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Allied Irish Bank
Source of need for risk management
Tracking error
Market imperfections that can create value
40. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Settlement risk
VaR - Value at Risk
Shortfall risk
Differences in financial risk management for financial companies vs industrial companies
41. 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 -
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Carry- backs and carry- forwards
Source of need for risk management
Expected return of two assets
42. 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
Correlation coefficient effect on diversification
Shortcomings of risk metrics
APT for passive portfolio management
Kidder Peabody
43. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Source of need for risk management
VaR- based analysis (formula)
Business risks
Barings
44. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Asset transformers
Risk
Settlement risk
Nonparametric VaR
45. Losses due to market activities ex. Interest rate changes or defaults
Barings
Financial risks
Market risk
Risk types addressed by ERM
46. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Solve for minimum variance portfolio
Standard deviation of two assets
Capital market line (CML)
Basic Market risk
47. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Sortino ratio
Ways firms can fail to account for risks
Importance of communication for risk managers
Effect of heterogeneous expectations on CAPM
48. 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
Jensen's alpha
Traits of ERM
Uncertainty
Morningstar Rating System
49. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Information ratio
Risk- adjusted performance measure (RAP)
Options motivation on volatility
Prices of risk vs sensitivity
50. Unanticipated movements in relative prices of assets in hedged position
APT in active portfolio management
Basic Market risk
Sharpe measure
Settlement risk