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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. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Parametric VaR
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Practical considerations related to ERM implementatio
Market imperfections that can create value
2. Potential amount that can be lost
Parametric VaR
Derivative contract
Exposure
Volatility Market risk
3. Prices of risk are common factors and do not change - Sensitivities can change
Source of need for risk management
Effect of heterogeneous expectations on CAPM
Tracking error
Prices of risk vs sensitivity
4. Concave function that extends from minimum variance portfolio to maximum return portfolio
Where is risk coming from
Solvency-related metrics
Efficient frontier
Barings
5. Quantile of a statistical distribution
Asset liquidity risk
Parametric VaR
Options motivation on volatility
Nonmarketable asset impact on CAPM
6. Hazard - Financial - Operational - Strategic
Risk types addressed by ERM
Kidder Peabody
Parametric VaR
Sharpe measure
7. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
VaR- based analysis (formula)
Nonmarketable asset impact on CAPM
Performance- related metrics
Ways risk can be mismeasured
8. Volatility of unexpected outcomes
VaR- based analysis (formula)
Barings
Risk
Capital market line (CML)
9. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Expected return of two assets
APT in active portfolio management
Ten assumptions underlying CAPM
Uncertainty
10. 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
Source of need for risk management
Valuation vs. Risk management
Contango
Risk
11. Absolute and relative risk - direction and non-directional
Drysdale Securities (Chase Manhattan)
Forms of Market risk
Source of need for risk management
Morningstar Rating System
12. When two payments are exchanged the same day and one party may default after payment is made
Risk Management Irrelevance Proposition
Basis risk
Risk
Settlement risk
13. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Risk Management Irrelevance Proposition
Ways risk can be mismeasured
Risk
Exposure
14. Changes in vol - implied or actual
Debt overhang
Sortino ratio
Ri = Rz + (gamma)(beta)
Volatility Market risk
15. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Risk
Sharpe measure
Capital market line (CML)
CAPM assumption for EMH
16. 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
Shortfall risk
Uncertainty
Shortcomings of risk metrics
Capital market line (CML)
17. 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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18. Expected value of unfavorable deviations of a random variable from a specified target level
Recovery rate
BTR - Below Target Risk
Financial risks
Shortfall risk
19. 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
Carry- backs and carry- forwards
Four major types of risk
Business Risk
Zero- beta CAPM (two factor model)
20. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Business risks
VaR - Value at Risk
Liquidity risk
Efficient frontier
21. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
RAR = relative return of portfolio (RRp)
Risk- adjusted performance measure (RAP)
Tracking error
APT in active portfolio management
22. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Practical considerations related to ERM implementatio
Solve for minimum variance portfolio
Risk Management Irrelevance Proposition
Financial Risk
23. 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
Risk
Uncertainty
Barings
Funding liquidity risk
24. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Traits of ERM
3 main types of operational risk
Sovereign risk
RAR = relative return of portfolio (RRp)
25. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Solvency-related metrics
Risk
Effect of heterogeneous expectations on CAPM
Importance of communication for risk managers
26. 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
LTCM
APT for passive portfolio management
Nonmarketable asset impact on CAPM
Options motivation on volatility
27. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
CAPM (formula)
Zero- beta CAPM (two factor model)
Business Risk
Valuation vs. Risk management
28. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Business risks
Ri = Rz + (gamma)(beta)
Shortcomings of risk metrics
Ri = ai + bi1l1 + bi2l2....+ei
29. Probability that a random variable falls below a specified threshold level
Shortfall risk
Tracking error
Asset liquidity risk
APT in active portfolio management
30. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Solvency-related metrics
Settlement risk
LTCM
RAR = relative return of portfolio (RRp)
31. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
CAPM with taxes included (equation)
Differences in financial risk management for financial companies vs industrial companies
Basis risk
Jensen's alpha
32. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Risk
Standard deviation of two assets
Models used in ERM framework
EPD or ECOR - Expected Policyholder Deficit (EPD)
33. 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)
Source of need for risk management
Effect of heterogeneous expectations on CAPM
Risk types addressed by ERM
34. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Nonparametric VaR
Information ratio
Models used in ERM framework
Shortcomings of risk metrics
35. 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
Credit event
Settlement risk
Capital market line (CML)
Ri = Rz + (gamma)(beta)
36. Modeling approach is typically between statistical analytic models and structural simulation models
Tax shield
Sovereign risk
Business Risk
Models used in ERM framework
37. 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
RAR = relative return of portfolio (RRp)
Roles of risk management
LTCM
Risk- adjusted performance measure (RAP)
38. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Nonmarketable asset impact on CAPM
Correlation coefficient effect on diversification
Debt overhang
Drysdale Securities (Chase Manhattan)
39. Derives value from an underlying asset - rate - or index - Derives value from a security
Basis risk
Kidder Peabody
Derivative contract
Solvency-related metrics
40. Strategic risk - Business risk - Reputational risk
Uncertainty
Asset transformers
Risks excluded from operational risk
Jensen's alpha
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
Banker's Trust
Performance- related metrics
Multi- period version of CAPM
Probability of ruin
42. The uses of debt to fall into a lower tax rate
Probability of ruin
Allied Irish Bank
Tax shield
Sovereign risk
43. Need to assess risk and tell management so they can determine which risks to take on
Basis risk
Importance of communication for risk managers
Information ratio
Asset liquidity risk
44. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Risk types addressed by ERM
Morningstar Rating System
Ten assumptions underlying CAPM
Three main reasons for financial disasters
45. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Market risk
Contango
Banker's Trust
Credit event
46. Rp = XaRa + XbRb
Financial Risk
Security (primary vs secondary)
LTCM
Expected return of two assets
47. Quantile of an empirical distribution
EPD or ECOR - Expected Policyholder Deficit (EPD)
LTCM
Correlation coefficient effect on diversification
Nonparametric VaR
48. 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 -
Source of need for risk management
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Ten assumptions underlying CAPM
Asset liquidity risk
49. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Firms becoming more sensitive to changes(bank deregulation)
Jensen's alpha
Settlement risk
Multi- period version of CAPM
50. The lower (closer to - 1) - the higher the payoff from diversification
CAPM assumption for EMH
Prices of risk vs sensitivity
Settlement risk
Correlation coefficient effect on diversification