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Test your basic knowledge |
FRM: Foundations Of Risk Management
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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. Potential amount that can be lost
Probability of ruin
Ways risk can be mismeasured
Effect of non- price- taking behavior on CAPM
Exposure
2. 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
Allied Irish Bank
Settlement risk
Drysdale Securities (Chase Manhattan)
Morningstar Rating System
3. The lower (closer to - 1) - the higher the payoff from diversification
Volatility Market risk
Options motivation on volatility
Correlation coefficient effect on diversification
Risk
4. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Settlement risk
Effect of non- price- taking behavior on CAPM
Risk- adjusted performance measure (RAP)
Multi- period version of CAPM
5. Derives value from an underlying asset - rate - or index - Derives value from a security
Security (primary vs secondary)
Derivative contract
Allied Irish Bank
3 main types of operational risk
6. Rp = XaRa + XbRb
Expected return of two assets
Nonparametric VaR
Performance- related metrics
3 main types of operational risk
7. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Basic Market risk
3 main types of operational risk
Nonmarketable asset impact on CAPM
Jensen's alpha
8. 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
Business risks
Expected return of two assets
Multi- period version of CAPM
Capital market line (CML)
9. Returns on any stock are linearly related to a set of indexes
Effect of non- price- taking behavior on CAPM
Risks excluded from operational risk
Ri = ai + bi1l1 + bi2l2....+ei
Prices of risk vs sensitivity
10. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Security (primary vs secondary)
Sovereign risk
APT (equation and assumptions)
Traits of ERM
11. Occurs the day when two parties exchange payments same day
Settlement risk
Market imperfections that can create value
Standard deviation of two assets
Derivative contract
12. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Settlement risk
Settlement risk
Firms becoming more sensitive to changes(bank deregulation)
BTR - Below Target Risk
13. When two payments are exchanged the same day and one party may default after payment is made
Shortfall risk
Settlement risk
Financial risks
Differences in financial risk management for financial companies vs industrial companies
14. Future price is greater than the spot price
Sovereign risk
Source of need for risk management
Ways risk can be mismeasured
Contango
15. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Shortcomings of risk metrics
Four major types of risk
Where is risk coming from
Risk Management Irrelevance Proposition
16. 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
Morningstar Rating System
Ways firms can fail to account for risks
Prices of risk vs sensitivity
Carry- backs and carry- forwards
17. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Differences in financial risk management for financial companies vs industrial companies
Business Risk
Traits of ERM
Tax shield
18. Both probability and cost of tail events are considered
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Market imperfections that can create value
Practical considerations related to ERM implementatio
RAR = relative return of portfolio (RRp)
19. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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20. Modeling approach is typically between statistical analytic models and structural simulation models
Settlement risk
VaR- based analysis (formula)
Models used in ERM framework
Valuation vs. Risk management
21. Asset-liability/market-liquidity risk
Ri = Rz + (gamma)(beta)
Debt overhang
Valuation vs. Risk management
Liquidity risk
22. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Jensen's alpha
Risk Management Irrelevance Proposition
Credit event
Asset liquidity risk
23. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Recovery rate
Where is risk coming from
Formula for covariance
Business risks
24. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Parametric VaR
APT in active portfolio management
Formula for covariance
Volatility Market risk
25. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
EPD or ECOR - Expected Policyholder Deficit (EPD)
Standard deviation of two assets
Firms becoming more sensitive to changes(bank deregulation)
Debt overhang
26. Hazard - Financial - Operational - Strategic
CAPM (formula)
What lead to the exponential growth to derivatives mkt?
Risk types addressed by ERM
Financial Risk
27. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Parametric VaR
Morningstar Rating System
Practical considerations related to ERM implementatio
Ri = Rz + (gamma)(beta)
28. Interest rate movements - derivatives - defaults
Roles of risk management
Multi- period version of CAPM
Risks excluded from operational risk
Financial Risk
29. Asses firm risks - Communicate risks - Manage and monitor risks
Roles of risk management
Valuation vs. Risk management
Uncertainty
Solve for minimum variance portfolio
30. Quantile of a statistical distribution
Drysdale Securities (Chase Manhattan)
Zero- beta CAPM (two factor model)
Efficient frontier
Parametric VaR
31. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
3 main types of operational risk
Information ratio
Sharpe measure
Nonparametric VaR
32. 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
Sortino ratio
Firms becoming more sensitive to changes(bank deregulation)
EPD or ECOR - Expected Policyholder Deficit (EPD)
33. Wrong distribution - Historical sample may not apply
Ways risk can be mismeasured
Multi- period version of CAPM
Financial Risk
Operational risk
34. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Nonparametric VaR
Risk- adjusted performance measure (RAP)
Zero- beta CAPM (two factor model)
Options motivation on volatility
35. 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
Volatility Market risk
Risk
Parametric VaR
36. Losses due to market activities ex. Interest rate changes or defaults
Expected return of two assets
Forms of Market risk
Financial risks
Ways firms can fail to account for risks
37. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Zero- beta CAPM (two factor model)
Business risks
Solvency-related metrics
Treynor measure
38. The need to hedge against risks - for firms need to speculate.
Carry- backs and carry- forwards
Debt overhang
Importance of communication for risk managers
What lead to the exponential growth to derivatives mkt?
39. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Forms of Market risk
Shape of portfolio possibilities curve
CAPM (formula)
CAPM assumption for EMH
40. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Traits of ERM
Debt overhang
Efficient frontier
Correlation coefficient effect on diversification
41. 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
Market risk
Settlement risk
Kidder Peabody
Ways risk can be mismeasured
42. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
APT (equation and assumptions)
Formula for covariance
What lead to the exponential growth to derivatives mkt?
Sortino ratio
43. Unanticipated movements in relative prices of assets in hedged position
Basic Market risk
Ways risk can be mismeasured
Sovereign risk
Funding liquidity risk
44. 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
Risks excluded from operational risk
Where is risk coming from
Valuation vs. Risk management
Risk
45. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Ways firms can fail to account for risks
Risk- adjusted performance measure (RAP)
RAR = relative return of portfolio (RRp)
APT (equation and assumptions)
46. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Valuation vs. Risk management
Basic Market risk
Basis
Options motivation on volatility
47. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Exposure
APT for passive portfolio management
CAPM assumption for EMH
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
48. Covariance = correlation coefficient std dev(a) std dev(b)
APT in active portfolio management
Formula for covariance
Business Risk
Options motivation on volatility
49. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Asset transformers
Ways firms can fail to account for risks
Drysdale Securities (Chase Manhattan)
Standard deviation of two assets
50. Market risk - Liquidity risk - Credit risk - Operational risk
Tax shield
Recovery rate
Parametric VaR
Four major types of risk