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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. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Options motivation on volatility
Tracking error
Credit event
Sharpe measure
2. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
CAPM assumption for EMH
Sortino ratio
VaR - Value at Risk
Risk types addressed by ERM
3. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Basis
Exposure
Ri = Rz + (gamma)(beta)
4. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Forms of Market risk
Sovereign risk
Firms becoming more sensitive to changes(bank deregulation)
Security (primary vs secondary)
5. 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
3 main types of operational risk
Practical considerations related to ERM implementatio
Settlement risk
Prices of risk vs sensitivity
6. 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
Capital market line (CML)
Banker's Trust
Source of need for risk management
Options motivation on volatility
7. Strategic risk - Business risk - Reputational risk
Practical considerations related to ERM implementatio
Operational risk
Ri = ai + bi1l1 + bi2l2....+ei
Risks excluded from operational risk
8. When two payments are exchanged the same day and one party may default after payment is made
Settlement risk
Debt overhang
Volatility Market risk
Credit event
9. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Treynor measure
Models used in ERM framework
Risk- adjusted performance measure (RAP)
Derivative contract
10. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
APT in active portfolio management
Differences in financial risk management for financial companies vs industrial companies
Parametric VaR
Credit event
11. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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12. When negative taxable income is moved to a different year to offset future or past taxable income
CAPM with taxes included (equation)
Expected return of two assets
Financial risks
Carry- backs and carry- forwards
13. Concave function that extends from minimum variance portfolio to maximum return portfolio
Efficient frontier
Tracking error
Multi- period version of CAPM
Risk types addressed by ERM
14. Return is linearly related to growth rate in consumption
Business Risk
Capital market line (CML)
Practical considerations related to ERM implementatio
Multi- period version of CAPM
15. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Settlement risk
RAR = relative return of portfolio (RRp)
APT for passive portfolio management
APT in active portfolio management
16. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Operational risk
Three main reasons for financial disasters
Tax shield
Business risks
17. Relative portfolio risk (RRiskp) - Based on a one- month investment period
RAR = relative return of portfolio (RRp)
Risk
Forms of Market risk
LTCM
18. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Derivative contract
Operational risk
VaR- based analysis (formula)
Formula for covariance
19. Market risk - Liquidity risk - Credit risk - Operational risk
Banker's Trust
Prices of risk vs sensitivity
Formula for covariance
Four major types of risk
20. 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
Market imperfections that can create value
Barings
Three main reasons for financial disasters
Credit event
21. 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
Shortfall risk
APT (equation and assumptions)
Solve for minimum variance portfolio
Probability of ruin
22. 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
Debt overhang
Drysdale Securities (Chase Manhattan)
Risk
Morningstar Rating System
23. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Ri = Rz + (gamma)(beta)
Three main reasons for financial disasters
Efficient frontier
Traits of ERM
24. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Source of need for risk management
Risks excluded from operational risk
Four major types of risk
Asset transformers
25. 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
Jensen's alpha
LTCM
Credit event
Financial risks
26. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
BTR - Below Target Risk
Probability of ruin
Performance- related metrics
Effect of heterogeneous expectations on CAPM
27. Probability that a random variable falls below a specified threshold level
Shortfall risk
Risk- adjusted performance measure (RAP)
LTCM
Zero- beta CAPM (two factor model)
28. Quantile of an empirical distribution
APT for passive portfolio management
Traits of ERM
Nonparametric VaR
Solve for minimum variance portfolio
29. Inability to make payment obligations (ex. Margin calls)
Forms of Market risk
Information ratio
Funding liquidity risk
Credit event
30. Absolute and relative risk - direction and non-directional
Forms of Market risk
Expected return of two assets
Basic Market risk
CAPM with taxes included (equation)
31. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Nonmarketable asset impact on CAPM
Tax shield
Business risks
Ways firms can fail to account for risks
32. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Effect of non- price- taking behavior on CAPM
Source of need for risk management
CAPM with taxes included (equation)
Morningstar Rating System
33. 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
Kidder Peabody
Performance- related metrics
Morningstar Rating System
Nonmarketable asset impact on CAPM
34. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Tracking error
Roles of risk management
Drysdale Securities (Chase Manhattan)
Barings
35. Wrong distribution - Historical sample may not apply
Ways risk can be mismeasured
CAPM assumption for EMH
CAPM with taxes included (equation)
Business Risk
36. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Importance of communication for risk managers
Sovereign risk
BTR - Below Target Risk
Market imperfections that can create value
37. 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
Sovereign risk
Financial risks
Asset liquidity risk
38. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Four major types of risk
Contango
Basis
Effect of heterogeneous expectations on CAPM
39. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Probability of ruin
Risk
Traits of ERM
Models used in ERM framework
40. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
EPD or ECOR - Expected Policyholder Deficit (EPD)
Risk Management Irrelevance Proposition
Funding liquidity risk
Basis risk
41. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Exposure
Tax shield
CAPM (formula)
Shortfall risk
42. Expected value of unfavorable deviations of a random variable from a specified target level
RAR = relative return of portfolio (RRp)
BTR - Below Target Risk
Liquidity risk
Credit event
43. Prices of risk are common factors and do not change - Sensitivities can change
Practical considerations related to ERM implementatio
Basis risk
Prices of risk vs sensitivity
Zero- beta CAPM (two factor model)
44. Need to assess risk and tell management so they can determine which risks to take on
Risk types addressed by ERM
Capital market line (CML)
Recovery rate
Importance of communication for risk managers
45. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Ways risk can be mismeasured
Basis
Business Risk
Zero- beta CAPM (two factor model)
46. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Market risk
Asset transformers
Solve for minimum variance portfolio
Tracking error
47. 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
Tax shield
Multi- period version of CAPM
Business Risk
APT for passive portfolio management
48. Multibeta CAPM Ri - Rf =
Recovery rate
Banker's Trust
Kidder Peabody
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
49. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Basic Market risk
Where is risk coming from
APT for passive portfolio management
Sharpe measure
50. Interest rate movements - derivatives - defaults
Financial Risk
Market imperfections that can create value
Liquidity risk
Shortcomings of risk metrics