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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. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Market imperfections that can create value
RAR = relative return of portfolio (RRp)
Business Risk
Contango
2. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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3. Unanticipated movements in relative prices of assets in hedged position
Sortino ratio
Basic Market risk
Ri = Rz + (gamma)(beta)
Settlement risk
4. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Settlement risk
Recovery rate
Allied Irish Bank
Debt overhang
5. Occurs the day when two parties exchange payments same day
EPD or ECOR - Expected Policyholder Deficit (EPD)
Settlement risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Ri = ai + bi1l1 + bi2l2....+ei
6. Need to assess risk and tell management so they can determine which risks to take on
Basis risk
Importance of communication for risk managers
VaR - Value at Risk
Kidder Peabody
7. Market risk - Liquidity risk - Credit risk - Operational risk
Traits of ERM
Drysdale Securities (Chase Manhattan)
Four major types of risk
Expected return of two assets
8. Future price is greater than the spot price
Basic Market risk
Contango
Effect of non- price- taking behavior on CAPM
BTR - Below Target Risk
9. 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
APT for passive portfolio management
CAPM assumption for EMH
APT (equation and assumptions)
Shape of portfolio possibilities curve
10. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Risk
Solve for minimum variance portfolio
Debt overhang
Asset liquidity risk
11. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Volatility Market risk
Risk- adjusted performance measure (RAP)
LTCM
Solve for minimum variance portfolio
12. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Barings
Risk
Standard deviation of two assets
Valuation vs. Risk management
13. 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
Risk- adjusted performance measure (RAP)
Risks excluded from operational risk
Debt overhang
14. Probability that a random variable falls below a specified threshold level
Asset liquidity risk
Shape of portfolio possibilities curve
Shortfall risk
Settlement risk
15. Volatility of unexpected outcomes
Market imperfections that can create value
Market risk
Liquidity risk
Risk
16. Both probability and cost of tail events are considered
Effect of heterogeneous expectations on CAPM
Shortfall risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Effect of non- price- taking behavior on CAPM
17. 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
Asset liquidity risk
CAPM with taxes included (equation)
Ways firms can fail to account for risks
Derivative contract
18. 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.
Where is risk coming from
Treynor measure
Risk Management Irrelevance Proposition
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
19. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Firms becoming more sensitive to changes(bank deregulation)
Basis
Valuation vs. Risk management
Kidder Peabody
20. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Three main reasons for financial disasters
Where is risk coming from
CAPM (formula)
3 main types of operational risk
21. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Carry- backs and carry- forwards
Shortfall risk
Where is risk coming from
BTR - Below Target Risk
22. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Debt overhang
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Effect of non- price- taking behavior on CAPM
Roles of risk management
23. 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
Volatility Market risk
CAPM (formula)
LTCM
VaR- based analysis (formula)
24. Hazard - Financial - Operational - Strategic
Valuation vs. Risk management
Risk Management Irrelevance Proposition
Ways risk can be mismeasured
Risk types addressed by ERM
25. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Market risk
Effect of heterogeneous expectations on CAPM
Treynor measure
Risk- adjusted performance measure (RAP)
26. Potential amount that can be lost
Exposure
Market imperfections that can create value
Tail VaR or TCE - Tail Conditional Expectation(TCE)
CAPM assumption for EMH
27. Curve must be concave - Straight line connecting any two points must be under the curve
Expected return of two assets
CAPM with taxes included (equation)
Shape of portfolio possibilities curve
Sortino ratio
28. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Funding liquidity risk
Security (primary vs secondary)
Nonmarketable asset impact on CAPM
Practical considerations related to ERM implementatio
29. 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
Effect of non- price- taking behavior on CAPM
Capital market line (CML)
LTCM
Sortino ratio
30. Changes in vol - implied or actual
Zero- beta CAPM (two factor model)
Risk
Volatility Market risk
3 main types of operational risk
31. Covariance = correlation coefficient std dev(a) std dev(b)
Risk
Probability of ruin
Basic Market risk
Formula for covariance
32. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Ways risk can be mismeasured
Standard deviation of two assets
Settlement risk
Differences in financial risk management for financial companies vs industrial companies
33. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Settlement risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
Morningstar Rating System
Financial risks
34. 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
Security (primary vs secondary)
Credit event
Effect of heterogeneous expectations on CAPM
Traits of ERM
35. Cannot exit position in market due to size of the position
Banker's Trust
Asset liquidity risk
Roles of risk management
APT in active portfolio management
36. 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 -
Uncertainty
Source of need for risk management
Effect of heterogeneous expectations on CAPM
Morningstar Rating System
37. 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
Funding liquidity risk
Expected return of two assets
Practical considerations related to ERM implementatio
APT (equation and assumptions)
38. 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
Financial risks
Shortcomings of risk metrics
Risk
Shortfall risk
39. 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
Funding liquidity risk
Barings
Zero- beta CAPM (two factor model)
Drysdale Securities (Chase Manhattan)
40. Asset-liability/market-liquidity risk
Jensen's alpha
Sovereign risk
Drysdale Securities (Chase Manhattan)
Liquidity risk
41. 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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42. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Allied Irish Bank
Uncertainty
Options motivation on volatility
Effect of non- price- taking behavior on CAPM
43. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Traits of ERM
Tracking error
Kidder Peabody
Sortino ratio
44. The uses of debt to fall into a lower tax rate
Tax shield
Parametric VaR
RAR = relative return of portfolio (RRp)
Morningstar Rating System
45. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Security (primary vs secondary)
Performance- related metrics
Effect of non- price- taking behavior on CAPM
Information ratio
46. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Firms becoming more sensitive to changes(bank deregulation)
Risk- adjusted performance measure (RAP)
Basic Market risk
APT in active portfolio management
47. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Zero- beta CAPM (two factor model)
Banker's Trust
Nonmarketable asset impact on CAPM
Performance- related metrics
48. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
VaR- based analysis (formula)
3 main types of operational risk
Business Risk
Asset transformers
49. Strategic risk - Business risk - Reputational risk
Risks excluded from operational risk
Differences in financial risk management for financial companies vs industrial companies
Asset liquidity risk
Solvency-related metrics
50. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Financial risks
Sharpe measure
Liquidity risk
Ri = Rz + (gamma)(beta)