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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.
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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. Capital structure (financial distress) - Taxes - Agency and information asymmetries
CAPM with taxes included (equation)
Market imperfections that can create value
Basic Market risk
Banker's Trust
2. 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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3. 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
Basic Market risk
Derivative contract
Kidder Peabody
EPD or ECOR - Expected Policyholder Deficit (EPD)
4. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
3 main types of operational risk
Effect of heterogeneous expectations on CAPM
Asset transformers
Liquidity risk
5. Rp = XaRa + XbRb
Shortfall risk
Expected return of two assets
Basis risk
Solvency-related metrics
6. Derives value from an underlying asset - rate - or index - Derives value from a security
Tax shield
EPD or ECOR - Expected Policyholder Deficit (EPD)
Kidder Peabody
Derivative contract
7. Changes in vol - implied or actual
Risks excluded from operational risk
Effect of non- price- taking behavior on CAPM
Volatility Market risk
Roles of risk management
8. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Sovereign risk
Funding liquidity risk
Security (primary vs secondary)
Source of need for risk management
9. Volatility of unexpected outcomes
Basis risk
CAPM assumption for EMH
Derivative contract
Risk
10. Quantile of an empirical distribution
Parametric VaR
Multi- period version of CAPM
Standard deviation of two assets
Nonparametric VaR
11. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Multi- period version of CAPM
Credit event
Effect of heterogeneous expectations on CAPM
Nonparametric VaR
12. 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)
Treynor measure
Practical considerations related to ERM implementatio
Information ratio
13. Probability that a random variable falls below a specified threshold level
Shortfall risk
Tracking error
Capital market line (CML)
Sortino ratio
14. Returns on any stock are linearly related to a set of indexes
VaR- based analysis (formula)
Ways risk can be mismeasured
Formula for covariance
Ri = ai + bi1l1 + bi2l2....+ei
15. 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 -
Zero- beta CAPM (two factor model)
Source of need for risk management
Allied Irish Bank
Funding liquidity risk
16. Both probability and cost of tail events are considered
Treynor measure
Shape of portfolio possibilities curve
Tail VaR or TCE - Tail Conditional Expectation(TCE)
BTR - Below Target Risk
17. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Treynor measure
Exposure
Nonparametric VaR
Solve for minimum variance portfolio
18. Probability distribution is unknown (ex. A terrorist attack)
Formula for covariance
Multi- period version of CAPM
Uncertainty
Derivative contract
19. Losses due to market activities ex. Interest rate changes or defaults
Kidder Peabody
Ten assumptions underlying CAPM
Financial risks
Efficient frontier
20. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Four major types of risk
Options motivation on volatility
Three main reasons for financial disasters
What lead to the exponential growth to derivatives mkt?
21. 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
Business Risk
APT in active portfolio management
Barings
Ways firms can fail to account for risks
22. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Parametric VaR
Nonmarketable asset impact on CAPM
Risks excluded from operational risk
Shortcomings of risk metrics
23. 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
Barings
Roles of risk management
Risk- adjusted performance measure (RAP)
24. 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
EPD or ECOR - Expected Policyholder Deficit (EPD)
APT (equation and assumptions)
Uncertainty
25. Potential amount that can be lost
Ri = Rz + (gamma)(beta)
Parametric VaR
APT in active portfolio management
Exposure
26. Strategic risk - Business risk - Reputational risk
Four major types of risk
APT for passive portfolio management
CAPM with taxes included (equation)
Risks excluded from operational risk
27. When negative taxable income is moved to a different year to offset future or past taxable income
Carry- backs and carry- forwards
Solve for minimum variance portfolio
Nonparametric VaR
CAPM assumption for EMH
28. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Business risks
VaR - Value at Risk
Debt overhang
CAPM with taxes included (equation)
29. 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
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Barings
CAPM assumption for EMH
Capital market line (CML)
30. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Jensen's alpha
Sortino ratio
Security (primary vs secondary)
APT in active portfolio management
31. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Business risks
Tracking error
Basis risk
Allied Irish Bank
32. Asses firm risks - Communicate risks - Manage and monitor risks
Practical considerations related to ERM implementatio
Traits of ERM
Roles of risk management
Effect of heterogeneous expectations on CAPM
33. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Basic Market risk
Sovereign risk
Carry- backs and carry- forwards
APT in active portfolio management
34. Multibeta CAPM Ri - Rf =
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Banker's Trust
Barings
Settlement risk
35. 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
Ten assumptions underlying CAPM
Correlation coefficient effect on diversification
Sortino ratio
Asset liquidity risk
36. Future price is greater than the spot price
Derivative contract
EPD or ECOR - Expected Policyholder Deficit (EPD)
Settlement risk
Contango
37. Asset-liability/market-liquidity risk
Exposure
Credit event
Liquidity risk
Nonparametric VaR
38. Quantile of a statistical distribution
Nonparametric VaR
Three main reasons for financial disasters
Parametric VaR
Contango
39. Concave function that extends from minimum variance portfolio to maximum return portfolio
Efficient frontier
Tracking error
Financial Risk
Shortcomings of risk metrics
40. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
CAPM with taxes included (equation)
Importance of communication for risk managers
Sovereign risk
What lead to the exponential growth to derivatives mkt?
41. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Debt overhang
Firms becoming more sensitive to changes(bank deregulation)
Ri = Rz + (gamma)(beta)
Ways firms can fail to account for risks
42. Firms became multinational - - >watched xchange rates more - deregulation and globalization
CAPM (formula)
Firms becoming more sensitive to changes(bank deregulation)
Basic Market risk
Importance of communication for risk managers
43. Law of one price - Homogeneous expectations - Security returns process
Shortfall risk
Morningstar Rating System
Exposure
APT (equation and assumptions)
44. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Asset transformers
Parametric VaR
Roles of risk management
Tail VaR or TCE - Tail Conditional Expectation(TCE)
45. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Options motivation on volatility
VaR- based analysis (formula)
Morningstar Rating System
Business Risk
46. 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
Volatility Market risk
Traits of ERM
Tax shield
Sovereign risk
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
3 main types of operational risk
Information ratio
Zero- beta CAPM (two factor model)
Barings
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.
Sortino ratio
Risk Management Irrelevance Proposition
Asset liquidity risk
Financial risks
49. 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
Ri = ai + bi1l1 + bi2l2....+ei
Asset transformers
Drysdale Securities (Chase Manhattan)
Recovery rate
50. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Funding liquidity risk
Effect of non- price- taking behavior on CAPM
Efficient frontier
3 main types of operational risk