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Test your basic knowledge 
FRM: Foundations Of Risk Management
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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 reenforces your understanding as you take the test each time.
1. Inability to make payment obligations (ex. Margin calls)
CAPM assumption for EMH
Funding liquidity risk
APT for passive portfolio management
Correlation coefficient effect on diversification
2. Need to assess risk and tell management so they can determine which risks to take on
Ten assumptions underlying CAPM
Risk
Importance of communication for risk managers
Capital market line (CML)
3. Human  created: business cycles  inflation  govt policy changes  wars  Natural: weather  quakes
Where is risk coming from
Capital market line (CML)
Risk types addressed by ERM
Drysdale Securities (Chase Manhattan)
4. Misleading reporting (incorrect market info)  Due to large market moves  Due to conduct of customer business
Settlement risk
Sovereign risk
Ways firms can fail to account for risks
Three main reasons for financial disasters
5. People risk = fraud  etc.  Model risk = flawed valuation models  Legal risk = exposure to fines and lawsuits
Prices of risk vs sensitivity
Basis risk
Funding liquidity risk
3 main types of operational risk
6. ex. Human capital  Equilibrium return can be higher or lower than it is under standard CAPM
Capital market line (CML)
Nonmarketable asset impact on CAPM
Kidder Peabody
APT for passive portfolio management
7. Liquidity and maturity transformation  Brokers  Reduces transaction and information costs between households and corporations
Asset transformers
Standard deviation of two assets
Risk Management Irrelevance Proposition
3 main types of operational risk
8. Gamma = market price of the consumption beta  Beta = E(r) of zero consumption beta
Ri = Rz + (gamma)(beta)
Shortcomings of risk metrics
Tail VaR or TCE  Tail Conditional Expectation(TCE)
Kidder Peabody
9. Simple form of CAPM  but market price of risk is lower than if all investors were price takers
Funding liquidity risk
Differences in financial risk management for financial companies vs industrial companies
Effect of non price taking behavior on CAPM
Effect of heterogeneous expectations on CAPM
10. Risk adjusted rating (RAR)  Difference between relative returns and relative risk
Morningstar Rating System
Differences in financial risk management for financial companies vs industrial companies
Zero beta CAPM (two factor model)
Risk
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
Probability of ruin
Tail VaR or TCE  Tail Conditional Expectation(TCE)
Shape of portfolio possibilities curve
Asset transformers
12. Modeling approach is typically between statistical analytic models and structural simulation models
Ways risk can be mismeasured
Models used in ERM framework
Asset transformers
Financial Risk
13. Curve must be concave  Straight line connecting any two points must be under the curve
Options motivation on volatility
Debt overhang
VaR  Value at Risk
Shape of portfolio possibilities curve
14. Wrong distribution  Historical sample may not apply
Ways risk can be mismeasured
VaR  Value at Risk
Basic Market risk
Drysdale Securities (Chase Manhattan)
15. When two payments are exchanged the same day and one party may default after payment is made
3 main types of operational risk
Settlement risk
Solve for minimum variance portfolio
Financial risks
16. Risk replaced with VaR (Portfolio return  risk free rate)/(portfolio VaR/initial value of portfolio)
Where is risk coming from
Uncertainty
VaR based analysis (formula)
Barings
17. 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
Sovereign risk
Models used in ERM framework
Roles of risk management
Barings
18. IR = (E(Rp)  E(Rb))/(std dev(Rp Rb))  Evaluate manager of a benchmark fund
Nonparametric VaR
Information ratio
CAPM assumption for EMH
Prices of risk vs sensitivity
19. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp)  Rf)/(std dev of Rp)  Better for non diversified portfolios
CAPM (formula)
Sharpe measure
Valuation vs. Risk management
Business Risk
20. Derives value from an underlying asset  rate  or index  Derives value from a security
APT in active portfolio management
Carry backs and carry forwards
Effect of heterogeneous expectations on CAPM
Derivative contract
21. Unanticipated movements in relative prices of assets in hedged position
Jensen's alpha
Zero beta CAPM (two factor model)
(market beta)(Rm  Rf) + (sensitivity to inflation risk)(price of inflation risk)
Basic Market risk
22. 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
Firms becoming more sensitive to changes(bank deregulation)
Ways firms can fail to account for risks
Nonparametric VaR
Traits of ERM
23. 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
Importance of communication for risk managers
Drysdale Securities (Chase Manhattan)
Allied Irish Bank
