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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 reenforces your understanding as you take the test each time.
1. 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
Prices of risk vs sensitivity
Ten assumptions underlying CAPM
Risk
2. ex. Human capital  Equilibrium return can be higher or lower than it is under standard CAPM
Recovery rate
Allied Irish Bank
APT for passive portfolio management
Nonmarketable asset impact on CAPM
3. Sqrt((Xa^2)(variance of a) + (1 Xa)^2(variance of b) + 2(Xa)(1 Xa)(covariance))
Efficient frontier
Standard deviation of two assets
Security (primary vs secondary)
Multi period version of CAPM
4. Changes in vol  implied or actual
CAPM with taxes included (equation)
Financial Risk
Volatility Market risk
APT in active portfolio management
5. 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
Standard deviation of two assets
Traits of ERM
Shortcomings of risk metrics
APT for passive portfolio management
6. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Basic Market risk
Barings
(market beta)(Rm  Rf) + (sensitivity to inflation risk)(price of inflation risk)
Credit event
7. Law of one price  Homogeneous expectations  Security returns process
APT for passive portfolio management
3 main types of operational risk
APT (equation and assumptions)
LTCM
8. Quantile of an empirical distribution
Nonparametric VaR
Settlement risk
Ri = ai + bi1l1 + bi2l2....+ei
LTCM
9. (E(Rp)  MAR)/(sqrt((1/T)summation(Rpt MAR)^2)  MAR  minimum acceptable return
Sortino ratio
Risk Management Irrelevance Proposition
Basic Market risk
3 main types of operational risk
10. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp)  Rf)/(std dev of Rp)  Better for non diversified portfolios
Tax shield
Valuation vs. Risk management
Standard deviation of two assets
Sharpe measure
11. Capital Asset Pricing Model Ri = Rf + beta*(Rm  Rf)
Zero beta CAPM (two factor model)
Formula for covariance
Asset transformers
CAPM (formula)
12. Inability to make payment obligations (ex. Margin calls)
APT for passive portfolio management
Funding liquidity risk
Treynor measure
Derivative contract
13. Covariance = correlation coefficient std dev(a) std dev(b)
Settlement risk
Formula for covariance
APT for passive portfolio management
Volatility Market risk
14. Need to assess risk and tell management so they can determine which risks to take on
Sharpe measure
Four major types of risk
Importance of communication for risk managers
Debt overhang
15. Xmvp = ((variance of b)  covariance)/((variance of a) + (variance of b)  2 * covariance)
Uncertainty
Parametric VaR
Solve for minimum variance portfolio
Asset liquidity risk
16. Proportion of loss that is recovered  Also referred to as "cents on the dollar"
Shortfall risk
Multi period version of CAPM
Recovery rate
Business risks
17. Security is a financial claim issued to raise capital  Primary securities are backed by real assets  Secondary securities are backed by primary securities
Liquidity risk
Nonmarketable asset impact on CAPM
Exposure
Security (primary vs secondary)
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
Performance related metrics
VaR  Value at Risk
Where is risk coming from
Valuation vs. Risk management
19. 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
CAPM (formula)
Probability of ruin
Options motivation on volatility
Three main reasons for financial disasters
20. Risk replaced with VaR (Portfolio return  risk free rate)/(portfolio VaR/initial value of portfolio)
Standard deviation of two assets
Source of need for risk management
Shortcomings of risk metrics
VaR based analysis (formula)
21. Wrong distribution  Historical sample may not apply
Nonparametric VaR
Ways firms can fail to account for risks
Risk types addressed by ERM
Ways risk can be mismeasured
22. E(Ri) = Rf + beta[(E(Rm) Rf) (tax factor)(dividend yield for market  Rf)] + (tax factor)(dividend yield for stock  Rf)
Jensen's alpha
CAPM with taxes included (equation)
APT in active portfolio management
Risk types addressed by ERM
23. 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 
Financial Risk
Risks excluded from operational risk
Source of need for risk management
Debt overhang
24. Unanticipated movements in relative prices of assets in a hedged position  All hedges imply some basis risk
Roles of risk management
Basis risk
Drysdale Securities (Chase Manhattan)
Volatility Market risk
25. Hazard  Financial  Operational  Strategic
Risk types addressed by ERM
Basis
Capital market line (CML)
Roles of risk management
