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Test your basic knowledge |
FRM: Foundations Of Risk Management
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business-skills
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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. When two payments are exchanged the same day and one party may default after payment is made
Risk Management Irrelevance Proposition
Settlement risk
Barings
Efficient frontier
2. Modeling approach is typically between statistical analytic models and structural simulation models
Three main reasons for financial disasters
Basis risk
Risk- adjusted performance measure (RAP)
Models used in ERM framework
3. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Treynor measure
VaR - Value at Risk
Correlation coefficient effect on diversification
Forms of Market risk
4. Prices of risk are common factors and do not change - Sensitivities can change
Prices of risk vs sensitivity
CAPM (formula)
Treynor measure
Sharpe measure
5. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Performance- related metrics
Zero- beta CAPM (two factor model)
Drysdale Securities (Chase Manhattan)
APT (equation and assumptions)
6. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Three main reasons for financial disasters
Source of need for risk management
3 main types of operational risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
7. 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
Practical considerations related to ERM implementatio
Effect of non- price- taking behavior on CAPM
Security (primary vs secondary)
Allied Irish Bank
8. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Debt overhang
Carry- backs and carry- forwards
Funding liquidity risk
LTCM
9. 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 -
Models used in ERM framework
Uncertainty
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Source of need for risk management
10. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Capital market line (CML)
Treynor measure
Effect of non- price- taking behavior on CAPM
Settlement risk
11. Cannot exit position in market due to size of the position
Risk types addressed by ERM
Efficient frontier
Ri = ai + bi1l1 + bi2l2....+ei
Asset liquidity risk
12. Probability distribution is unknown (ex. A terrorist attack)
Information ratio
Uncertainty
Sharpe measure
Financial Risk
13. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Banker's Trust
Source of need for risk management
Three main reasons for financial disasters
Funding liquidity risk
14. 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
RAR = relative return of portfolio (RRp)
Traits of ERM
Options motivation on volatility
Tracking error
15. Future price is greater than the spot price
Shape of portfolio possibilities curve
VaR - Value at Risk
Contango
Business risks
16. Volatility of unexpected outcomes
Settlement risk
Correlation coefficient effect on diversification
Risk
APT for passive portfolio management
17. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Financial Risk
Operational risk
Correlation coefficient effect on diversification
Practical considerations related to ERM implementatio
18. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Asset transformers
Tracking error
Risk types addressed by ERM
Expected return of two assets
19. 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
Drysdale Securities (Chase Manhattan)
Sovereign risk
VaR - Value at Risk
CAPM with taxes included (equation)
20. Asses firm risks - Communicate risks - Manage and monitor risks
Credit event
BTR - Below Target Risk
Debt overhang
Roles of risk management
21. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Sharpe measure
VaR - Value at Risk
Solvency-related metrics
22. Risk of loses owing to movements in level or volatility of market prices
Standard deviation of two assets
LTCM
Market risk
Firms becoming more sensitive to changes(bank deregulation)
23. Concave function that extends from minimum variance portfolio to maximum return portfolio
RAR = relative return of portfolio (RRp)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
CAPM with taxes included (equation)
Efficient frontier
24. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Business risks
Allied Irish Bank
Differences in financial risk management for financial companies vs industrial companies
Operational risk
25. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Solve for minimum variance portfolio
Risk- adjusted performance measure (RAP)
CAPM (formula)
Risk
26. Inability to make payment obligations (ex. Margin calls)
Parametric VaR
Traits of ERM
Four major types of risk
Funding liquidity risk
27. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Probability of ruin
APT in active portfolio management
Barings
Practical considerations related to ERM implementatio
28. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Ten assumptions underlying CAPM
Liquidity risk
Nonmarketable asset impact on CAPM
Models used in ERM framework
29. 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
Importance of communication for risk managers
Probability of ruin
Ri = Rz + (gamma)(beta)
Ways firms can fail to account for risks
30. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Models used in ERM framework
Firms becoming more sensitive to changes(bank deregulation)
Tax shield
Standard deviation of two assets
31. 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
Barings
Ten assumptions underlying CAPM
Risk
Ways firms can fail to account for risks
32. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Practical considerations related to ERM implementatio
Valuation vs. Risk management
Solve for minimum variance portfolio
Ten assumptions underlying CAPM
33. Absolute and relative risk - direction and non-directional
Credit event
Forms of Market risk
Barings
Effect of non- price- taking behavior on CAPM
34. Law of one price - Homogeneous expectations - Security returns process
APT for passive portfolio management
APT (equation and assumptions)
CAPM with taxes included (equation)
Solvency-related metrics
35. 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
Basis risk
Probability of ruin
Funding liquidity risk
Contango
36. Probability that a random variable falls below a specified threshold level
Solvency-related metrics
Parametric VaR
Shortfall risk
Credit event
37. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Settlement risk
Recovery rate
Financial Risk
Debt overhang
38. Rp = XaRa + XbRb
Expected return of two assets
Tax shield
CAPM with taxes included (equation)
Uncertainty
39. Both probability and cost of tail events are considered
Tail VaR or TCE - Tail Conditional Expectation(TCE)
APT for passive portfolio management
RAR = relative return of portfolio (RRp)
Performance- related metrics
40. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Credit event
Contango
Financial risks
Banker's Trust
41. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Importance of communication for risk managers
Formula for covariance
Sortino ratio
Probability of ruin
42. Multibeta CAPM Ri - Rf =
Standard deviation of two assets
RAR = relative return of portfolio (RRp)
APT in active portfolio management
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
43. The uses of debt to fall into a lower tax rate
Tax shield
Multi- period version of CAPM
Traits of ERM
Probability of ruin
44. The lower (closer to - 1) - the higher the payoff from diversification
Formula for covariance
Correlation coefficient effect on diversification
Prices of risk vs sensitivity
Roles of risk management
45. Strategic risk - Business risk - Reputational risk
Formula for covariance
BTR - Below Target Risk
Risks excluded from operational risk
Source of need for risk management
46. Market risk - Liquidity risk - Credit risk - Operational risk
Four major types of risk
What lead to the exponential growth to derivatives mkt?
APT for passive portfolio management
Funding liquidity risk
47. Quantile of an empirical distribution
Recovery rate
Nonparametric VaR
Information ratio
Risk types addressed by ERM
48. Interest rate movements - derivatives - defaults
Financial Risk
What lead to the exponential growth to derivatives mkt?
Correlation coefficient effect on diversification
Uncertainty
49. Asset-liability/market-liquidity risk
Liquidity risk
Effect of heterogeneous expectations on CAPM
Kidder Peabody
Differences in financial risk management for financial companies vs industrial companies
50. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Settlement risk
Debt overhang
Zero- beta CAPM (two factor model)
CAPM assumption for EMH