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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. Risk of loses owing to movements in level or volatility of market prices
Business Risk
Tax shield
Roles of risk management
Market risk
2. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Multi- period version of CAPM
Settlement risk
Barings
Differences in financial risk management for financial companies vs industrial companies
3. 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
Market risk
Operational risk
Treynor measure
Allied Irish Bank
4. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Sortino ratio
Business risks
Ways firms can fail to account for risks
RAR = relative return of portfolio (RRp)
5. 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
Traits of ERM
What lead to the exponential growth to derivatives mkt?
Risks excluded from operational risk
Information ratio
6. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Parametric VaR
Security (primary vs secondary)
CAPM with taxes included (equation)
Financial risks
7. Cannot exit position in market due to size of the position
APT for passive portfolio management
Market imperfections that can create value
Formula for covariance
Asset liquidity risk
8. Expected value of unfavorable deviations of a random variable from a specified target level
Sovereign risk
Ri = Rz + (gamma)(beta)
3 main types of operational risk
BTR - Below Target Risk
9. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Funding liquidity risk
Effect of non- price- taking behavior on CAPM
APT for passive portfolio management
Asset transformers
10. Prices of risk are common factors and do not change - Sensitivities can change
Risks excluded from operational risk
Shape of portfolio possibilities curve
Prices of risk vs sensitivity
Tracking error
11. 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
Credit event
Ri = ai + bi1l1 + bi2l2....+ei
Barings
12. Quantile of a statistical distribution
Multi- period version of CAPM
Source of need for risk management
Parametric VaR
Solvency-related metrics
13. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Zero- beta CAPM (two factor model)
Parametric VaR
Debt overhang
Probability of ruin
14. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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15. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Basis
Asset transformers
Nonmarketable asset impact on CAPM
Basis risk
16. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Treynor measure
Carry- backs and carry- forwards
Effect of heterogeneous expectations on CAPM
Ways firms can fail to account for risks
17. 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
Traits of ERM
VaR - Value at Risk
Liquidity risk
APT for passive portfolio management
18. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Valuation vs. Risk management
EPD or ECOR - Expected Policyholder Deficit (EPD)
VaR- based analysis (formula)
Effect of non- price- taking behavior on CAPM
19. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Asset transformers
CAPM with taxes included (equation)
Tracking error
20. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
APT for passive portfolio management
Risk
Risk Management Irrelevance Proposition
Models used in ERM framework
21. Interest rate movements - derivatives - defaults
Liquidity risk
Business Risk
Zero- beta CAPM (two factor model)
Financial Risk
22. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Three main reasons for financial disasters
Risk- adjusted performance measure (RAP)
Basic Market risk
3 main types of operational risk
23. Future price is greater than the spot price
Operational risk
Contango
Security (primary vs secondary)
3 main types of operational risk
24. Both probability and cost of tail events are considered
Differences in financial risk management for financial companies vs industrial companies
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Shape of portfolio possibilities curve
Financial risks
25. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Source of need for risk management
RAR = relative return of portfolio (RRp)
Risk- adjusted performance measure (RAP)
Risk Management Irrelevance Proposition
26. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Kidder Peabody
Tracking error
Market imperfections that can create value
Barings
27. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Ri = Rz + (gamma)(beta)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Sharpe measure
Asset transformers
28. Need to assess risk and tell management so they can determine which risks to take on
Importance of communication for risk managers
CAPM with taxes included (equation)
Debt overhang
Solve for minimum variance portfolio
29. Market risk - Liquidity risk - Credit risk - Operational risk
Source of need for risk management
Morningstar Rating System
Shortcomings of risk metrics
Four major types of risk
30. Absolute and relative risk - direction and non-directional
Expected return of two assets
Shortcomings of risk metrics
Financial risks
Forms of Market risk
31. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Standard deviation of two assets
Ten assumptions underlying CAPM
EPD or ECOR - Expected Policyholder Deficit (EPD)
Market imperfections that can create value
32. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Parametric VaR
Where is risk coming from
Models used in ERM framework
VaR - Value at Risk
33. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Traits of ERM
Options motivation on volatility
Sovereign risk
Risk types addressed by ERM
34. Quantile of an empirical distribution
Effect of heterogeneous expectations on CAPM
Nonparametric VaR
Models used in ERM framework
Practical considerations related to ERM implementatio
35. Unanticipated movements in relative prices of assets in hedged position
Expected return of two assets
Basic Market risk
Effect of heterogeneous expectations on CAPM
RAR = relative return of portfolio (RRp)
36. Probability distribution is unknown (ex. A terrorist attack)
Where is risk coming from
Risk
Uncertainty
Risk Management Irrelevance Proposition
37. Strategic risk - Business risk - Reputational risk
Risks excluded from operational risk
Formula for covariance
Traits of ERM
Sortino ratio
38. Inability to make payment obligations (ex. Margin calls)
Settlement risk
Liquidity risk
Correlation coefficient effect on diversification
Funding liquidity risk
39. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Solvency-related metrics
Parametric VaR
EPD or ECOR - Expected Policyholder Deficit (EPD)
Source of need for risk management
40. When two payments are exchanged the same day and one party may default after payment is made
Risks excluded from operational risk
Tracking error
Settlement risk
Recovery rate
41. 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
Risk- adjusted performance measure (RAP)
Capital market line (CML)
Business Risk
Security (primary vs secondary)
42. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Settlement risk
Zero- beta CAPM (two factor model)
Drysdale Securities (Chase Manhattan)
Nonmarketable asset impact on CAPM
43. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Contango
Shortfall risk
Kidder Peabody
Basis risk
44. 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
Basic Market risk
Practical considerations related to ERM implementatio
Volatility Market risk
Treynor measure
45. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Effect of non- price- taking behavior on CAPM
Performance- related metrics
Financial Risk
Nonmarketable asset impact on CAPM
46. Wrong distribution - Historical sample may not apply
Risk types addressed by ERM
Ways risk can be mismeasured
Kidder Peabody
Importance of communication for risk managers
47. 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
Ways firms can fail to account for risks
Nonmarketable asset impact on CAPM
Shortcomings of risk metrics
48. Probability that a random variable falls below a specified threshold level
Shortfall risk
Business risks
Credit event
Ri = Rz + (gamma)(beta)
49. Rp = XaRa + XbRb
Tax shield
Expected return of two assets
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Ten assumptions underlying CAPM
50. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
CAPM (formula)
Differences in financial risk management for financial companies vs industrial companies
Shortcomings of risk metrics
Risk Management Irrelevance Proposition