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Test your basic knowledge |
FRM: Foundations Of Risk Management
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Subjects
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business-skills
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certifications
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frm
Instructions:
Answer 50 questions in 15 minutes.
If you are not ready to take this test, you can
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. Interest rate movements - derivatives - defaults
Contango
Valuation vs. Risk management
RAR = relative return of portfolio (RRp)
Financial Risk
2. Return is linearly related to growth rate in consumption
Shape of portfolio possibilities curve
Exposure
Multi- period version of CAPM
Basis
3. The need to hedge against risks - for firms need to speculate.
Risks excluded from operational risk
Shortfall risk
What lead to the exponential growth to derivatives mkt?
Business Risk
4. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Debt overhang
Tax shield
Operational risk
Correlation coefficient effect on diversification
5. 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
VaR - Value at Risk
Basic Market risk
Practical considerations related to ERM implementatio
Barings
6. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Probability of ruin
Security (primary vs secondary)
Correlation coefficient effect on diversification
7. 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
Risk
Solve for minimum variance portfolio
Drysdale Securities (Chase Manhattan)
Where is risk coming from
8. Capital structure (financial distress) - Taxes - Agency and information asymmetries
3 main types of operational risk
Market imperfections that can create value
Debt overhang
Solve for minimum variance portfolio
9. 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
Nonmarketable asset impact on CAPM
Volatility Market risk
Debt overhang
10. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Security (primary vs secondary)
Asset transformers
Sharpe measure
Differences in financial risk management for financial companies vs industrial companies
11. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Ways firms can fail to account for risks
Source of need for risk management
Zero- beta CAPM (two factor model)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
12. Probability that a random variable falls below a specified threshold level
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Multi- period version of CAPM
Carry- backs and carry- forwards
Shortfall risk
13. Covariance = correlation coefficient std dev(a) std dev(b)
Liquidity risk
Formula for covariance
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Exposure
14. Country specific - Foreign exchange controls that prohibit counterparty's obligations
LTCM
Sharpe measure
Sovereign risk
Drysdale Securities (Chase Manhattan)
15. Occurs the day when two parties exchange payments same day
Derivative contract
Allied Irish Bank
Shortfall risk
Settlement risk
16. 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
Ten assumptions underlying CAPM
Kidder Peabody
Shortfall risk
Recovery rate
17. Strategic risk - Business risk - Reputational risk
Risks excluded from operational risk
Importance of communication for risk managers
Jensen's alpha
Ten assumptions underlying CAPM
18. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
VaR - Value at Risk
Business risks
Effect of non- price- taking behavior on CAPM
Recovery rate
19. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Debt overhang
Carry- backs and carry- forwards
Solve for minimum variance portfolio
Ways firms can fail to account for risks
20. 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 risks
Business Risk
Information ratio
Formula for covariance
21. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Basis
RAR = relative return of portfolio (RRp)
Banker's Trust
Treynor measure
22. 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
Performance- related metrics
Four major types of risk
Differences in financial risk management for financial companies vs industrial companies
Probability of ruin
23. 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
Drysdale Securities (Chase Manhattan)
Debt overhang
Risk Management Irrelevance Proposition
Ten assumptions underlying CAPM
24. Hazard - Financial - Operational - Strategic
Zero- beta CAPM (two factor model)
Risk types addressed by ERM
Differences in financial risk management for financial companies vs industrial companies
Nonmarketable asset impact on CAPM
25. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Market imperfections that can create value
Risk- adjusted performance measure (RAP)
Morningstar Rating System
Standard deviation of two assets
26. Asses firm risks - Communicate risks - Manage and monitor risks
Kidder Peabody
Zero- beta CAPM (two factor model)
Roles of risk management
Funding liquidity risk
27. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
3 main types of operational risk
Debt overhang
Market risk
Debt overhang
28. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
CAPM (formula)
Where is risk coming from
Settlement risk
Recovery rate
29. Unanticipated movements in relative prices of assets in hedged position
Exposure
Settlement risk
Basic Market risk
Nonparametric VaR
30. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
LTCM
Three main reasons for financial disasters
Sortino ratio
Credit event
31. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Options motivation on volatility
Roles of risk management
Standard deviation of two assets
Barings
32. Changes in vol - implied or actual
Practical considerations related to ERM implementatio
Settlement risk
Volatility Market risk
Forms of Market risk
33. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Business Risk
Risk Management Irrelevance Proposition
Differences in financial risk management for financial companies vs industrial companies
Zero- beta CAPM (two factor model)
34. Concave function that extends from minimum variance portfolio to maximum return portfolio
Shortfall risk
Roles of risk management
Efficient frontier
VaR - Value at Risk
35. Cannot exit position in market due to size of the position
Asset liquidity risk
Correlation coefficient effect on diversification
Security (primary vs secondary)
Tax shield
36. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
APT for passive portfolio management
Effect of heterogeneous expectations on CAPM
Risk Management Irrelevance Proposition
Sortino ratio
37. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Nonmarketable asset impact on CAPM
Operational risk
Liquidity risk
APT (equation and assumptions)
38. Quantile of an empirical distribution
Credit event
Options motivation on volatility
Nonparametric VaR
Business risks
39. Rp = XaRa + XbRb
Correlation coefficient effect on diversification
Business risks
Settlement risk
Expected return of two assets
40. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Valuation vs. Risk management
Tracking error
Financial risks
BTR - Below Target Risk
41. Absolute and relative risk - direction and non-directional
Three main reasons for financial disasters
Forms of Market risk
Parametric VaR
Carry- backs and carry- forwards
42. 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
BTR - Below Target Risk
Valuation vs. Risk management
Performance- related metrics
Debt overhang
43. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Effect of heterogeneous expectations on CAPM
Derivative contract
CAPM (formula)
APT in active portfolio management
44. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Firms becoming more sensitive to changes(bank deregulation)
Shape of portfolio possibilities curve
Debt overhang
Basic Market risk
45. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Settlement risk
VaR- based analysis (formula)
Market risk
Ten assumptions underlying CAPM
46. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Volatility Market risk
Tax shield
RAR = relative return of portfolio (RRp)
Tail VaR or TCE - Tail Conditional Expectation(TCE)
47. Need to assess risk and tell management so they can determine which risks to take on
Tax shield
Treynor measure
Importance of communication for risk managers
Business risks
48. 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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49. When negative taxable income is moved to a different year to offset future or past taxable income
Risk- adjusted performance measure (RAP)
Standard deviation of two assets
Carry- backs and carry- forwards
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
50. Potential amount that can be lost
Basic Market risk
Source of need for risk management
Roles of risk management
Exposure