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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. Potential amount that can be lost
Exposure
Ri = ai + bi1l1 + bi2l2....+ei
Probability of ruin
Parametric VaR
2. Curve must be concave - Straight line connecting any two points must be under the curve
Shape of portfolio possibilities curve
Morningstar Rating System
Expected return of two assets
Three main reasons for financial disasters
3. Returns on any stock are linearly related to a set of indexes
Parametric VaR
Ri = ai + bi1l1 + bi2l2....+ei
Traits of ERM
Zero- beta CAPM (two factor model)
4. Capital structure (financial distress) - Taxes - Agency and information asymmetries
EPD or ECOR - Expected Policyholder Deficit (EPD)
Market imperfections that can create value
Where is risk coming from
Ri = Rz + (gamma)(beta)
5. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Settlement risk
Differences in financial risk management for financial companies vs industrial companies
Importance of communication for risk managers
Nonmarketable asset impact on CAPM
6. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Differences in financial risk management for financial companies vs industrial companies
Risk Management Irrelevance Proposition
Basis risk
CAPM with taxes included (equation)
7. When negative taxable income is moved to a different year to offset future or past taxable income
Basic Market risk
Capital market line (CML)
Carry- backs and carry- forwards
Risk
8. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Ways risk can be mismeasured
Tax shield
Exposure
Solve for minimum variance portfolio
9. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Ten assumptions underlying CAPM
CAPM (formula)
Four major types of risk
Asset transformers
10. 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
Practical considerations related to ERM implementatio
Shortcomings of risk metrics
Source of need for risk management
11. Prices of risk are common factors and do not change - Sensitivities can change
Banker's Trust
Allied Irish Bank
Prices of risk vs sensitivity
EPD or ECOR - Expected Policyholder Deficit (EPD)
12. Changes in vol - implied or actual
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Formula for covariance
Volatility Market risk
Differences in financial risk management for financial companies vs industrial companies
13. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Ri = Rz + (gamma)(beta)
Zero- beta CAPM (two factor model)
CAPM (formula)
Financial Risk
14. 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
Ri = ai + bi1l1 + bi2l2....+ei
Business Risk
Barings
Treynor measure
15. 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
Four major types of risk
Multi- period version of CAPM
LTCM
Settlement risk
16. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
APT in active portfolio management
Shape of portfolio possibilities curve
Asset transformers
Recovery rate
17. Occurs the day when two parties exchange payments same day
CAPM with taxes included (equation)
Settlement risk
Operational risk
Zero- beta CAPM (two factor model)
18. Absolute and relative risk - direction and non-directional
Information ratio
Risks excluded from operational risk
Forms of Market risk
Nonparametric VaR
19. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Asset transformers
Three main reasons for financial disasters
Standard deviation of two assets
Risks excluded from operational risk
20. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Uncertainty
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Solvency-related metrics
Basis
21. 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.
Risk Management Irrelevance Proposition
Roles of risk management
Performance- related metrics
Multi- period version of CAPM
22. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Nonmarketable asset impact on CAPM
Operational risk
Exposure
Effect of non- price- taking behavior on CAPM
23. Both probability and cost of tail events are considered
EPD or ECOR - Expected Policyholder Deficit (EPD)
Liquidity risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Ri = Rz + (gamma)(beta)
24. Return is linearly related to growth rate in consumption
Risks excluded from operational risk
Multi- period version of CAPM
Recovery rate
Exposure
25. Need to assess risk and tell management so they can determine which risks to take on
Liquidity risk
Shape of portfolio possibilities curve
Treynor measure
Importance of communication for risk managers
26. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Debt overhang
Operational risk
CAPM assumption for EMH
Firms becoming more sensitive to changes(bank deregulation)
27. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Treynor measure
Risk Management Irrelevance Proposition
Risks excluded from operational risk
VaR- based analysis (formula)
28. Covariance = correlation coefficient std dev(a) std dev(b)
Source of need for risk management
CAPM assumption for EMH
Formula for covariance
Parametric VaR
29. Wrong distribution - Historical sample may not apply
Risk
Risks excluded from operational risk
Effect of non- price- taking behavior on CAPM
Ways risk can be mismeasured
30. 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
Jensen's alpha
Sovereign risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
31. Law of one price - Homogeneous expectations - Security returns process
Operational risk
APT (equation and assumptions)
Ri = ai + bi1l1 + bi2l2....+ei
Risk
32. Asses firm risks - Communicate risks - Manage and monitor risks
Ri = ai + bi1l1 + bi2l2....+ei
Probability of ruin
Market risk
Roles of risk management
33. Volatility of unexpected outcomes
Uncertainty
Drysdale Securities (Chase Manhattan)
Information ratio
Risk
34. 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
Volatility Market risk
Valuation vs. Risk management
Recovery rate
Carry- backs and carry- forwards
35. Cannot exit position in market due to size of the position
Standard deviation of two assets
CAPM (formula)
Ways firms can fail to account for risks
Asset liquidity risk
36. 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
Multi- period version of CAPM
Barings
Traits of ERM
Banker's Trust
37. Market risk - Liquidity risk - Credit risk - Operational risk
Four major types of risk
Risk
Solve for minimum variance portfolio
Volatility Market risk
38. The uses of debt to fall into a lower tax rate
What lead to the exponential growth to derivatives mkt?
Correlation coefficient effect on diversification
APT in active portfolio management
Tax shield
39. Relative portfolio risk (RRiskp) - Based on a one- month investment period
EPD or ECOR - Expected Policyholder Deficit (EPD)
Risk- adjusted performance measure (RAP)
Risk Management Irrelevance Proposition
RAR = relative return of portfolio (RRp)
40. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Options motivation on volatility
Firms becoming more sensitive to changes(bank deregulation)
Asset liquidity risk
Funding liquidity risk
41. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Basis
Operational risk
Market imperfections that can create value
Market risk
42. 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
Risk
Probability of ruin
Effect of non- price- taking behavior on CAPM
Drysdale Securities (Chase Manhattan)
43. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
LTCM
Morningstar Rating System
Security (primary vs secondary)
Sortino ratio
44. 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
Shortcomings of risk metrics
Ways risk can be mismeasured
Forms of Market risk
Ways firms can fail to account for risks
45. 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
Recovery rate
Effect of non- price- taking behavior on CAPM
Kidder Peabody
Morningstar Rating System
46. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Options motivation on volatility
Funding liquidity risk
Business risks
Valuation vs. Risk management
47. Concave function that extends from minimum variance portfolio to maximum return portfolio
Shortcomings of risk metrics
Efficient frontier
Shortfall risk
Ri = Rz + (gamma)(beta)
48. Quantile of a statistical distribution
Parametric VaR
Differences in financial risk management for financial companies vs industrial companies
Efficient frontier
Capital market line (CML)
49. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Uncertainty
EPD or ECOR - Expected Policyholder Deficit (EPD)
Solve for minimum variance portfolio
Jensen's alpha
50. When two payments are exchanged the same day and one party may default after payment is made
Prices of risk vs sensitivity
Settlement risk
Tracking error
Operational risk