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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. Asset-liability/market-liquidity risk
Credit event
Risk- adjusted performance measure (RAP)
Liquidity risk
Basis
2. 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
Nonmarketable asset impact on CAPM
Settlement risk
Capital market line (CML)
Tail VaR or TCE - Tail Conditional Expectation(TCE)
3. Inability to make payment obligations (ex. Margin calls)
Security (primary vs secondary)
Funding liquidity risk
Basis
Probability of ruin
4. Absolute and relative risk - direction and non-directional
Expected return of two assets
Carry- backs and carry- forwards
Forms of Market risk
3 main types of operational risk
5. Quantile of an empirical distribution
VaR- based analysis (formula)
Nonparametric VaR
Asset liquidity risk
Solve for minimum variance portfolio
6. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Firms becoming more sensitive to changes(bank deregulation)
Sharpe measure
Zero- beta CAPM (two factor model)
Debt overhang
7. Hazard - Financial - Operational - Strategic
Nonmarketable asset impact on CAPM
Risk types addressed by ERM
Business risks
Settlement risk
8. Derives value from an underlying asset - rate - or index - Derives value from a security
APT for passive portfolio management
Asset transformers
Derivative contract
Risks excluded from operational risk
9. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Volatility Market risk
Forms of Market risk
BTR - Below Target Risk
Morningstar Rating System
10. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Funding liquidity risk
Financial Risk
Risks excluded from operational risk
Tracking error
11. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Operational risk
Solve for minimum variance portfolio
Tracking error
Roles of risk management
12. Asses firm risks - Communicate risks - Manage and monitor risks
Roles of risk management
Shortcomings of risk metrics
Correlation coefficient effect on diversification
APT in active portfolio management
13. 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 -
Exposure
Standard deviation of two assets
Basic Market risk
Source of need for risk management
14. 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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15. Probability that a random variable falls below a specified threshold level
Derivative contract
Shortfall risk
CAPM with taxes included (equation)
Basis risk
16. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
CAPM (formula)
Shortfall risk
Volatility Market risk
Options motivation on volatility
17. 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
Firms becoming more sensitive to changes(bank deregulation)
VaR - Value at Risk
APT for passive portfolio management
Kidder Peabody
18. Unanticipated movements in relative prices of assets in hedged position
Effect of non- price- taking behavior on CAPM
Treynor measure
Basic Market risk
Options motivation on volatility
19. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Banker's Trust
Where is risk coming from
Business Risk
Effect of non- price- taking behavior on CAPM
20. 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
Risk
Practical considerations related to ERM implementatio
Valuation vs. Risk management
21. Law of one price - Homogeneous expectations - Security returns process
Liquidity risk
Security (primary vs secondary)
Prices of risk vs sensitivity
APT (equation and assumptions)
22. Losses due to market activities ex. Interest rate changes or defaults
CAPM with taxes included (equation)
Financial risks
Basis
Business risks
23. When negative taxable income is moved to a different year to offset future or past taxable income
Treynor measure
Carry- backs and carry- forwards
Risk Management Irrelevance Proposition
Solve for minimum variance portfolio
24. Country specific - Foreign exchange controls that prohibit counterparty's obligations
APT for passive portfolio management
Sovereign risk
CAPM with taxes included (equation)
Kidder Peabody
25. Expected value of unfavorable deviations of a random variable from a specified target level
Information ratio
BTR - Below Target Risk
Banker's Trust
CAPM (formula)
26. Modeling approach is typically between statistical analytic models and structural simulation models
Models used in ERM framework
Recovery rate
Effect of non- price- taking behavior on CAPM
Liquidity risk
27. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
VaR - Value at Risk
Asset liquidity risk
Nonparametric VaR
Performance- related metrics
28. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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29. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
3 main types of operational risk
Sortino ratio
Morningstar Rating System
Nonmarketable asset impact on CAPM
30. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Performance- related metrics
Standard deviation of two assets
CAPM with taxes included (equation)
Risk- adjusted performance measure (RAP)
31. Future price is greater than the spot price
Risks excluded from operational risk
Contango
Recovery rate
Models used in ERM framework
32. 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)
Recovery rate
Expected return of two assets
Effect of non- price- taking behavior on CAPM
33. Risk of loses owing to movements in level or volatility of market prices
Debt overhang
Asset transformers
Barings
Market risk
34. Need to assess risk and tell management so they can determine which risks to take on
Standard deviation of two assets
CAPM assumption for EMH
Importance of communication for risk managers
Ways firms can fail to account for risks
35. 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
Ways firms can fail to account for risks
Basis risk
Practical considerations related to ERM implementatio
Carry- backs and carry- forwards
36. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
EPD or ECOR - Expected Policyholder Deficit (EPD)
Asset transformers
Sortino ratio
Jensen's alpha
37. 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
CAPM with taxes included (equation)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Basic Market risk
Ten assumptions underlying CAPM
38. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Basis
Four major types of risk
Roles of risk management
Basic Market risk
39. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Ri = Rz + (gamma)(beta)
Ways risk can be mismeasured
Ri = ai + bi1l1 + bi2l2....+ei
Four major types of risk
40. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Credit event
Asset transformers
CAPM (formula)
Where is risk coming from
41. 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
Probability of ruin
Differences in financial risk management for financial companies vs industrial companies
LTCM
Expected return of two assets
42. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Effect of non- price- taking behavior on CAPM
Efficient frontier
RAR = relative return of portfolio (RRp)
Volatility Market risk
43. Prices of risk are common factors and do not change - Sensitivities can change
Prices of risk vs sensitivity
Risk Management Irrelevance Proposition
Barings
Three main reasons for financial disasters
44. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Business risks
Practical considerations related to ERM implementatio
Banker's Trust
Efficient frontier
45. Volatility of unexpected outcomes
Risk
CAPM (formula)
Formula for covariance
Zero- beta CAPM (two factor model)
46. When two payments are exchanged the same day and one party may default after payment is made
Basis
Settlement risk
Asset transformers
APT for passive portfolio management
47. Multibeta CAPM Ri - Rf =
Business Risk
Sharpe measure
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Settlement risk
48. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Debt overhang
Three main reasons for financial disasters
Liquidity risk
Credit event
49. Enterprise Risk Management - ERM is a discipline - culture of enterprise - ERM applies to all industries - ERM is not just defensive - adds value - ERM encompasses all risks - ERM addresses all stakeholders
Allied Irish Bank
Sharpe measure
Traits of ERM
Ri = ai + bi1l1 + bi2l2....+ei
50. Both probability and cost of tail events are considered
Expected return of two assets
Jensen's alpha
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Where is risk coming from