26. People risk = fraud  etc.  Model risk = flawed valuation models  Legal risk = exposure to fines and lawsuits
Performance related metrics
Probability of ruin
3 main types of operational risk
Nonparametric VaR
27. Absolute and relative risk  direction and nondirectional
RAR = relative return of portfolio (RRp)
Correlation coefficient effect on diversification
Forms of Market risk
Information ratio
28. When two payments are exchanged the same day and one party may default after payment is made
Differences in financial risk management for financial companies vs industrial companies
Settlement risk
Efficient frontier
Drysdale Securities (Chase Manhattan)
29. Strategic risk  Business risk  Reputational risk
CAPM assumption for EMH
Treynor measure
Solve for minimum variance portfolio
Risks excluded from operational risk
30. 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
Ten assumptions underlying CAPM
CAPM (formula)
APT for passive portfolio management
Risks excluded from operational risk
31. 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
Prices of risk vs sensitivity
Market risk
CAPM with taxes included (equation)
Shortcomings of risk metrics
32. Modeling approach is typically between statistical analytic models and structural simulation models
Models used in ERM framework
Four major types of risk
Solvencyrelated metrics
Standard deviation of two assets
33. Returns on any stock are linearly related to a set of indexes
Ri = ai + bi1l1 + bi2l2....+ei
Exposure
Jensen's alpha
Risk Management Irrelevance Proposition
34. Long in options = expecting volatility increase  Short in options = expecting volatility decrease
Volatility Market risk
Drysdale Securities (Chase Manhattan)
Probability of ruin
Options motivation on volatility
35. Risk of loses owing to movements in level or volatility of market prices
Exposure
Settlement risk
Differences in financial risk management for financial companies vs industrial companies
Market risk
36. Unanticipated movements in relative prices of assets in hedged position
Business Risk
Basic Market risk
Ways firms can fail to account for risks
VaR based analysis (formula)
37. Economic Cost of Ruin(ECOR)  Enhancement to probability of ruin where severity of ruin is reflected
Treynor measure
Models used in ERM framework
Kidder Peabody
EPD or ECOR  Expected Policyholder Deficit (EPD)
38. Asses firm risks  Communicate risks  Manage and monitor risks
Roles of risk management
Financial Risk
Prices of risk vs sensitivity
Risk adjusted performance measure (RAP)
39. Cannot exit position in market due to size of the position
Morningstar Rating System
Settlement risk
Nonmarketable asset impact on CAPM
Asset liquidity risk
40. Misleading reporting (incorrect market info)  Due to large market moves  Due to conduct of customer business
Sharpe measure
Differences in financial risk management for financial companies vs industrial companies
Basic Market risk
Three main reasons for financial disasters
41. 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
42. Firms became multinational   >watched xchange rates more  deregulation and globalization
Business Risk
Uncertainty
Firms becoming more sensitive to changes(bank deregulation)
BTR  Below Target Risk
43. Concentrate on mid region of probability distribution  Relevant to owners and proxies
Drysdale Securities (Chase Manhattan)
Performance related metrics
Business risks
Shape of portfolio possibilities curve
44. 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
Nonparametric VaR
RAR = relative return of portfolio (RRp)
Importance of communication for risk managers
Barings
45. 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)
LTCM
Recovery rate
Basis
46. Risks that are assumed willingly  to gain a competitive edge or add shareholder value
Market risk
Business risks
Valuation vs. Risk management
Nonparametric VaR
47. Multibeta CAPM Ri  Rf =
Effect of heterogeneous expectations on CAPM
(market beta)(Rm  Rf) + (sensitivity to inflation risk)(price of inflation risk)
Nonmarketable asset impact on CAPM
Parametric VaR
48. Probability that a random variable falls below a specified threshold level
Tracking error
Solvencyrelated metrics
Asset liquidity risk
Shortfall risk
49. Ri = Rz + (Rm  Rz)*beta  Rz = return on zero beta portfolio
Zero beta CAPM (two factor model)
Risk Management Irrelevance Proposition
Multi period version of CAPM
Traits of ERM
50. When negative taxable income is moved to a different year to offset future or past taxable income
Shape of portfolio possibilities curve
Treynor measure
Jensen's alpha
Carry backs and carry forwards