Jensen's alpha
24. Covariance = correlation coefficient std dev(a) std dev(b)
Basic Market risk
Formula for covariance
Market risk
Exposure
25. 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
Credit event
Shortcomings of risk metrics
Forms of Market risk
Standard deviation of two assets
26. 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
Kidder Peabody
Ri = Rz + (gamma)(beta)
Differences in financial risk management for financial companies vs industrial companies
Practical considerations related to ERM implementatio
27. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Ten assumptions underlying CAPM
Credit event
Sovereign risk
Effect of non price taking behavior on CAPM
28. Equilibrium can still be expressed in returns  covariance  and variance  but they become complex weighted averages
Ri = Rz + (gamma)(beta)
Effect of heterogeneous expectations on CAPM
LTCM
Security (primary vs secondary)
29. Absolute and relative risk  direction and nondirectional
Expected return of two assets
Forms of Market risk
Probability of ruin
Drysdale Securities (Chase Manhattan)
30. Ri = Rz + (Rm  Rz)*beta  Rz = return on zero beta portfolio
Zero beta CAPM (two factor model)
(market beta)(Rm  Rf) + (sensitivity to inflation risk)(price of inflation risk)
Importance of communication for risk managers
Effect of non price taking behavior on CAPM
31. Law of one price  Homogeneous expectations  Security returns process
CAPM (formula)
APT (equation and assumptions)
Derivative contract
Correlation coefficient effect on diversification
32. Changes in vol  implied or actual
Volatility Market risk
VaR  Value at Risk
APT in active portfolio management
APT for passive portfolio management
33. Returns on any stock are linearly related to a set of indexes
Funding liquidity risk
Exposure
Ri = ai + bi1l1 + bi2l2....+ei
Shortcomings of risk metrics
34. 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
Firms becoming more sensitive to changes(bank deregulation)
Effect of non price taking behavior on CAPM
Financial Risk
Drysdale Securities (Chase Manhattan)
35. Both probability and cost of tail events are considered
Firms becoming more sensitive to changes(bank deregulation)
Basis
Sortino ratio
Tail VaR or TCE  Tail Conditional Expectation(TCE)
36. Capital Asset Pricing Model Ri = Rf + beta*(Rm  Rf)
Importance of communication for risk managers
Differences in financial risk management for financial companies vs industrial companies
Risk
CAPM (formula)
37. Probability that a random variable falls below a specified threshold level
Risk
Risk
CAPM assumption for EMH
Shortfall risk
38. Future price is greater than the spot price
Tail VaR or TCE  Tail Conditional Expectation(TCE)
Contango
Information ratio
Asset transformers
39. 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
Business Risk
RAR = relative return of portfolio (RRp)
Multi period version of CAPM
40. Risk of loses owing to movements in level or volatility of market prices
Ri = Rz + (gamma)(beta)
Market risk
Basis risk
Financial Risk
41. (E(Rp)  MAR)/(sqrt((1/T)summation(Rpt MAR)^2)  MAR  minimum acceptable return
Three main reasons for financial disasters
Tracking error
Treynor measure
Sortino ratio
42. Xmvp = ((variance of b)  covariance)/((variance of a) + (variance of b)  2 * covariance)
Solve for minimum variance portfolio
Recovery rate
VaR based analysis (formula)
Business Risk
43. Make common factor beta  Build optimal portfolios  Judge valuation of securities  Track an index but enhance with stock selection
Sovereign risk
RAR = relative return of portfolio (RRp)
APT in active portfolio management
Drysdale Securities (Chase Manhattan)
44. Asses firm risks  Communicate risks  Manage and monitor risks
Ways risk can be mismeasured
Settlement risk
APT (equation and assumptions)
Roles of risk management
45. Firms became multinational   >watched xchange rates more  deregulation and globalization
Firms becoming more sensitive to changes(bank deregulation)
EPD or ECOR  Expected Policyholder Deficit (EPD)
Market risk
Basis risk
46. 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
Ways firms can fail to account for risks
Nonparametric VaR
(market beta)(Rm  Rf) + (sensitivity to inflation risk)(price of inflation risk)
Asset liquidity risk
47. Return is linearly related to growth rate in consumption
Business Risk
Tax shield
Efficient frontier
Multi period version of CAPM
48. Occurs the day when two parties exchange payments same day
Asset liquidity risk
Settlement risk
Source of need for risk management
APT for passive portfolio management
49. Volatility of expected outcomes  Outcomes are random but distribution is known or approximated
Business risks
Tail VaR or TCE  Tail Conditional Expectation(TCE)
Risk
Risks excluded from operational risk
50. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence  Always one tailed
Allied Irish Bank
Solvencyrelated metrics
VaR  Value at Risk
Where is risk coming from