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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. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Zero- beta CAPM (two factor model)
Nonparametric VaR
Settlement risk
Sharpe measure
2. 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
Where is risk coming from
Traits of ERM
Nonparametric VaR
Nonmarketable asset impact on CAPM
3. When negative taxable income is moved to a different year to offset future or past taxable income
Business risks
APT in active portfolio management
Carry- backs and carry- forwards
Performance- related metrics
4. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Information ratio
Asset transformers
Ri = Rz + (gamma)(beta)
APT for passive portfolio management
5. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Ri = Rz + (gamma)(beta)
RAR = relative return of portfolio (RRp)
Risk types addressed by ERM
Standard deviation of two assets
6. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Risks excluded from operational risk
Four major types of risk
Basis risk
Allied Irish Bank
7. Potential amount that can be lost
Debt overhang
Forms of Market risk
Effect of non- price- taking behavior on CAPM
Exposure
8. Asset-liability/market-liquidity risk
Ways risk can be mismeasured
Liquidity risk
Treynor measure
Standard deviation of two assets
9. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Allied Irish Bank
Solve for minimum variance portfolio
EPD or ECOR - Expected Policyholder Deficit (EPD)
VaR- based analysis (formula)
10. 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
Nonparametric VaR
Debt overhang
Probability of ruin
Basis risk
11. 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
Options motivation on volatility
Prices of risk vs sensitivity
Ways firms can fail to account for risks
Information ratio
12. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Recovery rate
EPD or ECOR - Expected Policyholder Deficit (EPD)
Practical considerations related to ERM implementatio
RAR = relative return of portfolio (RRp)
13. 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
Shortfall risk
Risk Management Irrelevance Proposition
Risk types addressed by ERM
14. Volatility of unexpected outcomes
Risk
Risk types addressed by ERM
Risk- adjusted performance measure (RAP)
Shortcomings of risk metrics
15. 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
Where is risk coming from
Roles of risk management
Drysdale Securities (Chase Manhattan)
Tax shield
16. Quantile of a statistical distribution
Parametric VaR
Risk types addressed by ERM
Practical considerations related to ERM implementatio
Market imperfections that can create value
17. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Treynor measure
RAR = relative return of portfolio (RRp)
Nonmarketable asset impact on CAPM
Tracking error
18. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Risk types addressed by ERM
Information ratio
Sovereign risk
Differences in financial risk management for financial companies vs industrial companies
19. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Basic Market risk
VaR- based analysis (formula)
APT for passive portfolio management
Forms of Market risk
20. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Uncertainty
Credit event
Options motivation on volatility
Practical considerations related to ERM implementatio
21. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Exposure
Solve for minimum variance portfolio
Effect of non- price- taking behavior on CAPM
22. Losses due to market activities ex. Interest rate changes or defaults
CAPM (formula)
APT for passive portfolio management
What lead to the exponential growth to derivatives mkt?
Financial risks
23. Both probability and cost of tail events are considered
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Shape of portfolio possibilities curve
Morningstar Rating System
Basis
24. Changes in vol - implied or actual
Business risks
CAPM with taxes included (equation)
Traits of ERM
Volatility Market risk
25. When two payments are exchanged the same day and one party may default after payment is made
APT (equation and assumptions)
Business risks
Standard deviation of two assets
Settlement risk
26. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Credit event
Firms becoming more sensitive to changes(bank deregulation)
Treynor measure
Derivative contract
27. Cannot exit position in market due to size of the position
Asset liquidity risk
Settlement risk
VaR - Value at Risk
APT in active portfolio management
28. Interest rate movements - derivatives - defaults
Information ratio
Nonparametric VaR
Financial Risk
Exposure
29. Concave function that extends from minimum variance portfolio to maximum return portfolio
Volatility Market risk
Jensen's alpha
Efficient frontier
Source of need for risk management
30. The lower (closer to - 1) - the higher the payoff from diversification
Capital market line (CML)
Debt overhang
Where is risk coming from
Correlation coefficient effect on diversification
31. Law of one price - Homogeneous expectations - Security returns process
Tracking error
CAPM with taxes included (equation)
APT (equation and assumptions)
Ways risk can be mismeasured
32. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Tracking error
CAPM (formula)
Ri = Rz + (gamma)(beta)
Importance of communication for risk managers
33. Relative portfolio risk (RRiskp) - Based on a one- month investment period
RAR = relative return of portfolio (RRp)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Ri = ai + bi1l1 + bi2l2....+ei
Prices of risk vs sensitivity
34. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Efficient frontier
Multi- period version of CAPM
APT in active portfolio management
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
35. 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
Ten assumptions underlying CAPM
Firms becoming more sensitive to changes(bank deregulation)
Capital market line (CML)
EPD or ECOR - Expected Policyholder Deficit (EPD)
36. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Performance- related metrics
Differences in financial risk management for financial companies vs industrial companies
Sortino ratio
Risk
37. Expected value of unfavorable deviations of a random variable from a specified target level
Tax shield
Forms of Market risk
BTR - Below Target Risk
Business risks
38. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Morningstar Rating System
Shortcomings of risk metrics
Zero- beta CAPM (two factor model)
Roles of risk management
39. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Sortino ratio
Morningstar Rating System
Business risks
3 main types of operational risk
40. Risk of loses owing to movements in level or volatility of market prices
Shortcomings of risk metrics
Market risk
Probability of ruin
Models used in ERM framework
41. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Performance- related metrics
Effect of non- price- taking behavior on CAPM
Market risk
Three main reasons for financial disasters
42. 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
Ways risk can be mismeasured
Basic Market risk
Valuation vs. Risk management
Source of need for risk management
43. Prices of risk are common factors and do not change - Sensitivities can change
Prices of risk vs sensitivity
Ten assumptions underlying CAPM
APT for passive portfolio management
Allied Irish Bank
44. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Drysdale Securities (Chase Manhattan)
Recovery rate
Firms becoming more sensitive to changes(bank deregulation)
Financial risks
45. 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
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Ways risk can be mismeasured
Basic Market risk
46. 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
APT for passive portfolio management
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Kidder Peabody
Capital market line (CML)
47. Derives value from an underlying asset - rate - or index - Derives value from a security
Derivative contract
APT for passive portfolio management
Volatility Market risk
Efficient frontier
48. Returns on any stock are linearly related to a set of indexes
Financial risks
Where is risk coming from
Ri = ai + bi1l1 + bi2l2....+ei
LTCM
49. Need to assess risk and tell management so they can determine which risks to take on
Importance of communication for risk managers
Basic Market risk
BTR - Below Target Risk
Sortino ratio
50. The uses of debt to fall into a lower tax rate
APT (equation and assumptions)
Information ratio
Prices of risk vs sensitivity
Tax shield