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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. John Rusnak - a currency option trader - produced losses of 691 million by using imaginary trades to disguise large naked positions. - Enforced need for back office controls
Allied Irish Bank
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Valuation vs. Risk management
Jensen's alpha
2. 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)
Sharpe measure
Recovery rate
Solve for minimum variance portfolio
3. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Settlement risk
Efficient frontier
Business risks
Forms of Market risk
4. 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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5. Need to assess risk and tell management so they can determine which risks to take on
Basis
Firms becoming more sensitive to changes(bank deregulation)
Importance of communication for risk managers
Nonmarketable asset impact on CAPM
6. Multibeta CAPM Ri - Rf =
Volatility Market risk
Multi- period version of CAPM
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Correlation coefficient effect on diversification
7. Asset-liability/market-liquidity risk
Banker's Trust
Debt overhang
Liquidity risk
CAPM (formula)
8. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Tracking error
Uncertainty
Ri = ai + bi1l1 + bi2l2....+ei
Where is risk coming from
9. When two payments are exchanged the same day and one party may default after payment is made
Sortino ratio
Morningstar Rating System
Basis
Settlement risk
10. Return is linearly related to growth rate in consumption
Financial Risk
Multi- period version of CAPM
CAPM with taxes included (equation)
Morningstar Rating System
11. Probability distribution is unknown (ex. A terrorist attack)
Basic Market risk
Uncertainty
Morningstar Rating System
Debt overhang
12. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Differences in financial risk management for financial companies vs industrial companies
Zero- beta CAPM (two factor model)
Effect of heterogeneous expectations on CAPM
Barings
13. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Derivative contract
Capital market line (CML)
Basis
Prices of risk vs sensitivity
14. Future price is greater than the spot price
LTCM
Uncertainty
Asset transformers
Contango
15. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Ri = Rz + (gamma)(beta)
Performance- related metrics
BTR - Below Target Risk
Three main reasons for financial disasters
16. 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
Financial risks
Tracking error
Capital market line (CML)
Traits of ERM
17. Rp = XaRa + XbRb
Efficient frontier
Liquidity risk
Tax shield
Expected return of two assets
18. Both probability and cost of tail events are considered
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Standard deviation of two assets
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Recovery rate
19. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Valuation vs. Risk management
Nonmarketable asset impact on CAPM
Source of need for risk management
Sovereign risk
20. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Ten assumptions underlying CAPM
Sortino ratio
Market imperfections that can create value
Basis risk
21. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Ways risk can be mismeasured
Morningstar Rating System
Market imperfections that can create value
Drysdale Securities (Chase Manhattan)
22. 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
Recovery rate
EPD or ECOR - Expected Policyholder Deficit (EPD)
Practical considerations related to ERM implementatio
Risk
23. Firms became multinational - - >watched xchange rates more - deregulation and globalization
RAR = relative return of portfolio (RRp)
Efficient frontier
Firms becoming more sensitive to changes(bank deregulation)
Shape of portfolio possibilities curve
24. When negative taxable income is moved to a different year to offset future or past taxable income
Debt overhang
Volatility Market risk
Nonparametric VaR
Carry- backs and carry- forwards
25. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Tax shield
Financial risks
EPD or ECOR - Expected Policyholder Deficit (EPD)
Nonparametric VaR
26. Volatility of unexpected outcomes
Basis risk
VaR - Value at Risk
Source of need for risk management
Risk
27. Wrong distribution - Historical sample may not apply
Debt overhang
Funding liquidity risk
Ways risk can be mismeasured
Solvency-related metrics
28. Changes in vol - implied or actual
Volatility Market risk
APT in active portfolio management
Shortcomings of risk metrics
APT for passive portfolio management
29. Quantile of an empirical distribution
Shortcomings of risk metrics
Probability of ruin
3 main types of operational risk
Nonparametric VaR
30. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Financial Risk
CAPM with taxes included (equation)
APT for passive portfolio management
Kidder Peabody
31. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
VaR- based analysis (formula)
Allied Irish Bank
APT in active portfolio management
Jensen's alpha
32. 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
Business risks
Settlement risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
Ways firms can fail to account for risks
33. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Forms of Market risk
Capital market line (CML)
Business Risk
VaR - Value at Risk
34. 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
Effect of non- price- taking behavior on CAPM
Sharpe measure
Drysdale Securities (Chase Manhattan)
Security (primary vs secondary)
35. Cannot exit position in market due to size of the position
Risk
Settlement risk
Forms of Market risk
Asset liquidity risk
36. Strategic risk - Business risk - Reputational risk
Formula for covariance
Risks excluded from operational risk
Risk Management Irrelevance Proposition
Efficient frontier
37. 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
Source of need for risk management
Business Risk
Ri = ai + bi1l1 + bi2l2....+ei
Four major types of risk
38. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Operational risk
Ri = Rz + (gamma)(beta)
Effect of heterogeneous expectations on CAPM
Financial risks
39. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Basis
Liquidity risk
Operational risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
40. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Expected return of two assets
Uncertainty
Effect of non- price- taking behavior on CAPM
Drysdale Securities (Chase Manhattan)
41. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Financial risks
Nonmarketable asset impact on CAPM
Settlement risk
What lead to the exponential growth to derivatives mkt?
42. Asses firm risks - Communicate risks - Manage and monitor risks
Roles of risk management
Zero- beta CAPM (two factor model)
Banker's Trust
Funding liquidity risk
43. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Standard deviation of two assets
CAPM assumption for EMH
Risks excluded from operational risk
Where is risk coming from
44. Unanticipated movements in relative prices of assets in hedged position
Source of need for risk management
Basic Market risk
Expected return of two assets
Practical considerations related to ERM implementatio
45. Concave function that extends from minimum variance portfolio to maximum return portfolio
Efficient frontier
Traits of ERM
3 main types of operational risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
46. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Treynor measure
Solve for minimum variance portfolio
Basis
Probability of ruin
47. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Three main reasons for financial disasters
Solve for minimum variance portfolio
EPD or ECOR - Expected Policyholder Deficit (EPD)
Tracking error
48. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Debt overhang
EPD or ECOR - Expected Policyholder Deficit (EPD)
Correlation coefficient effect on diversification
CAPM (formula)
49. 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
Kidder Peabody
Shape of portfolio possibilities curve
What lead to the exponential growth to derivatives mkt?
Ways firms can fail to account for risks
50. Derives value from an underlying asset - rate - or index - Derives value from a security
Four major types of risk
Derivative contract
Market imperfections that can create value
Ten assumptions underlying CAPM