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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. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Asset transformers
Debt overhang
Ways risk can be mismeasured
Morningstar Rating System
2. Absolute and relative risk - direction and non-directional
Forms of Market risk
Efficient frontier
Morningstar Rating System
Liquidity risk
3. Strategic risk - Business risk - Reputational risk
Risks excluded from operational risk
Solve for minimum variance portfolio
Tracking error
Treynor measure
4. 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
CAPM (formula)
CAPM with taxes included (equation)
Uncertainty
Barings
5. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Practical considerations related to ERM implementatio
CAPM assumption for EMH
Firms becoming more sensitive to changes(bank deregulation)
EPD or ECOR - Expected Policyholder Deficit (EPD)
6. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Derivative contract
Standard deviation of two assets
Nonmarketable asset impact on CAPM
Expected return of two assets
7. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Parametric VaR
VaR - Value at Risk
Carry- backs and carry- forwards
Sharpe measure
8. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
CAPM with taxes included (equation)
Risk
Ri = Rz + (gamma)(beta)
Drysdale Securities (Chase Manhattan)
9. When negative taxable income is moved to a different year to offset future or past taxable income
Carry- backs and carry- forwards
Allied Irish Bank
Sovereign risk
Business risks
10. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Standard deviation of two assets
Information ratio
Firms becoming more sensitive to changes(bank deregulation)
Models used in ERM framework
11. Need to assess risk and tell management so they can determine which risks to take on
Importance of communication for risk managers
EPD or ECOR - Expected Policyholder Deficit (EPD)
Treynor measure
Volatility Market risk
12. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Risk- adjusted performance measure (RAP)
Settlement risk
Exposure
Operational risk
13. 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 with taxes included (equation)
Efficient frontier
Probability of ruin
Market risk
14. 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
Treynor measure
Ways firms can fail to account for risks
Market imperfections that can create value
Formula for covariance
15. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Source of need for risk management
Business risks
Basis risk
Carry- backs and carry- forwards
16. Expected value of unfavorable deviations of a random variable from a specified target level
Allied Irish Bank
Shape of portfolio possibilities curve
Funding liquidity risk
BTR - Below Target Risk
17. Losses due to market activities ex. Interest rate changes or defaults
Risk- adjusted performance measure (RAP)
Solve for minimum variance portfolio
Financial risks
Practical considerations related to ERM implementatio
18. Modeling approach is typically between statistical analytic models and structural simulation models
Debt overhang
Jensen's alpha
Models used in ERM framework
Prices of risk vs sensitivity
19. 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
CAPM assumption for EMH
Basis risk
Traits of ERM
Capital market line (CML)
20. 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
21. 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
Basis risk
Effect of non- price- taking behavior on CAPM
Capital market line (CML)
Tax shield
22. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Prices of risk vs sensitivity
Practical considerations related to ERM implementatio
VaR- based analysis (formula)
Ways risk can be mismeasured
23. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Kidder Peabody
Security (primary vs secondary)
Debt overhang
24. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Funding liquidity risk
Market imperfections that can create value
Settlement risk
Shortcomings of risk metrics
25. Asses firm risks - Communicate risks - Manage and monitor risks
Zero- beta CAPM (two factor model)
Valuation vs. Risk management
Roles of risk management
CAPM assumption for EMH
26. Returns on any stock are linearly related to a set of indexes
Kidder Peabody
Shortcomings of risk metrics
Ri = ai + bi1l1 + bi2l2....+ei
Ri = Rz + (gamma)(beta)
27. Occurs the day when two parties exchange payments same day
Valuation vs. Risk management
Debt overhang
Volatility Market risk
Settlement risk
28. Volatility of unexpected outcomes
Risk Management Irrelevance Proposition
Risk
Standard deviation of two assets
Tax shield
29. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Morningstar Rating System
Nonmarketable asset impact on CAPM
3 main types of operational risk
Treynor measure
30. Probability distribution is unknown (ex. A terrorist attack)
Business risks
Contango
Three main reasons for financial disasters
Uncertainty
31. Both probability and cost of tail events are considered
Zero- beta CAPM (two factor model)
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Source of need for risk management
VaR - Value at Risk
32. 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 -
Shape of portfolio possibilities curve
Uncertainty
Source of need for risk management
Shortfall risk
33. Future price is greater than the spot price
Ways firms can fail to account for risks
BTR - Below Target Risk
Financial Risk
Contango
34. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Sharpe measure
Operational risk
VaR - Value at Risk
APT (equation and assumptions)
35. RM cannot increase firm value when it costs the same to bear a risk w/in the firm or outside the firm - For RM to increase firm value it must be more expensive to bear risks internally than to pay capital markets to bear them.
Firms becoming more sensitive to changes(bank deregulation)
Basis
Source of need for risk management
Risk Management Irrelevance Proposition
36. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
CAPM assumption for EMH
Where is risk coming from
Financial Risk
Risks excluded from operational risk
37. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Market risk
BTR - Below Target Risk
Liquidity risk
Solve for minimum variance portfolio
38. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Performance- related metrics
Options motivation on volatility
LTCM
Differences in financial risk management for financial companies vs industrial companies
39. Wrong distribution - Historical sample may not apply
Capital market line (CML)
Ways risk can be mismeasured
Tracking error
Business Risk
40. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Banker's Trust
APT in active portfolio management
EPD or ECOR - Expected Policyholder Deficit (EPD)
Shortcomings of risk metrics
41. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Ten assumptions underlying CAPM
Operational risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
Security (primary vs secondary)
42. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Roles of risk management
Forms of Market risk
Volatility Market risk
Effect of heterogeneous expectations on CAPM
43. 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)
Shape of portfolio possibilities curve
BTR - Below Target Risk
Shortcomings of risk metrics
44. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
LTCM
Business risks
Asset transformers
Risk
45. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Sortino ratio
Ways risk can be mismeasured
RAR = relative return of portfolio (RRp)
Carry- backs and carry- forwards
46. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Performance- related metrics
Parametric VaR
Barings
Capital market line (CML)
47. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Forms of Market risk
Risk types addressed by ERM
Credit event
Roles of risk management
48. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Risk
Ri = Rz + (gamma)(beta)
Solvency-related metrics
Asset transformers
49. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Risk
Risk
Basis risk
Effect of non- price- taking behavior on CAPM
50. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Options motivation on volatility
Uncertainty
Solvency-related metrics
Ri = Rz + (gamma)(beta)