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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. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Funding liquidity risk
Parametric VaR
Treynor measure
Standard deviation of two assets
2. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Standard deviation of two assets
Basis risk
Barings
Importance of communication for risk managers
3. RM cannot increase firm value when it costs the same to bear a risk w/in the firm or outside the firm - For RM to increase firm value it must be more expensive to bear risks internally than to pay capital markets to bear them.
Valuation vs. Risk management
Ways firms can fail to account for risks
Solve for minimum variance portfolio
Risk Management Irrelevance Proposition
4. When negative taxable income is moved to a different year to offset future or past taxable income
Carry- backs and carry- forwards
Operational risk
Drysdale Securities (Chase Manhattan)
Firms becoming more sensitive to changes(bank deregulation)
5. The need to hedge against risks - for firms need to speculate.
Basic Market risk
What lead to the exponential growth to derivatives mkt?
Carry- backs and carry- forwards
Ways firms can fail to account for risks
6. 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
Nonparametric VaR
Options motivation on volatility
Ways risk can be mismeasured
7. 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
Probability of ruin
Capital market line (CML)
Financial Risk
8. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Effect of heterogeneous expectations on CAPM
Where is risk coming from
Expected return of two assets
Sortino ratio
9. 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
Allied Irish Bank
Risk
Information ratio
10. Asset-liability/market-liquidity risk
VaR - Value at Risk
Liquidity risk
3 main types of operational risk
CAPM assumption for EMH
11. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Security (primary vs secondary)
Recovery rate
Risk
Financial risks
12. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Practical considerations related to ERM implementatio
Firms becoming more sensitive to changes(bank deregulation)
BTR - Below Target Risk
CAPM assumption for EMH
13. 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
Solvency-related metrics
Debt overhang
Formula for covariance
Barings
14. 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)
Barings
Four major types of risk
Drysdale Securities (Chase Manhattan)
15. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Carry- backs and carry- forwards
Roles of risk management
Information ratio
Effect of heterogeneous expectations on CAPM
16. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Source of need for risk management
Debt overhang
Risk- adjusted performance measure (RAP)
Debt overhang
17. Both probability and cost of tail events are considered
Liquidity risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Shape of portfolio possibilities curve
Market imperfections that can create value
18. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Nonmarketable asset impact on CAPM
Security (primary vs secondary)
Efficient frontier
Jensen's alpha
19. Occurs the day when two parties exchange payments same day
Settlement risk
Jensen's alpha
What lead to the exponential growth to derivatives mkt?
Risk
20. The uses of debt to fall into a lower tax rate
Source of need for risk management
3 main types of operational risk
Tax shield
APT in active portfolio management
21. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Effect of non- price- taking behavior on CAPM
Multi- period version of CAPM
Jensen's alpha
Allied Irish Bank
22. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Ri = Rz + (gamma)(beta)
Effect of non- price- taking behavior on CAPM
CAPM (formula)
Multi- period version of CAPM
23. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
3 main types of operational risk
Funding liquidity risk
APT in active portfolio management
Expected return of two assets
24. 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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25. Potential amount that can be lost
VaR - Value at Risk
Exposure
Ten assumptions underlying CAPM
Treynor measure
26. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Source of need for risk management
RAR = relative return of portfolio (RRp)
VaR- based analysis (formula)
Funding liquidity risk
27. Derives value from an underlying asset - rate - or index - Derives value from a security
Practical considerations related to ERM implementatio
Derivative contract
Probability of ruin
Importance of communication for risk managers
28. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Sovereign risk
Four major types of risk
Debt overhang
Traits of ERM
29. Volatility of unexpected outcomes
Funding liquidity risk
Risk
Probability of ruin
Zero- beta CAPM (two factor model)
30. 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
Ten assumptions underlying CAPM
Tax shield
Allied Irish Bank
Funding liquidity risk
31. Absolute and relative risk - direction and non-directional
Nonparametric VaR
Forms of Market risk
VaR- based analysis (formula)
CAPM assumption for EMH
32. Curve must be concave - Straight line connecting any two points must be under the curve
Shape of portfolio possibilities curve
APT (equation and assumptions)
Risk Management Irrelevance Proposition
Asset liquidity risk
33. Returns on any stock are linearly related to a set of indexes
Firms becoming more sensitive to changes(bank deregulation)
Ri = ai + bi1l1 + bi2l2....+ei
Liquidity risk
Parametric VaR
34. Prices of risk are common factors and do not change - Sensitivities can change
Ways firms can fail to account for risks
Nonmarketable asset impact on CAPM
Prices of risk vs sensitivity
Traits of ERM
35. The lower (closer to - 1) - the higher the payoff from diversification
Correlation coefficient effect on diversification
VaR- based analysis (formula)
Zero- beta CAPM (two factor model)
Ri = ai + bi1l1 + bi2l2....+ei
36. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Liquidity risk
RAR = relative return of portfolio (RRp)
Security (primary vs secondary)
Efficient frontier
37. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Basic Market risk
Ri = Rz + (gamma)(beta)
Multi- period version of CAPM
Credit event
38. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Forms of Market risk
Morningstar Rating System
Options motivation on volatility
Tracking error
39. Cannot exit position in market due to size of the position
Asset liquidity risk
Market risk
Tax shield
Risk
40. 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
Forms of Market risk
Correlation coefficient effect on diversification
Valuation vs. Risk management
Zero- beta CAPM (two factor model)
41. Quantile of an empirical distribution
Ten assumptions underlying CAPM
Correlation coefficient effect on diversification
Basic Market risk
Nonparametric VaR
42. When two payments are exchanged the same day and one party may default after payment is made
Settlement risk
Recovery rate
Derivative contract
Allied Irish Bank
43. Future price is greater than the spot price
Basis
Correlation coefficient effect on diversification
Contango
Nonparametric VaR
44. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Solve for minimum variance portfolio
Shortcomings of risk metrics
Allied Irish Bank
APT (equation and assumptions)
45. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Asset transformers
Zero- beta CAPM (two factor model)
Volatility Market risk
Kidder Peabody
46. Relative portfolio risk (RRiskp) - Based on a one- month investment period
What lead to the exponential growth to derivatives mkt?
Risk
Debt overhang
RAR = relative return of portfolio (RRp)
47. Probability distribution is unknown (ex. A terrorist attack)
Carry- backs and carry- forwards
Allied Irish Bank
Settlement risk
Uncertainty
48. Strategic risk - Business risk - Reputational risk
Risks excluded from operational risk
Traits of ERM
Risk Management Irrelevance Proposition
Models used in ERM framework
49. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Probability of ruin
Zero- beta CAPM (two factor model)
Effect of non- price- taking behavior on CAPM
Treynor measure
50. Risk of loses owing to movements in level or volatility of market prices
Market risk
LTCM
Zero- beta CAPM (two factor model)
Solve for minimum variance portfolio