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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. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Basis risk
Drysdale Securities (Chase Manhattan)
Asset transformers
Debt overhang
2. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Operational risk
Multi- period version of CAPM
Basic Market risk
Uncertainty
3. 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
Uncertainty
Probability of ruin
Credit event
Three main reasons for financial disasters
4. Concave function that extends from minimum variance portfolio to maximum return portfolio
Credit event
Efficient frontier
CAPM assumption for EMH
Expected return of two assets
5. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Tracking error
Asset liquidity risk
Roles of risk management
Market imperfections that can create value
6. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Sovereign risk
Tax shield
Firms becoming more sensitive to changes(bank deregulation)
Sharpe measure
7. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Ways firms can fail to account for risks
Shortfall risk
Basis
Derivative contract
8. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Derivative contract
Risk- adjusted performance measure (RAP)
3 main types of operational risk
LTCM
9. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
CAPM (formula)
Shape of portfolio possibilities curve
APT (equation and assumptions)
VaR - Value at Risk
10. 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
VaR- based analysis (formula)
Traits of ERM
Volatility Market risk
Risks excluded from operational risk
11. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
LTCM
Differences in financial risk management for financial companies vs industrial companies
APT in active portfolio management
APT for passive portfolio management
12. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
What lead to the exponential growth to derivatives mkt?
EPD or ECOR - Expected Policyholder Deficit (EPD)
Sortino ratio
Options motivation on volatility
13. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Performance- related metrics
Basic Market risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Funding liquidity risk
14. Rp = XaRa + XbRb
Treynor measure
Expected return of two assets
Standard deviation of two assets
Volatility Market risk
15. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Three main reasons for financial disasters
Tax shield
Ten assumptions underlying CAPM
Debt overhang
16. 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
Market imperfections that can create value
CAPM assumption for EMH
Options motivation on volatility
17. Cannot exit position in market due to size of the position
Asset liquidity risk
Banker's Trust
Settlement risk
Security (primary vs secondary)
18. Prices of risk are common factors and do not change - Sensitivities can change
Prices of risk vs sensitivity
APT for passive portfolio management
Options motivation on volatility
Formula for covariance
19. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Standard deviation of two assets
Risks excluded from operational risk
Where is risk coming from
Treynor measure
20. Multibeta CAPM Ri - Rf =
Volatility Market risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Differences in financial risk management for financial companies vs industrial companies
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
21. Expected value of unfavorable deviations of a random variable from a specified target level
Firms becoming more sensitive to changes(bank deregulation)
BTR - Below Target Risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Basis risk
22. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Tracking error
Credit event
Debt overhang
Business Risk
23. Wrong distribution - Historical sample may not apply
Zero- beta CAPM (two factor model)
Valuation vs. Risk management
Risk
Ways risk can be mismeasured
24. Market risk - Liquidity risk - Credit risk - Operational risk
APT in active portfolio management
Four major types of risk
Morningstar Rating System
APT for passive portfolio management
25. Returns on any stock are linearly related to a set of indexes
Ri = ai + bi1l1 + bi2l2....+ei
Kidder Peabody
Nonmarketable asset impact on CAPM
Treynor measure
26. 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
Prices of risk vs sensitivity
Kidder Peabody
APT (equation and assumptions)
Nonparametric VaR
27. Covariance = correlation coefficient std dev(a) std dev(b)
Debt overhang
Formula for covariance
Ways firms can fail to account for risks
CAPM with taxes included (equation)
28. The need to hedge against risks - for firms need to speculate.
Morningstar Rating System
Security (primary vs secondary)
What lead to the exponential growth to derivatives mkt?
Contango
29. 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
Basis risk
Practical considerations related to ERM implementatio
Basic Market risk
Source of need for risk management
30. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Barings
Risk
Basic Market risk
Funding liquidity risk
31. Asset-liability/market-liquidity risk
Solvency-related metrics
Basis risk
Liquidity risk
Ways firms can fail to account for risks
32. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
APT for passive portfolio management
Treynor measure
Nonmarketable asset impact on CAPM
Exposure
33. The uses of debt to fall into a lower tax rate
Tax shield
Sovereign risk
Expected return of two assets
Three main reasons for financial disasters
34. 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
Valuation vs. Risk management
Standard deviation of two assets
Allied Irish Bank
Asset transformers
35. Quantile of an empirical distribution
Valuation vs. Risk management
Nonparametric VaR
3 main types of operational risk
Prices of risk vs sensitivity
36. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Recovery rate
Settlement risk
Solve for minimum variance portfolio
Uncertainty
37. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Models used in ERM framework
APT in active portfolio management
Effect of non- price- taking behavior on CAPM
Tracking error
38. Law of one price - Homogeneous expectations - Security returns process
Performance- related metrics
Derivative contract
APT (equation and assumptions)
Source of need for risk management
39. When negative taxable income is moved to a different year to offset future or past taxable income
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Carry- backs and carry- forwards
Formula for covariance
Shape of portfolio possibilities curve
40. Modeling approach is typically between statistical analytic models and structural simulation models
Models used in ERM framework
Banker's Trust
Basic Market risk
Security (primary vs secondary)
41. 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
Jensen's alpha
Allied Irish Bank
Formula for covariance
Tax shield
42. Interest rate movements - derivatives - defaults
VaR - Value at Risk
RAR = relative return of portfolio (RRp)
Shortfall risk
Financial Risk
43. Hazard - Financial - Operational - Strategic
Solvency-related metrics
Risk types addressed by ERM
Credit event
Risk
44. Derives value from an underlying asset - rate - or index - Derives value from a security
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Options motivation on volatility
Derivative contract
3 main types of operational risk
45. 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
BTR - Below Target Risk
3 main types of operational risk
Drysdale Securities (Chase Manhattan)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
46. Return is linearly related to growth rate in consumption
Risk- adjusted performance measure (RAP)
Multi- period version of CAPM
Settlement risk
Ri = ai + bi1l1 + bi2l2....+ei
47. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
APT (equation and assumptions)
Practical considerations related to ERM implementatio
Where is risk coming from
CAPM with taxes included (equation)
48. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Shortfall risk
Practical considerations related to ERM implementatio
Market risk
Effect of heterogeneous expectations on CAPM
49. Those which corporations assume whillingly to create competitive advantage/add shareholder value - Business Decisions: investment decisions - prod - dev choices - marketing strategies - organizational struct. - Business Environment: competitive and
Business Risk
Ten assumptions underlying CAPM
Banker's Trust
Tail VaR or TCE - Tail Conditional Expectation(TCE)
50. Strategic risk - Business risk - Reputational risk
Efficient frontier
Risks excluded from operational risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Information ratio