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Test your basic knowledge |
FRM: Foundations Of Risk Management
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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. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Ri = Rz + (gamma)(beta)
Contango
Kidder Peabody
Nonmarketable asset impact on CAPM
2. 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.
Risk Management Irrelevance Proposition
Solvency-related metrics
Volatility Market risk
Kidder Peabody
3. Expected value of unfavorable deviations of a random variable from a specified target level
Asset transformers
Effect of heterogeneous expectations on CAPM
BTR - Below Target Risk
Zero- beta CAPM (two factor model)
4. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Kidder Peabody
Banker's Trust
Sovereign risk
Importance of communication for risk managers
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
Ways risk can be mismeasured
Traits of ERM
Allied Irish Bank
Derivative contract
6. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Tax shield
Treynor measure
Sortino ratio
CAPM with taxes included (equation)
7. Quantile of a statistical distribution
LTCM
Recovery rate
Settlement risk
Parametric VaR
8. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Valuation vs. Risk management
Basis risk
Three main reasons for financial disasters
9. Percentile of the distribution corresponding to the point which capital is exhausted - Typically - a minimum acceptable probability of ruin is specified - and economic capital is derived from it
Sovereign risk
Expected return of two assets
Probability of ruin
Business Risk
10. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
APT in active portfolio management
Solve for minimum variance portfolio
Market risk
Ways risk can be mismeasured
11. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Practical considerations related to ERM implementatio
Morningstar Rating System
Forms of Market risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
12. Market risk - Liquidity risk - Credit risk - Operational risk
Debt overhang
Allied Irish Bank
Four major types of risk
Jensen's alpha
13. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Banker's Trust
CAPM assumption for EMH
Sortino ratio
Efficient frontier
14. 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
Effect of non- price- taking behavior on CAPM
Where is risk coming from
Valuation vs. Risk management
Roles of risk management
15. Risk of loses owing to movements in level or volatility of market prices
Where is risk coming from
Traits of ERM
Market risk
Carry- backs and carry- forwards
16. Interest rate movements - derivatives - defaults
EPD or ECOR - Expected Policyholder Deficit (EPD)
Financial Risk
Effect of non- price- taking behavior on CAPM
Capital market line (CML)
17. The uses of debt to fall into a lower tax rate
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Tax shield
Carry- backs and carry- forwards
Four major types of risk
18. 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
Importance of communication for risk managers
Tax shield
Shortcomings of risk metrics
BTR - Below Target Risk
19. Concave function that extends from minimum variance portfolio to maximum return portfolio
Efficient frontier
RAR = relative return of portfolio (RRp)
Recovery rate
Sovereign risk
20. Law of one price - Homogeneous expectations - Security returns process
EPD or ECOR - Expected Policyholder Deficit (EPD)
Risks excluded from operational risk
APT (equation and assumptions)
Differences in financial risk management for financial companies vs industrial companies
21. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Liquidity risk
VaR- based analysis (formula)
Market imperfections that can create value
Funding liquidity risk
22. Return is linearly related to growth rate in consumption
Prices of risk vs sensitivity
Practical considerations related to ERM implementatio
Business risks
Multi- period version of CAPM
23. 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 -
Options motivation on volatility
Source of need for risk management
Three main reasons for financial disasters
Shape of portfolio possibilities curve
24. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Correlation coefficient effect on diversification
Risk
Operational risk
Shape of portfolio possibilities curve
25. Covariance = correlation coefficient std dev(a) std dev(b)
Formula for covariance
Settlement risk
VaR- based analysis (formula)
Exposure
26. Absolute and relative risk - direction and non-directional
Probability of ruin
Forms of Market risk
Ways firms can fail to account for risks
Derivative contract
27. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Three main reasons for financial disasters
Security (primary vs secondary)
Financial Risk
Standard deviation of two assets
28. Probability distribution is unknown (ex. A terrorist attack)
Exposure
Zero- beta CAPM (two factor model)
Uncertainty
Market imperfections that can create value
29. When negative taxable income is moved to a different year to offset future or past taxable income
Kidder Peabody
LTCM
Carry- backs and carry- forwards
Forms of Market risk
30. 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
LTCM
Market imperfections that can create value
CAPM (formula)
Debt overhang
31. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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32. Quantile of an empirical distribution
Barings
Nonparametric VaR
Credit event
Risk
33. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Credit event
Ri = Rz + (gamma)(beta)
Solve for minimum variance portfolio
Contango
34. 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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35. Occurs the day when two parties exchange payments same day
Risk
Ri = Rz + (gamma)(beta)
Exposure
Settlement risk
36. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Effect of heterogeneous expectations on CAPM
Liquidity risk
Options motivation on volatility
APT for passive portfolio management
37. Cannot exit position in market due to size of the position
Treynor measure
Operational risk
Ten assumptions underlying CAPM
Asset liquidity risk
38. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
APT (equation and assumptions)
Asset transformers
Risk types addressed by ERM
Uncertainty
39. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Market imperfections that can create value
Zero- beta CAPM (two factor model)
Barings
EPD or ECOR - Expected Policyholder Deficit (EPD)
40. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Drysdale Securities (Chase Manhattan)
Expected return of two assets
Shape of portfolio possibilities curve
Business risks
41. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Tail VaR or TCE - Tail Conditional Expectation(TCE)
CAPM (formula)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Efficient frontier
42. Firms became multinational - - >watched xchange rates more - deregulation and globalization
RAR = relative return of portfolio (RRp)
Prices of risk vs sensitivity
Firms becoming more sensitive to changes(bank deregulation)
Volatility Market risk
43. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Funding liquidity risk
Uncertainty
Operational risk
Ri = Rz + (gamma)(beta)
44. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Settlement risk
Performance- related metrics
Shortcomings of risk metrics
Prices of risk vs sensitivity
45. Future price is greater than the spot price
Shape of portfolio possibilities curve
Multi- period version of CAPM
Correlation coefficient effect on diversification
Contango
46. Multibeta CAPM Ri - Rf =
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Uncertainty
Shortcomings of risk metrics
Shape of portfolio possibilities curve
47. 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
CAPM (formula)
Drysdale Securities (Chase Manhattan)
Risk Management Irrelevance Proposition
Barings
48. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Where is risk coming from
Differences in financial risk management for financial companies vs industrial companies
Risk types addressed by ERM
APT in active portfolio management
49. Hazard - Financial - Operational - Strategic
Sortino ratio
Risk types addressed by ERM
Carry- backs and carry- forwards
Settlement risk
50. 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
Volatility Market risk
Ways risk can be mismeasured
Sortino ratio