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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. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
What lead to the exponential growth to derivatives mkt?
Options motivation on volatility
Asset transformers
Correlation coefficient effect on diversification
2. 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
Shortcomings of risk metrics
Barings
Asset liquidity risk
Banker's Trust
3. Asset-liability/market-liquidity risk
Liquidity risk
Contango
Traits of ERM
CAPM assumption for EMH
4. Rp = XaRa + XbRb
Shortfall risk
Expected return of two assets
Prices of risk vs sensitivity
Forms of Market risk
5. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Probability of ruin
Uncertainty
CAPM (formula)
Basis
6. Risk of loses owing to movements in level or volatility of market prices
Nonparametric VaR
Market risk
Credit event
Probability of ruin
7. Changes in vol - implied or actual
Three main reasons for financial disasters
Volatility Market risk
Banker's Trust
Forms of Market risk
8. 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
APT for passive portfolio management
Basis
Contango
Sortino ratio
9. Unanticipated movements in relative prices of assets in hedged position
Nonparametric VaR
Barings
Sharpe measure
Basic Market risk
10. Strategic risk - Business risk - Reputational risk
Basis risk
Solvency-related metrics
APT in active portfolio management
Risks excluded from operational risk
11. Concave function that extends from minimum variance portfolio to maximum return portfolio
Practical considerations related to ERM implementatio
Efficient frontier
Business risks
Jensen's alpha
12. Hazard - Financial - Operational - Strategic
Risk
Risk types addressed by ERM
Business Risk
What lead to the exponential growth to derivatives mkt?
13. 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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14. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Banker's Trust
Treynor measure
Probability of ruin
Multi- period version of CAPM
15. 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
Debt overhang
Ten assumptions underlying CAPM
Tax shield
Jensen's alpha
16. Losses due to market activities ex. Interest rate changes or defaults
Parametric VaR
Risk Management Irrelevance Proposition
Source of need for risk management
Financial risks
17. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Effect of heterogeneous expectations on CAPM
Risk Management Irrelevance Proposition
APT in active portfolio management
Sortino ratio
18. 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 -
Source of need for risk management
Debt overhang
Options motivation on volatility
Formula for covariance
19. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Liquidity risk
Effect of non- price- taking behavior on CAPM
Jensen's alpha
Ri = Rz + (gamma)(beta)
20. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Uncertainty
Risk- adjusted performance measure (RAP)
Importance of communication for risk managers
Risk
21. Probability distribution is unknown (ex. A terrorist attack)
Funding liquidity risk
Recovery rate
Uncertainty
CAPM with taxes included (equation)
22. Derives value from an underlying asset - rate - or index - Derives value from a security
Derivative contract
Ways firms can fail to account for risks
Contango
CAPM (formula)
23. 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
APT (equation and assumptions)
Capital market line (CML)
Nonparametric VaR
24. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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25. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Business Risk
Three main reasons for financial disasters
Carry- backs and carry- forwards
What lead to the exponential growth to derivatives mkt?
26. 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
Information ratio
Performance- related metrics
Risk Management Irrelevance Proposition
Allied Irish Bank
27. 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
Risk
Barings
Settlement risk
Basis
28. The need to hedge against risks - for firms need to speculate.
What lead to the exponential growth to derivatives mkt?
Settlement risk
Recovery rate
Performance- related metrics
29. Occurs the day when two parties exchange payments same day
Nonmarketable asset impact on CAPM
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Settlement risk
Performance- related metrics
30. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Formula for covariance
Tax shield
Market imperfections that can create value
Basic Market risk
31. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Valuation vs. Risk management
Jensen's alpha
Nonmarketable asset impact on CAPM
Shortcomings of risk metrics
32. The uses of debt to fall into a lower tax rate
Sharpe measure
Kidder Peabody
VaR- based analysis (formula)
Tax shield
33. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
3 main types of operational risk
Risk- adjusted performance measure (RAP)
VaR - Value at Risk
Efficient frontier
34. Probability that a random variable falls below a specified threshold level
Drysdale Securities (Chase Manhattan)
Risk
Shortfall risk
Debt overhang
35. Need to assess risk and tell management so they can determine which risks to take on
Importance of communication for risk managers
Solve for minimum variance portfolio
Nonmarketable asset impact on CAPM
Standard deviation of two assets
36. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
CAPM with taxes included (equation)
Shortcomings of risk metrics
Standard deviation of two assets
Tax shield
37. 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
Forms of Market risk
LTCM
Recovery rate
Business risks
38. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Capital market line (CML)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Contango
Information ratio
39. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Debt overhang
Where is risk coming from
Formula for covariance
Ten assumptions underlying CAPM
40. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Barings
Credit event
Uncertainty
Differences in financial risk management for financial companies vs industrial companies
41. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Effect of heterogeneous expectations on CAPM
Uncertainty
Options motivation on volatility
Ri = ai + bi1l1 + bi2l2....+ei
42. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Basic Market risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
Where is risk coming from
Source of need for risk management
43. Absolute and relative risk - direction and non-directional
Forms of Market risk
Settlement risk
Zero- beta CAPM (two factor model)
Models used in ERM framework
44. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Shortfall risk
Importance of communication for risk managers
Performance- related metrics
Effect of heterogeneous expectations on CAPM
45. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Morningstar Rating System
Correlation coefficient effect on diversification
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
APT for passive portfolio management
46. Interest rate movements - derivatives - defaults
Operational risk
Financial Risk
APT in active portfolio management
Nonmarketable asset impact on CAPM
47. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Practical considerations related to ERM implementatio
Credit event
Firms becoming more sensitive to changes(bank deregulation)
VaR- based analysis (formula)
48. Prices of risk are common factors and do not change - Sensitivities can change
Barings
Uncertainty
Sortino ratio
Prices of risk vs sensitivity
49. Country specific - Foreign exchange controls that prohibit counterparty's obligations
CAPM with taxes included (equation)
RAR = relative return of portfolio (RRp)
Differences in financial risk management for financial companies vs industrial companies
Sovereign risk
50. 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
Expected return of two assets
Shape of portfolio possibilities curve
Firms becoming more sensitive to changes(bank deregulation)