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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.
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. Risk of loses owing to movements in level or volatility of market prices
Ways firms can fail to account for risks
Source of need for risk management
Differences in financial risk management for financial companies vs industrial companies
Market risk
2. 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
Kidder Peabody
RAR = relative return of portfolio (RRp)
Basis risk
Options motivation on volatility
3. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Treynor measure
Differences in financial risk management for financial companies vs industrial companies
Risk- adjusted performance measure (RAP)
APT for passive portfolio management
4. 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
Risk Management Irrelevance Proposition
Valuation vs. Risk management
Information ratio
5. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Basis
Carry- backs and carry- forwards
Effect of non- price- taking behavior on CAPM
Liquidity risk
6. Cannot exit position in market due to size of the position
Asset liquidity risk
What lead to the exponential growth to derivatives mkt?
Ri = ai + bi1l1 + bi2l2....+ei
Parametric VaR
7. Asses firm risks - Communicate risks - Manage and monitor risks
Roles of risk management
Options motivation on volatility
LTCM
CAPM with taxes included (equation)
8. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Options motivation on volatility
Differences in financial risk management for financial companies vs industrial companies
Business Risk
Barings
9. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Uncertainty
Performance- related metrics
Expected return of two assets
Debt overhang
10. Return is linearly related to growth rate in consumption
Multi- period version of CAPM
Solvency-related metrics
Practical considerations related to ERM implementatio
Shortcomings of risk metrics
11. Modeling approach is typically between statistical analytic models and structural simulation models
Exposure
Derivative contract
Traits of ERM
Models used in ERM framework
12. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Shape of portfolio possibilities curve
Asset liquidity risk
Sovereign risk
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
Sharpe measure
Multi- period version of CAPM
Barings
CAPM assumption for EMH
14. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Settlement risk
APT for passive portfolio management
Sharpe measure
Credit event
15. Probability distribution is unknown (ex. A terrorist attack)
Ways firms can fail to account for risks
Uncertainty
CAPM (formula)
Contango
16. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Three main reasons for financial disasters
Capital market line (CML)
Business Risk
Ri = ai + bi1l1 + bi2l2....+ei
17. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Zero- beta CAPM (two factor model)
APT in active portfolio management
Differences in financial risk management for financial companies vs industrial companies
Operational risk
18. 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
Ways risk can be mismeasured
Shortfall risk
Models used in ERM framework
19. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
CAPM assumption for EMH
Zero- beta CAPM (two factor model)
Tax shield
Standard deviation of two assets
20. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Asset transformers
Solvency-related metrics
Uncertainty
Nonmarketable asset impact on CAPM
21. 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
Importance of communication for risk managers
Asset liquidity risk
Ri = ai + bi1l1 + bi2l2....+ei
APT for passive portfolio management
22. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Risk- adjusted performance measure (RAP)
Liquidity risk
VaR - Value at Risk
Recovery rate
23. Unanticipated movements in relative prices of assets in hedged position
Contango
Basic Market risk
Asset liquidity risk
Jensen's alpha
24. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Asset liquidity risk
CAPM with taxes included (equation)
APT in active portfolio management
Efficient frontier
25. 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 -
Basis risk
Source of need for risk management
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Expected return of two assets
26. Quantile of a statistical distribution
Forms of Market risk
Risk Management Irrelevance Proposition
Parametric VaR
Ways firms can fail to account for risks
27. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Debt overhang
Performance- related metrics
VaR - Value at Risk
Efficient frontier
28. Hazard - Financial - Operational - Strategic
Operational risk
What lead to the exponential growth to derivatives mkt?
Risk types addressed by ERM
Roles of risk management
29. Occurs the day when two parties exchange payments same day
Ways risk can be mismeasured
Business risks
Nonmarketable asset impact on CAPM
Settlement risk
30. 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
3 main types of operational risk
Practical considerations related to ERM implementatio
Basic Market risk
31. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Banker's Trust
Standard deviation of two assets
Funding liquidity risk
CAPM (formula)
32. 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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33. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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34. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Recovery rate
Expected return of two assets
CAPM (formula)
What lead to the exponential growth to derivatives mkt?
35. The lower (closer to - 1) - the higher the payoff from diversification
Four major types of risk
Probability of ruin
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Correlation coefficient effect on diversification
36. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Options motivation on volatility
Tax shield
Traits of ERM
Zero- beta CAPM (two factor model)
37. Derives value from an underlying asset - rate - or index - Derives value from a security
Market imperfections that can create value
Derivative contract
RAR = relative return of portfolio (RRp)
Ways risk can be mismeasured
38. Returns on any stock are linearly related to a set of indexes
Ri = ai + bi1l1 + bi2l2....+ei
Volatility Market risk
Multi- period version of CAPM
Options motivation on volatility
39. When negative taxable income is moved to a different year to offset future or past taxable income
Source of need for risk management
CAPM (formula)
Market imperfections that can create value
Carry- backs and carry- forwards
40. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Differences in financial risk management for financial companies vs industrial companies
Market risk
41. Probability that a random variable falls below a specified threshold level
Kidder Peabody
Prices of risk vs sensitivity
Security (primary vs secondary)
Shortfall risk
42. Law of one price - Homogeneous expectations - Security returns process
Capital market line (CML)
Practical considerations related to ERM implementatio
APT (equation and assumptions)
Expected return of two assets
43. 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
Contango
Drysdale Securities (Chase Manhattan)
Market imperfections that can create value
LTCM
44. Volatility of unexpected outcomes
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Risk
Shortfall risk
APT for passive portfolio management
45. When two payments are exchanged the same day and one party may default after payment is made
Efficient frontier
Prices of risk vs sensitivity
Volatility Market risk
Settlement risk
46. Inability to make payment obligations (ex. Margin calls)
Funding liquidity risk
Banker's Trust
Source of need for risk management
Information ratio
47. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Practical considerations related to ERM implementatio
Debt overhang
Correlation coefficient effect on diversification
Ways risk can be mismeasured
48. Both probability and cost of tail events are considered
Solvency-related metrics
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Business Risk
Funding liquidity risk
49. Multibeta CAPM Ri - Rf =
Funding liquidity risk
Derivative contract
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
RAR = relative return of portfolio (RRp)
50. Absolute and relative risk - direction and non-directional
Basis
Forms of Market risk
Capital market line (CML)
Practical considerations related to ERM implementatio