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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. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Credit event
APT in active portfolio management
Financial risks
Security (primary vs secondary)
2. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Morningstar Rating System
Financial risks
Ten assumptions underlying CAPM
Barings
3. Market risk - Liquidity risk - Credit risk - Operational risk
Four major types of risk
What lead to the exponential growth to derivatives mkt?
Parametric VaR
Options motivation on volatility
4. Modeling approach is typically between statistical analytic models and structural simulation models
Effect of non- price- taking behavior on CAPM
Models used in ERM framework
Basis
Ways firms can fail to account for risks
5. Need to assess risk and tell management so they can determine which risks to take on
Risks excluded from operational risk
Ri = ai + bi1l1 + bi2l2....+ei
Importance of communication for risk managers
CAPM (formula)
6. Return is linearly related to growth rate in consumption
Parametric VaR
Nonmarketable asset impact on CAPM
RAR = relative return of portfolio (RRp)
Multi- period version of CAPM
7. Prices of risk are common factors and do not change - Sensitivities can change
Shortcomings of risk metrics
Volatility Market risk
Prices of risk vs sensitivity
Three main reasons for financial disasters
8. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Business risks
Treynor measure
Ten assumptions underlying CAPM
Operational risk
9. Asset-liability/market-liquidity risk
BTR - Below Target Risk
Liquidity risk
Tracking error
Firms becoming more sensitive to changes(bank deregulation)
10. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Ri = Rz + (gamma)(beta)
Shape of portfolio possibilities curve
RAR = relative return of portfolio (RRp)
3 main types of operational risk
11. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Operational risk
Basis
VaR- based analysis (formula)
RAR = relative return of portfolio (RRp)
12. 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
Drysdale Securities (Chase Manhattan)
Zero- beta CAPM (two factor model)
Settlement risk
Kidder Peabody
13. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Options motivation on volatility
VaR - Value at Risk
Allied Irish Bank
Effect of non- price- taking behavior on CAPM
14. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Solve for minimum variance portfolio
Information ratio
Market risk
Ways risk can be mismeasured
15. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Importance of communication for risk managers
APT in active portfolio management
Credit event
Sortino ratio
16. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
APT (equation and assumptions)
Performance- related metrics
VaR- based analysis (formula)
Sharpe measure
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
What lead to the exponential growth to derivatives mkt?
Kidder Peabody
Nonparametric VaR
Nonmarketable asset impact on CAPM
18. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Solvency-related metrics
Asset transformers
Risk
CAPM with taxes included (equation)
19. Covariance = correlation coefficient std dev(a) std dev(b)
Formula for covariance
Firms becoming more sensitive to changes(bank deregulation)
Zero- beta CAPM (two factor model)
Differences in financial risk management for financial companies vs industrial companies
20. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Practical considerations related to ERM implementatio
What lead to the exponential growth to derivatives mkt?
Basis
Solvency-related metrics
21. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Formula for covariance
Capital market line (CML)
Debt overhang
CAPM (formula)
22. Returns on any stock are linearly related to a set of indexes
CAPM (formula)
Risk
Zero- beta CAPM (two factor model)
Ri = ai + bi1l1 + bi2l2....+ei
23. 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
Basis
Funding liquidity risk
Market imperfections that can create value
24. Losses due to market activities ex. Interest rate changes or defaults
Financial Risk
Basic Market risk
Financial risks
RAR = relative return of portfolio (RRp)
25. When negative taxable income is moved to a different year to offset future or past taxable income
Capital market line (CML)
Carry- backs and carry- forwards
Debt overhang
Correlation coefficient effect on diversification
26. Interest rate movements - derivatives - defaults
Risk
Financial Risk
Effect of non- price- taking behavior on CAPM
Shortcomings of risk metrics
27. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Basis
Practical considerations related to ERM implementatio
Efficient frontier
Basis risk
28. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Risk types addressed by ERM
RAR = relative return of portfolio (RRp)
Volatility Market risk
Asset transformers
29. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Business Risk
Zero- beta CAPM (two factor model)
APT in active portfolio management
Operational risk
30. When two payments are exchanged the same day and one party may default after payment is made
Uncertainty
RAR = relative return of portfolio (RRp)
Market imperfections that can create value
Settlement risk
31. Law of one price - Homogeneous expectations - Security returns process
Settlement risk
APT (equation and assumptions)
Asset transformers
Asset liquidity risk
32. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Capital market line (CML)
Kidder Peabody
Parametric VaR
Ri = Rz + (gamma)(beta)
33. Cannot exit position in market due to size of the position
Basic Market risk
Options motivation on volatility
Asset liquidity risk
What lead to the exponential growth to derivatives mkt?
34. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Debt overhang
Recovery rate
Where is risk coming from
APT in active portfolio management
35. Asses firm risks - Communicate risks - Manage and monitor risks
Models used in ERM framework
Firms becoming more sensitive to changes(bank deregulation)
Roles of risk management
Business Risk
36. Volatility of unexpected outcomes
Ways risk can be mismeasured
Risk
Tax shield
CAPM with taxes included (equation)
37. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Firms becoming more sensitive to changes(bank deregulation)
Information ratio
Derivative contract
Importance of communication for risk managers
38. The uses of debt to fall into a lower tax rate
Tax shield
Capital market line (CML)
Shape of portfolio possibilities curve
VaR - Value at Risk
39. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Volatility Market risk
Differences in financial risk management for financial companies vs industrial companies
Probability of ruin
Basic Market risk
40. The lower (closer to - 1) - the higher the payoff from diversification
Options motivation on volatility
Asset liquidity risk
Correlation coefficient effect on diversification
Tax shield
41. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Risk- adjusted performance measure (RAP)
Prices of risk vs sensitivity
Market imperfections that can create value
42. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Sortino ratio
Basis risk
Drysdale Securities (Chase Manhattan)
Treynor measure
43. 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
Shortcomings of risk metrics
Formula for covariance
Asset liquidity risk
Ten assumptions underlying CAPM
44. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Probability of ruin
Sharpe measure
VaR - Value at Risk
Effect of heterogeneous expectations on CAPM
45. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Ways firms can fail to account for risks
Tracking error
Sovereign risk
Ri = ai + bi1l1 + bi2l2....+ei
46. Future price is greater than the spot price
Contango
Solve for minimum variance portfolio
Standard deviation of two assets
Ways risk can be mismeasured
47. 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
Performance- related metrics
Settlement risk
Recovery rate
Business Risk
48. Hazard - Financial - Operational - Strategic
Risks excluded from operational risk
Debt overhang
Risk types addressed by ERM
Solvency-related metrics
49. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Tracking error
Market risk
Risk
Zero- beta CAPM (two factor model)
50. 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
Sovereign risk
Solve for minimum variance portfolio
Banker's Trust
APT for passive portfolio management