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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 re-enforces your understanding as you take the test each time.
1. When negative taxable income is moved to a different year to offset future or past taxable income
Credit event
Drysdale Securities (Chase Manhattan)
Carry- backs and carry- forwards
CAPM with taxes included (equation)
2. Quantile of an empirical distribution
Nonparametric VaR
Uncertainty
Recovery rate
Forms of Market risk
3. Curve must be concave - Straight line connecting any two points must be under the curve
CAPM (formula)
CAPM with taxes included (equation)
Debt overhang
Shape of portfolio possibilities curve
4. 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
LTCM
Options motivation on volatility
Basis risk
Basic Market risk
5. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Source of need for risk management
Nonparametric VaR
APT in active portfolio management
Exposure
6. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Ri = Rz + (gamma)(beta)
Options motivation on volatility
Firms becoming more sensitive to changes(bank deregulation)
Parametric VaR
7. Absolute and relative risk - direction and non-directional
What lead to the exponential growth to derivatives mkt?
Nonparametric VaR
Forms of Market risk
Source of need for risk management
8. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Treynor measure
Debt overhang
BTR - Below Target Risk
Solve for minimum variance portfolio
9. Cannot exit position in market due to size of the position
Debt overhang
Asset liquidity risk
CAPM with taxes included (equation)
VaR - Value at Risk
10. Probability that a random variable falls below a specified threshold level
Practical considerations related to ERM implementatio
Source of need for risk management
Basic Market risk
Shortfall risk
11. Probability distribution is unknown (ex. A terrorist attack)
Carry- backs and carry- forwards
Practical considerations related to ERM implementatio
Uncertainty
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
12. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Three main reasons for financial disasters
Uncertainty
Carry- backs and carry- forwards
Effect of non- price- taking behavior on CAPM
13. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Jensen's alpha
Risk- adjusted performance measure (RAP)
Asset transformers
Tracking error
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
Shape of portfolio possibilities curve
Traits of ERM
What lead to the exponential growth to derivatives mkt?
Performance- related metrics
15. 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
Prices of risk vs sensitivity
Models used in ERM framework
Valuation vs. Risk management
CAPM (formula)
16. Volatility of unexpected outcomes
Solvency-related metrics
Risk
Shape of portfolio possibilities curve
Basis risk
17. Both probability and cost of tail events are considered
Credit event
CAPM assumption for EMH
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Operational risk
18. Market risk - Liquidity risk - Credit risk - Operational risk
Multi- period version of CAPM
Capital market line (CML)
Four major types of risk
Carry- backs and carry- forwards
19. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Sharpe measure
Risks excluded from operational risk
Settlement risk
Ten assumptions underlying CAPM
20. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Business Risk
Valuation vs. Risk management
Basic Market risk
RAR = relative return of portfolio (RRp)
21. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Solve for minimum variance portfolio
Settlement risk
CAPM with taxes included (equation)
22. 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
Traits of ERM
Probability of ruin
Contango
Kidder Peabody
23. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Effect of heterogeneous expectations on CAPM
Morningstar Rating System
Asset transformers
Where is risk coming from
24. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Allied Irish Bank
Drysdale Securities (Chase Manhattan)
Liquidity risk
Options motivation on volatility
25. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Solvency-related metrics
Ri = Rz + (gamma)(beta)
VaR- based analysis (formula)
Effect of non- price- taking behavior on CAPM
26. Return is linearly related to growth rate in consumption
Exposure
Source of need for risk management
Multi- period version of CAPM
Performance- related metrics
27. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Contango
Importance of communication for risk managers
Nonparametric VaR
Sortino ratio
28. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Kidder Peabody
3 main types of operational risk
Sovereign risk
Tax shield
29. The lower (closer to - 1) - the higher the payoff from diversification
VaR - Value at Risk
Correlation coefficient effect on diversification
Sortino ratio
Risk types addressed by ERM
30. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
VaR- based analysis (formula)
BTR - Below Target Risk
Forms of Market risk
Effect of non- price- taking behavior on CAPM
31. 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
Operational risk
Risk Management Irrelevance Proposition
Shortcomings of risk metrics
Solve for minimum variance portfolio
32. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Credit event
Security (primary vs secondary)
Recovery rate
Uncertainty
33. Modeling approach is typically between statistical analytic models and structural simulation models
Risks excluded from operational risk
Models used in ERM framework
Nonparametric VaR
Three main reasons for financial disasters
34. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Options motivation on volatility
CAPM assumption for EMH
Nonmarketable asset impact on CAPM
Models used in ERM framework
35. 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 risk
CAPM with taxes included (equation)
Exposure
Barings
36. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Models used in ERM framework
Nonmarketable asset impact on CAPM
VaR - Value at Risk
Shortcomings of risk metrics
37. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Solvency-related metrics
Kidder Peabody
Uncertainty
Settlement risk
38. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Standard deviation of two assets
Sharpe measure
Shortfall risk
Differences in financial risk management for financial companies vs industrial companies
39. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Jensen's alpha
Basis
Security (primary vs secondary)
40. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Where is risk coming from
Zero- beta CAPM (two factor model)
Basic Market risk
Barings
41. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Business risks
Ri = ai + bi1l1 + bi2l2....+ei
Market risk
Asset liquidity risk
42. 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
Allied Irish Bank
Solve for minimum variance portfolio
Prices of risk vs sensitivity
Shortcomings of risk metrics
43. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
LTCM
Zero- beta CAPM (two factor model)
Three main reasons for financial disasters
Derivative contract
44. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Expected return of two assets
Standard deviation of two assets
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Asset transformers
45. Risk of loses owing to movements in level or volatility of market prices
Market risk
Expected return of two assets
Where is risk coming from
Barings
46. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Probability of ruin
What lead to the exponential growth to derivatives mkt?
Effect of non- price- taking behavior on CAPM
Standard deviation of two assets
47. Wrong distribution - Historical sample may not apply
Efficient frontier
Solvency-related metrics
RAR = relative return of portfolio (RRp)
Ways risk can be mismeasured
48. Interest rate movements - derivatives - defaults
Shape of portfolio possibilities curve
Valuation vs. Risk management
Financial Risk
Importance of communication for risk managers
49. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Solvency-related metrics
Basis risk
Zero- beta CAPM (two factor model)
Banker's Trust
50. Inability to make payment obligations (ex. Margin calls)
Effect of non- price- taking behavior on CAPM
Funding liquidity risk
Nonparametric VaR
Traits of ERM