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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. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Firms becoming more sensitive to changes(bank deregulation)
Banker's Trust
Models used in ERM framework
APT in active portfolio management
2. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Performance- related metrics
Operational risk
Kidder Peabody
Morningstar Rating System
3. 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
Ri = ai + bi1l1 + bi2l2....+ei
Sovereign risk
Shortcomings of risk metrics
Capital market line (CML)
4. Wrong distribution - Historical sample may not apply
What lead to the exponential growth to derivatives mkt?
Financial risks
Ways risk can be mismeasured
Practical considerations related to ERM implementatio
5. 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
Solve for minimum variance portfolio
Traits of ERM
Allied Irish Bank
Shape of portfolio possibilities curve
6. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Debt overhang
Sovereign risk
Ri = Rz + (gamma)(beta)
CAPM assumption for EMH
7. Interest rate movements - derivatives - defaults
Solve for minimum variance portfolio
Liquidity risk
Risk types addressed by ERM
Financial Risk
8. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Jensen's alpha
Debt overhang
Volatility Market risk
Prices of risk vs sensitivity
9. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Drysdale Securities (Chase Manhattan)
Risk types addressed by ERM
VaR - Value at Risk
10. Returns on any stock are linearly related to a set of indexes
Shape of portfolio possibilities curve
Debt overhang
Ri = ai + bi1l1 + bi2l2....+ei
Market imperfections that can create value
11. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Debt overhang
Information ratio
Forms of Market risk
Jensen's alpha
12. Potential amount that can be lost
APT for passive portfolio management
Risk types addressed by ERM
Efficient frontier
Exposure
13. Rp = XaRa + XbRb
Market imperfections that can create value
Expected return of two assets
Risks excluded from operational risk
Drysdale Securities (Chase Manhattan)
14. The uses of debt to fall into a lower tax rate
Tax shield
Carry- backs and carry- forwards
Debt overhang
Capital market line (CML)
15. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
VaR - Value at Risk
Market risk
Kidder Peabody
Security (primary vs secondary)
16. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Tracking error
Zero- beta CAPM (two factor model)
Effect of heterogeneous expectations on CAPM
BTR - Below Target Risk
17. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Operational risk
APT for passive portfolio management
18. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Solve for minimum variance portfolio
Asset transformers
Debt overhang
Risk types addressed by ERM
19. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Firms becoming more sensitive to changes(bank deregulation)
Financial risks
CAPM assumption for EMH
APT in active portfolio management
20. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Treynor measure
Market imperfections that can create value
APT in active portfolio management
BTR - Below Target Risk
21. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Sharpe measure
Settlement risk
Solvency-related metrics
Business risks
22. Occurs the day when two parties exchange payments same day
VaR- based analysis (formula)
Practical considerations related to ERM implementatio
Settlement risk
What lead to the exponential growth to derivatives mkt?
23. 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
Risk Management Irrelevance Proposition
Capital market line (CML)
Traits of ERM
LTCM
24. 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
Uncertainty
APT for passive portfolio management
Sharpe measure
CAPM with taxes included (equation)
25. Return is linearly related to growth rate in consumption
Jensen's alpha
Tax shield
Multi- period version of CAPM
Efficient frontier
26. The need to hedge against risks - for firms need to speculate.
Barings
Roles of risk management
What lead to the exponential growth to derivatives mkt?
Financial risks
27. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Jensen's alpha
Derivative contract
Business Risk
RAR = relative return of portfolio (RRp)
28. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Sharpe measure
3 main types of operational risk
Contango
Risk
29. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Effect of heterogeneous expectations on CAPM
Shape of portfolio possibilities curve
Kidder Peabody
Sharpe measure
30. When two payments are exchanged the same day and one party may default after payment is made
VaR - Value at Risk
Settlement risk
Solve for minimum variance portfolio
Basic Market risk
31. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Importance of communication for risk managers
EPD or ECOR - Expected Policyholder Deficit (EPD)
BTR - Below Target Risk
Three main reasons for financial disasters
32. Unanticipated movements in relative prices of assets in hedged position
Sharpe measure
Importance of communication for risk managers
Source of need for risk management
Basic Market risk
33. Hazard - Financial - Operational - Strategic
RAR = relative return of portfolio (RRp)
Risk types addressed by ERM
Asset liquidity risk
Operational risk
34. Cannot exit position in market due to size of the position
Asset liquidity risk
Ways firms can fail to account for risks
Solvency-related metrics
Shortfall risk
35. Future price is greater than the spot price
Contango
Financial Risk
Kidder Peabody
Capital market line (CML)
36. 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
Exposure
Capital market line (CML)
APT (equation and assumptions)
Drysdale Securities (Chase Manhattan)
37. Quantile of an empirical distribution
Nonparametric VaR
Risk types addressed by ERM
Tax shield
Traits of ERM
38. 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
Carry- backs and carry- forwards
VaR- based analysis (formula)
Multi- period version of CAPM
39. Derives value from an underlying asset - rate - or index - Derives value from a security
BTR - Below Target Risk
Firms becoming more sensitive to changes(bank deregulation)
Solvency-related metrics
Derivative contract
40. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Security (primary vs secondary)
Debt overhang
Asset transformers
Roles of risk management
41. Probability distribution is unknown (ex. A terrorist attack)
Risk types addressed by ERM
Contango
VaR - Value at Risk
Uncertainty
42. When negative taxable income is moved to a different year to offset future or past taxable income
Nonparametric VaR
Efficient frontier
Information ratio
Carry- backs and carry- forwards
43. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Risk Management Irrelevance Proposition
Differences in financial risk management for financial companies vs industrial companies
Solvency-related metrics
Financial Risk
44. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Debt overhang
Allied Irish Bank
Capital market line (CML)
Four major types of risk
45. Risk of loses owing to movements in level or volatility of market prices
Source of need for risk management
Models used in ERM framework
Market risk
Drysdale Securities (Chase Manhattan)
46. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Solvency-related metrics
Risk
CAPM with taxes included (equation)
Basis risk
47. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Nonmarketable asset impact on CAPM
Differences in financial risk management for financial companies vs industrial companies
Models used in ERM framework
Market imperfections that can create value
48. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
VaR - Value at Risk
Basis
Sovereign risk
Formula for covariance
49. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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50. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Shortcomings of risk metrics
Where is risk coming from
Settlement risk
Kidder Peabody