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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. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Basis
Practical considerations related to ERM implementatio
Nonmarketable asset impact on CAPM
Zero- beta CAPM (two factor model)
2. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Contango
Expected return of two assets
Security (primary vs secondary)
Risk
3. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
LTCM
Differences in financial risk management for financial companies vs industrial companies
Options motivation on volatility
Standard deviation of two assets
4. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Four major types of risk
Roles of risk management
Market imperfections that can create value
Liquidity risk
5. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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6. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Solvency-related metrics
Financial Risk
Debt overhang
3 main types of operational risk
7. Derives value from an underlying asset - rate - or index - Derives value from a security
Contango
Tracking error
Derivative contract
Shape of portfolio possibilities curve
8. Expected value of unfavorable deviations of a random variable from a specified target level
CAPM (formula)
VaR- based analysis (formula)
BTR - Below Target Risk
Allied Irish Bank
9. The lower (closer to - 1) - the higher the payoff from diversification
Correlation coefficient effect on diversification
VaR - Value at Risk
Shape of portfolio possibilities curve
Standard deviation of two assets
10. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Recovery rate
Jensen's alpha
Traits of ERM
Risk
11. 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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12. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Correlation coefficient effect on diversification
CAPM assumption for EMH
Credit event
APT for passive portfolio management
13. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Zero- beta CAPM (two factor model)
Differences in financial risk management for financial companies vs industrial companies
Contango
Shortcomings of risk metrics
14. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Ri = Rz + (gamma)(beta)
Multi- period version of CAPM
Parametric VaR
Formula for covariance
15. Asset-liability/market-liquidity risk
Risk
Liquidity risk
Business risks
Risk
16. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Tracking error
Importance of communication for risk managers
Capital market line (CML)
Nonparametric VaR
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
Treynor measure
Risk- adjusted performance measure (RAP)
Nonmarketable asset impact on CAPM
Barings
18. Quantile of an empirical distribution
APT (equation and assumptions)
Nonparametric VaR
Where is risk coming from
Four major types of risk
19. Curve must be concave - Straight line connecting any two points must be under the curve
Risk types addressed by ERM
Performance- related metrics
Shape of portfolio possibilities curve
Asset transformers
20. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Three main reasons for financial disasters
CAPM (formula)
Ri = ai + bi1l1 + bi2l2....+ei
Asset liquidity risk
21. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Volatility Market risk
Correlation coefficient effect on diversification
Information ratio
Nonmarketable asset impact on CAPM
22. Cannot exit position in market due to size of the position
Four major types of risk
BTR - Below Target Risk
Asset liquidity risk
Sharpe measure
23. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Solve for minimum variance portfolio
Parametric VaR
VaR - Value at Risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
24. The need to hedge against risks - for firms need to speculate.
Probability of ruin
Market risk
Differences in financial risk management for financial companies vs industrial companies
What lead to the exponential growth to derivatives mkt?
25. Asses firm risks - Communicate risks - Manage and monitor risks
APT for passive portfolio management
Drysdale Securities (Chase Manhattan)
Banker's Trust
Roles of risk management
26. When two payments are exchanged the same day and one party may default after payment is made
Settlement risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Parametric VaR
RAR = relative return of portfolio (RRp)
27. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
APT in active portfolio management
CAPM with taxes included (equation)
Information ratio
Prices of risk vs sensitivity
28. Return is linearly related to growth rate in consumption
Multi- period version of CAPM
CAPM assumption for EMH
APT in active portfolio management
Ri = ai + bi1l1 + bi2l2....+ei
29. 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
Capital market line (CML)
Liquidity risk
APT for passive portfolio management
Financial risks
30. 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
Operational risk
Traits of ERM
Carry- backs and carry- forwards
Funding liquidity risk
31. 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
Information ratio
Market imperfections that can create value
Risks excluded from operational risk
Ten assumptions underlying CAPM
32. Market risk - Liquidity risk - Credit risk - Operational risk
Debt overhang
Tax shield
Four major types of risk
Correlation coefficient effect on diversification
33. 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
Allied Irish Bank
Probability of ruin
Valuation vs. Risk management
CAPM assumption for EMH
34. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Where is risk coming from
APT (equation and assumptions)
Tax shield
Effect of heterogeneous expectations on CAPM
35. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
VaR- based analysis (formula)
Financial risks
Risk
Forms of Market risk
36. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Zero- beta CAPM (two factor model)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Prices of risk vs sensitivity
Information ratio
37. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Sovereign risk
Practical considerations related to ERM implementatio
VaR - Value at Risk
Allied Irish Bank
38. Wrong distribution - Historical sample may not apply
Probability of ruin
Asset liquidity risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Ways risk can be mismeasured
39. Need to assess risk and tell management so they can determine which risks to take on
Standard deviation of two assets
LTCM
Three main reasons for financial disasters
Importance of communication for risk managers
40. Risk of loses owing to movements in level or volatility of market prices
Carry- backs and carry- forwards
Treynor measure
Market risk
Shortfall risk
41. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Tracking error
Options motivation on volatility
Barings
Valuation vs. Risk management
42. Occurs the day when two parties exchange payments same day
Three main reasons for financial disasters
Settlement risk
Four major types of risk
Practical considerations related to ERM implementatio
43. 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
Derivative contract
Practical considerations related to ERM implementatio
Four major types of risk
Jensen's alpha
44. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Allied Irish Bank
CAPM with taxes included (equation)
Valuation vs. Risk management
Sortino ratio
45. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Sovereign risk
What lead to the exponential growth to derivatives mkt?
Formula for covariance
46. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
CAPM with taxes included (equation)
Basis risk
Practical considerations related to ERM implementatio
Standard deviation of two assets
47. 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
Practical considerations related to ERM implementatio
APT for passive portfolio management
Forms of Market risk
Valuation vs. Risk management
48. CAPM requires the strong form of the Efficient Market Hypothesis = private information
CAPM assumption for EMH
Asset transformers
Barings
Market imperfections that can create value
49. 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
Carry- backs and carry- forwards
Models used in ERM framework
Risk
LTCM
50. Strategic risk - Business risk - Reputational risk
Risks excluded from operational risk
Standard deviation of two assets
Expected return of two assets
Effect of non- price- taking behavior on CAPM