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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. Both probability and cost of tail events are considered
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Roles of risk management
Risk
Market imperfections that can create value
2. 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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3. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Ri = Rz + (gamma)(beta)
Morningstar Rating System
APT (equation and assumptions)
Sortino ratio
4. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Credit event
VaR- based analysis (formula)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Kidder Peabody
5. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Liquidity risk
RAR = relative return of portfolio (RRp)
Three main reasons for financial disasters
Solvency-related metrics
6. Multibeta CAPM Ri - Rf =
Recovery rate
APT (equation and assumptions)
3 main types of operational risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
7. Potential amount that can be lost
VaR- based analysis (formula)
Exposure
Three main reasons for financial disasters
Jensen's alpha
8. 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)
Tracking error
Ways risk can be mismeasured
Firms becoming more sensitive to changes(bank deregulation)
9. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
EPD or ECOR - Expected Policyholder Deficit (EPD)
Correlation coefficient effect on diversification
Efficient frontier
LTCM
10. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Importance of communication for risk managers
Firms becoming more sensitive to changes(bank deregulation)
VaR- based analysis (formula)
Performance- related metrics
11. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Debt overhang
VaR - Value at Risk
Where is risk coming from
LTCM
12. Modeling approach is typically between statistical analytic models and structural simulation models
Standard deviation of two assets
Models used in ERM framework
Correlation coefficient effect on diversification
Financial risks
13. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Probability of ruin
Basis risk
Derivative contract
Where is risk coming from
14. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
What lead to the exponential growth to derivatives mkt?
Traits of ERM
Debt overhang
Derivative contract
15. 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
APT for passive portfolio management
Ten assumptions underlying CAPM
Probability of ruin
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
16. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Funding liquidity risk
CAPM assumption for EMH
Treynor measure
Uncertainty
17. Need to assess risk and tell management so they can determine which risks to take on
Probability of ruin
Business risks
Importance of communication for risk managers
Basic Market risk
18. Country specific - Foreign exchange controls that prohibit counterparty's obligations
CAPM assumption for EMH
Volatility Market risk
Sovereign risk
Source of need for risk management
19. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Zero- beta CAPM (two factor model)
Forms of Market risk
Capital market line (CML)
Importance of communication for risk managers
20. Probability that a random variable falls below a specified threshold level
Market risk
Shortfall risk
BTR - Below Target Risk
Kidder Peabody
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
Nonparametric VaR
Correlation coefficient effect on diversification
APT in active portfolio management
Capital market line (CML)
22. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Operational risk
Credit event
Solvency-related metrics
Allied Irish Bank
23. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
EPD or ECOR - Expected Policyholder Deficit (EPD)
Three main reasons for financial disasters
CAPM (formula)
Solvency-related metrics
24. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Prices of risk vs sensitivity
Sharpe measure
Treynor measure
Risk- adjusted performance measure (RAP)
25. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Solvency-related metrics
Drysdale Securities (Chase Manhattan)
Correlation coefficient effect on diversification
Nonmarketable asset impact on CAPM
26. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Nonmarketable asset impact on CAPM
Risk Management Irrelevance Proposition
Liquidity risk
Three main reasons for financial disasters
27. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Efficient frontier
Tracking error
Allied Irish Bank
Security (primary vs secondary)
28. 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
Three main reasons for financial disasters
Ten assumptions underlying CAPM
Sovereign risk
Ways risk can be mismeasured
29. Inability to make payment obligations (ex. Margin calls)
Funding liquidity risk
3 main types of operational risk
Probability of ruin
Performance- related metrics
30. 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
LTCM
Solvency-related metrics
Contango
CAPM with taxes included (equation)
31. Occurs the day when two parties exchange payments same day
CAPM (formula)
Settlement risk
Drysdale Securities (Chase Manhattan)
Effect of heterogeneous expectations on CAPM
32. Curve must be concave - Straight line connecting any two points must be under the curve
Carry- backs and carry- forwards
Where is risk coming from
Source of need for risk management
Shape of portfolio possibilities curve
33. When negative taxable income is moved to a different year to offset future or past taxable income
Zero- beta CAPM (two factor model)
Recovery rate
Carry- backs and carry- forwards
Four major types of risk
34. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Treynor measure
Practical considerations related to ERM implementatio
APT in active portfolio management
Financial Risk
35. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Ways firms can fail to account for risks
Information ratio
Barings
Funding liquidity risk
36. The uses of debt to fall into a lower tax rate
Ri = ai + bi1l1 + bi2l2....+ei
APT for passive portfolio management
Tax shield
Roles of risk management
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
Ten assumptions underlying CAPM
Business Risk
Traits of ERM
Valuation vs. Risk management
38. Risk of loses owing to movements in level or volatility of market prices
Formula for covariance
Basis
Sharpe measure
Market risk
39. Market risk - Liquidity risk - Credit risk - Operational risk
Risks excluded from operational risk
Four major types of risk
VaR- based analysis (formula)
Recovery rate
40. Probability distribution is unknown (ex. A terrorist attack)
Uncertainty
Models used in ERM framework
Solve for minimum variance portfolio
Basic Market risk
41. Volatility of unexpected outcomes
Risk
Nonmarketable asset impact on CAPM
Firms becoming more sensitive to changes(bank deregulation)
VaR - Value at Risk
42. Derives value from an underlying asset - rate - or index - Derives value from a security
Exposure
Derivative contract
Shortcomings of risk metrics
Ri = ai + bi1l1 + bi2l2....+ei
43. Return is linearly related to growth rate in consumption
Kidder Peabody
Multi- period version of CAPM
Models used in ERM framework
APT in active portfolio management
44. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Basis
Asset transformers
Prices of risk vs sensitivity
Kidder Peabody
45. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Derivative contract
Forms of Market risk
Risk
3 main types of operational risk
46. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Business risks
Recovery rate
Practical considerations related to ERM implementatio
VaR - Value at Risk
47. When two payments are exchanged the same day and one party may default after payment is made
Debt overhang
Recovery rate
Settlement risk
APT (equation and assumptions)
48. Future price is greater than the spot price
Settlement risk
Contango
Basis risk
Jensen's alpha
49. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Debt overhang
Effect of non- price- taking behavior on CAPM
Correlation coefficient effect on diversification
Ways firms can fail to account for risks
50. Concave function that extends from minimum variance portfolio to maximum return portfolio
Efficient frontier
Models used in ERM framework
Allied Irish Bank
Uncertainty