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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. 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
Risk- adjusted performance measure (RAP)
Roles of risk management
LTCM
Asset transformers
2. Wrong distribution - Historical sample may not apply
Ways risk can be mismeasured
Funding liquidity risk
Nonparametric VaR
3 main types of operational risk
3. Modeling approach is typically between statistical analytic models and structural simulation models
Models used in ERM framework
Jensen's alpha
Ways risk can be mismeasured
CAPM with taxes included (equation)
4. 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
Shortcomings of risk metrics
Prices of risk vs sensitivity
Ways risk can be mismeasured
Credit event
5. Return is linearly related to growth rate in consumption
CAPM (formula)
Multi- period version of CAPM
Barings
Risk types addressed by ERM
6. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Tax shield
Practical considerations related to ERM implementatio
What lead to the exponential growth to derivatives mkt?
Firms becoming more sensitive to changes(bank deregulation)
7. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Uncertainty
Prices of risk vs sensitivity
Business Risk
CAPM with taxes included (equation)
8. Occurs the day when two parties exchange payments same day
Sortino ratio
Settlement risk
Tax shield
Options motivation on volatility
9. The uses of debt to fall into a lower tax rate
Volatility Market risk
APT for passive portfolio management
Security (primary vs secondary)
Tax shield
10. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Four major types of risk
Risk- adjusted performance measure (RAP)
RAR = relative return of portfolio (RRp)
Probability of ruin
11. 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
Settlement risk
Risk
Prices of risk vs sensitivity
Probability of ruin
12. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Solvency-related metrics
Shape of portfolio possibilities curve
Exposure
Probability of ruin
13. 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
Effect of non- price- taking behavior on CAPM
Allied Irish Bank
Market imperfections that can create value
Risks excluded from operational risk
14. Derives value from an underlying asset - rate - or index - Derives value from a security
Risk
Ri = Rz + (gamma)(beta)
Derivative contract
APT for passive portfolio management
15. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Options motivation on volatility
Effect of heterogeneous expectations on CAPM
Operational risk
Funding liquidity risk
16. Interest rate movements - derivatives - defaults
CAPM assumption for EMH
Efficient frontier
Financial risks
Financial Risk
17. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Barings
Business Risk
Contango
Basis
18. 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
Shortfall risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Basic Market risk
19. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Barings
Security (primary vs secondary)
Expected return of two assets
Shape of portfolio possibilities curve
20. Changes in vol - implied or actual
Exposure
Volatility Market risk
Formula for covariance
Derivative contract
21. 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
Four major types of risk
Shape of portfolio possibilities curve
Contango
22. No transaction costs - assets infinitely divisible - no personal tax - perfect competition - investors only care about mean and variance - short- selling allowed - unlimited lending and borrowing - homogeneity: single period - homogeneity: same mean
Recovery rate
Ten assumptions underlying CAPM
Basic Market risk
Jensen's alpha
23. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Banker's Trust
CAPM assumption for EMH
Multi- period version of CAPM
RAR = relative return of portfolio (RRp)
24. Curve must be concave - Straight line connecting any two points must be under the curve
Ways risk can be mismeasured
Sovereign risk
Shape of portfolio possibilities curve
Credit event
25. Risk of loses owing to movements in level or volatility of market prices
Market risk
CAPM (formula)
Source of need for risk management
Sharpe measure
26. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Derivative contract
Jensen's alpha
Efficient frontier
Standard deviation of two assets
27. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Tail VaR or TCE - Tail Conditional Expectation(TCE)
VaR- based analysis (formula)
Solvency-related metrics
CAPM with taxes included (equation)
28. Returns on any stock are linearly related to a set of indexes
BTR - Below Target Risk
Effect of heterogeneous expectations on CAPM
Market imperfections that can create value
Ri = ai + bi1l1 + bi2l2....+ei
29. Quantile of a statistical distribution
Volatility Market risk
Parametric VaR
Firms becoming more sensitive to changes(bank deregulation)
Correlation coefficient effect on diversification
30. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Debt overhang
Basis
CAPM (formula)
Carry- backs and carry- forwards
31. Probability distribution is unknown (ex. A terrorist attack)
Contango
CAPM (formula)
Uncertainty
Debt overhang
32. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Options motivation on volatility
Differences in financial risk management for financial companies vs industrial companies
Shortcomings of risk metrics
CAPM (formula)
33. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Zero- beta CAPM (two factor model)
Market risk
BTR - Below Target Risk
Morningstar Rating System
34. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Debt overhang
Recovery rate
RAR = relative return of portfolio (RRp)
Drysdale Securities (Chase Manhattan)
35. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Business risks
Risk types addressed by ERM
Differences in financial risk management for financial companies vs industrial companies
Performance- related metrics
36. Losses due to market activities ex. Interest rate changes or defaults
Debt overhang
Financial risks
Ri = ai + bi1l1 + bi2l2....+ei
Treynor measure
37. 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
Uncertainty
Drysdale Securities (Chase Manhattan)
Liquidity risk
Ways firms can fail to account for risks
38. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Asset transformers
Expected return of two assets
Operational risk
Market risk
39. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Morningstar Rating System
Risk Management Irrelevance Proposition
Ri = Rz + (gamma)(beta)
CAPM (formula)
40. Asset-liability/market-liquidity risk
Uncertainty
Liquidity risk
Market risk
Drysdale Securities (Chase Manhattan)
41. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
CAPM assumption for EMH
Zero- beta CAPM (two factor model)
CAPM (formula)
Debt overhang
42. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Nonparametric VaR
Sharpe measure
Expected return of two assets
Solve for minimum variance portfolio
43. 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
What lead to the exponential growth to derivatives mkt?
Effect of heterogeneous expectations on CAPM
Capital market line (CML)
Firms becoming more sensitive to changes(bank deregulation)
44. Absolute and relative risk - direction and non-directional
Recovery rate
Probability of ruin
Zero- beta CAPM (two factor model)
Forms of Market risk
45. The need to hedge against risks - for firms need to speculate.
Operational risk
What lead to the exponential growth to derivatives mkt?
Practical considerations related to ERM implementatio
APT (equation and assumptions)
46. 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
Sharpe measure
Ri = ai + bi1l1 + bi2l2....+ei
Kidder Peabody
Credit event
47. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Basis risk
VaR - Value at Risk
Risk
Solve for minimum variance portfolio
48. 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.
Settlement risk
Multi- period version of CAPM
Risk Management Irrelevance Proposition
Sovereign risk
49. Unanticipated movements in relative prices of assets in hedged position
Derivative contract
Basic Market risk
Information ratio
Efficient frontier
50. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Jensen's alpha
Probability of ruin
Funding liquidity risk
Debt overhang