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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. Potential amount that can be lost
Exposure
What lead to the exponential growth to derivatives mkt?
LTCM
Expected return of two assets
2. 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
Firms becoming more sensitive to changes(bank deregulation)
Tax shield
Valuation vs. Risk management
Options motivation on volatility
3. The need to hedge against risks - for firms need to speculate.
What lead to the exponential growth to derivatives mkt?
Sovereign risk
Derivative contract
VaR- based analysis (formula)
4. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Basis risk
Risks excluded from operational risk
Ways firms can fail to account for risks
Tracking error
5. 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
Roles of risk management
Financial risks
Risk- adjusted performance measure (RAP)
6. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Volatility Market risk
Treynor measure
Jensen's alpha
CAPM (formula)
7. Need to assess risk and tell management so they can determine which risks to take on
Risk- adjusted performance measure (RAP)
Performance- related metrics
Importance of communication for risk managers
Credit event
8. Curve must be concave - Straight line connecting any two points must be under the curve
CAPM with taxes included (equation)
Shape of portfolio possibilities curve
Parametric VaR
Performance- related metrics
9. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Effect of non- price- taking behavior on CAPM
LTCM
Parametric VaR
Firms becoming more sensitive to changes(bank deregulation)
10. Modeling approach is typically between statistical analytic models and structural simulation models
CAPM assumption for EMH
Models used in ERM framework
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Treynor measure
11. CAPM requires the strong form of the Efficient Market Hypothesis = private information
CAPM assumption for EMH
Morningstar Rating System
Capital market line (CML)
Debt overhang
12. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Options motivation on volatility
Risks excluded from operational risk
Exposure
APT for passive portfolio management
13. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Three main reasons for financial disasters
Solvency-related metrics
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Debt overhang
14. Market risk - Liquidity risk - Credit risk - Operational risk
Risk- adjusted performance measure (RAP)
Four major types of risk
3 main types of operational risk
Capital market line (CML)
15. Return is linearly related to growth rate in consumption
Liquidity risk
Settlement risk
Multi- period version of CAPM
Valuation vs. Risk management
16. 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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17. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Drysdale Securities (Chase Manhattan)
Settlement risk
Standard deviation of two assets
APT in active portfolio management
18. 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 -
APT (equation and assumptions)
Risks excluded from operational risk
Source of need for risk management
Firms becoming more sensitive to changes(bank deregulation)
19. Those which corporations assume whillingly to create competitive advantage/add shareholder value - Business Decisions: investment decisions - prod - dev choices - marketing strategies - organizational struct. - Business Environment: competitive and
Solvency-related metrics
Risk Management Irrelevance Proposition
Risk
Business Risk
20. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Security (primary vs secondary)
Sharpe measure
Nonmarketable asset impact on CAPM
Jensen's alpha
21. Wrong distribution - Historical sample may not apply
Risk- adjusted performance measure (RAP)
Multi- period version of CAPM
Ways risk can be mismeasured
Risk types addressed by ERM
22. Covariance = correlation coefficient std dev(a) std dev(b)
Business risks
Volatility Market risk
Risk types addressed by ERM
Formula for covariance
23. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Sovereign risk
Debt overhang
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Sortino ratio
24. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Importance of communication for risk managers
Risk types addressed by ERM
Zero- beta CAPM (two factor model)
Treynor measure
25. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Sortino ratio
Asset transformers
CAPM (formula)
Practical considerations related to ERM implementatio
26. 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
Tracking error
Nonparametric VaR
Shortcomings of risk metrics
APT for passive portfolio management
27. 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
Credit event
Ways firms can fail to account for risks
Options motivation on volatility
Asset liquidity risk
28. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Shortfall risk
Derivative contract
Risk- adjusted performance measure (RAP)
CAPM assumption for EMH
29. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Morningstar Rating System
Prices of risk vs sensitivity
Risk
Risk
30. Rp = XaRa + XbRb
Barings
Source of need for risk management
Zero- beta CAPM (two factor model)
Expected return of two assets
31. Probability distribution is unknown (ex. A terrorist attack)
Uncertainty
Ri = ai + bi1l1 + bi2l2....+ei
Solvency-related metrics
Financial risks
32. Asset-liability/market-liquidity risk
VaR - Value at Risk
VaR- based analysis (formula)
Funding liquidity risk
Liquidity risk
33. Occurs the day when two parties exchange payments same day
Basis
Settlement risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
Four major types of risk
34. Derives value from an underlying asset - rate - or index - Derives value from a security
Credit event
Sortino ratio
Tracking error
Derivative contract
35. Concave function that extends from minimum variance portfolio to maximum return portfolio
Debt overhang
Nonparametric VaR
Shortcomings of risk metrics
Efficient frontier
36. 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
Practical considerations related to ERM implementatio
Financial risks
Settlement risk
Source of need for risk management
37. Multibeta CAPM Ri - Rf =
BTR - Below Target Risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Basic Market risk
Where is risk coming from
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
Valuation vs. Risk management
Shortcomings of risk metrics
Zero- beta CAPM (two factor model)
Parametric VaR
39. Absolute and relative risk - direction and non-directional
Formula for covariance
Forms of Market risk
Zero- beta CAPM (two factor model)
Multi- period version of CAPM
40. Asses firm risks - Communicate risks - Manage and monitor risks
Roles of risk management
Forms of Market risk
Three main reasons for financial disasters
Asset transformers
41. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Firms becoming more sensitive to changes(bank deregulation)
Recovery rate
Importance of communication for risk managers
LTCM
42. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Sovereign risk
Credit event
Nonmarketable asset impact on CAPM
Allied Irish Bank
43. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Firms becoming more sensitive to changes(bank deregulation)
CAPM with taxes included (equation)
Risk
Shortfall risk
44. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Expected return of two assets
Operational risk
BTR - Below Target Risk
Asset liquidity risk
45. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Settlement risk
Expected return of two assets
Risk- adjusted performance measure (RAP)
Where is risk coming from
46. Losses due to market activities ex. Interest rate changes or defaults
Recovery rate
Financial risks
Zero- beta CAPM (two factor model)
Shortcomings of risk metrics
47. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
BTR - Below Target Risk
APT (equation and assumptions)
Expected return of two assets
Differences in financial risk management for financial companies vs industrial companies
48. Quantile of a statistical distribution
Effect of non- price- taking behavior on CAPM
Parametric VaR
Shape of portfolio possibilities curve
Tax shield
49. When negative taxable income is moved to a different year to offset future or past taxable income
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Carry- backs and carry- forwards
Probability of ruin
Shortfall risk
50. 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
VaR - Value at Risk
Shortfall risk
Drysdale Securities (Chase Manhattan)
Contango