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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. 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
Risk
Allied Irish Bank
Practical considerations related to ERM implementatio
Liquidity risk
2. Covariance = correlation coefficient std dev(a) std dev(b)
LTCM
Formula for covariance
Risk- adjusted performance measure (RAP)
What lead to the exponential growth to derivatives mkt?
3. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Roles of risk management
Traits of ERM
Debt overhang
Source of need for risk management
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
Tax shield
Sovereign risk
Expected return of two assets
LTCM
5. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Effect of heterogeneous expectations on CAPM
Business Risk
Shortcomings of risk metrics
EPD or ECOR - Expected Policyholder Deficit (EPD)
6. Asset-liability/market-liquidity risk
RAR = relative return of portfolio (RRp)
Liquidity risk
Parametric VaR
Recovery rate
7. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Sharpe measure
Models used in ERM framework
Risk
Kidder Peabody
8. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Importance of communication for risk managers
Sharpe measure
Risk- adjusted performance measure (RAP)
Risk Management Irrelevance Proposition
9. The need to hedge against risks - for firms need to speculate.
Exposure
VaR - Value at Risk
Standard deviation of two assets
What lead to the exponential growth to derivatives mkt?
10. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Risk- adjusted performance measure (RAP)
Liquidity risk
Practical considerations related to ERM implementatio
CAPM with taxes included (equation)
11. Multibeta CAPM Ri - Rf =
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Shape of portfolio possibilities curve
Three main reasons for financial disasters
Uncertainty
12. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Importance of communication for risk managers
Business Risk
Effect of non- price- taking behavior on CAPM
Asset liquidity risk
13. Law of one price - Homogeneous expectations - Security returns process
VaR- based analysis (formula)
Practical considerations related to ERM implementatio
APT (equation and assumptions)
EPD or ECOR - Expected Policyholder Deficit (EPD)
14. Risk of loses owing to movements in level or volatility of market prices
Market risk
Multi- period version of CAPM
Three main reasons for financial disasters
Firms becoming more sensitive to changes(bank deregulation)
15. 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
Sortino ratio
Risk- adjusted performance measure (RAP)
Shape of portfolio possibilities curve
16. The lower (closer to - 1) - the higher the payoff from diversification
Formula for covariance
Capital market line (CML)
Contango
Correlation coefficient effect on diversification
17. Interest rate movements - derivatives - defaults
Capital market line (CML)
Nonparametric VaR
Uncertainty
Financial Risk
18. Changes in vol - implied or actual
Business Risk
RAR = relative return of portfolio (RRp)
Volatility Market risk
Risk
19. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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20. Prices of risk are common factors and do not change - Sensitivities can change
Asset liquidity risk
Prices of risk vs sensitivity
LTCM
Solvency-related metrics
21. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Financial Risk
VaR- based analysis (formula)
Credit event
Effect of heterogeneous expectations on CAPM
22. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Debt overhang
Uncertainty
CAPM with taxes included (equation)
Market imperfections that can create value
23. 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
Performance- related metrics
Multi- period version of CAPM
Capital market line (CML)
Effect of heterogeneous expectations on CAPM
24. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Capital market line (CML)
Basis risk
Jensen's alpha
3 main types of operational risk
25. 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
RAR = relative return of portfolio (RRp)
Shortcomings of risk metrics
Kidder Peabody
Market risk
26. 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
Treynor measure
Parametric VaR
Practical considerations related to ERM implementatio
Ways firms can fail to account for risks
27. Wrong distribution - Historical sample may not apply
Ways risk can be mismeasured
Shape of portfolio possibilities curve
Allied Irish Bank
Shortcomings of risk metrics
28. 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
LTCM
3 main types of operational risk
CAPM (formula)
29. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Debt overhang
VaR - Value at Risk
RAR = relative return of portfolio (RRp)
Sovereign risk
30. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Contango
Risk
Source of need for risk management
VaR - Value at Risk
31. 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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32. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Ten assumptions underlying CAPM
Liquidity risk
Where is risk coming from
VaR- based analysis (formula)
33. 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
What lead to the exponential growth to derivatives mkt?
Security (primary vs secondary)
Effect of non- price- taking behavior on CAPM
Traits of ERM
34. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Nonmarketable asset impact on CAPM
Expected return of two assets
Ways risk can be mismeasured
3 main types of operational risk
35. 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)
Shortcomings of risk metrics
Market imperfections that can create value
Forms of Market risk
36. Absolute and relative risk - direction and non-directional
Forms of Market risk
Asset transformers
Uncertainty
VaR- based analysis (formula)
37. Rp = XaRa + XbRb
Expected return of two assets
Volatility Market risk
Risk Management Irrelevance Proposition
Risks excluded from operational risk
38. Need to assess risk and tell management so they can determine which risks to take on
Jensen's alpha
Roles of risk management
Importance of communication for risk managers
APT for passive portfolio management
39. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
APT in active portfolio management
BTR - Below Target Risk
Zero- beta CAPM (two factor model)
VaR - Value at Risk
40. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Risk- adjusted performance measure (RAP)
Shortcomings of risk metrics
Jensen's alpha
3 main types of operational risk
41. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Solvency-related metrics
Liquidity risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
Roles of risk management
42. Expected value of unfavorable deviations of a random variable from a specified target level
Market risk
Carry- backs and carry- forwards
Effect of heterogeneous expectations on CAPM
BTR - Below Target Risk
43. When two payments are exchanged the same day and one party may default after payment is made
Asset transformers
Shortcomings of risk metrics
Liquidity risk
Settlement risk
44. Modeling approach is typically between statistical analytic models and structural simulation models
Expected return of two assets
Models used in ERM framework
Risk Management Irrelevance Proposition
Source of need for risk management
45. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Options motivation on volatility
Correlation coefficient effect on diversification
Formula for covariance
Debt overhang
46. Occurs the day when two parties exchange payments same day
Settlement risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
Basis risk
Drysdale Securities (Chase Manhattan)
47. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Settlement risk
Options motivation on volatility
Market risk
Solve for minimum variance portfolio
48. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
APT for passive portfolio management
Market imperfections that can create value
Information ratio
Ways firms can fail to account for risks
49. When negative taxable income is moved to a different year to offset future or past taxable income
Firms becoming more sensitive to changes(bank deregulation)
Importance of communication for risk managers
Information ratio
Carry- backs and carry- forwards
50. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Solvency-related metrics
Sharpe measure
Effect of heterogeneous expectations on CAPM
Banker's Trust