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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. Potential amount that can be lost
Expected return of two assets
Prices of risk vs sensitivity
Exposure
Risk
2. Absolute and relative risk - direction and non-directional
Capital market line (CML)
Practical considerations related to ERM implementatio
Operational risk
Forms of Market risk
3. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Standard deviation of two assets
Information ratio
Tax shield
Prices of risk vs sensitivity
4. Law of one price - Homogeneous expectations - Security returns process
LTCM
APT (equation and assumptions)
Business risks
Shortfall risk
5. Wrong distribution - Historical sample may not apply
Business risks
Ways risk can be mismeasured
Risk- adjusted performance measure (RAP)
Credit event
6. The need to hedge against risks - for firms need to speculate.
What lead to the exponential growth to derivatives mkt?
Risks excluded from operational risk
Standard deviation of two assets
BTR - Below Target Risk
7. Losses due to market activities ex. Interest rate changes or defaults
Contango
Basic Market risk
Financial risks
Tax shield
8. Volatility of unexpected outcomes
Ways firms can fail to account for risks
Risk
Uncertainty
Four major types of risk
9. 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.
VaR- based analysis (formula)
Valuation vs. Risk management
Risk Management Irrelevance Proposition
Three main reasons for financial disasters
10. 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
Ten assumptions underlying CAPM
Effect of heterogeneous expectations on CAPM
Asset liquidity risk
Practical considerations related to ERM implementatio
11. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
APT in active portfolio management
Expected return of two assets
Nonmarketable asset impact on CAPM
Shape of portfolio possibilities curve
12. 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 -
Tax shield
Source of need for risk management
Liquidity risk
Operational risk
13. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
APT for passive portfolio management
Shortfall risk
Risk- adjusted performance measure (RAP)
Asset transformers
14. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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15. Occurs the day when two parties exchange payments same day
Settlement risk
Derivative contract
Traits of ERM
Basic Market risk
16. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Sovereign risk
Basis risk
Risk
Importance of communication for risk managers
17. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Asset transformers
Business Risk
Source of need for risk management
Morningstar Rating System
18. Curve must be concave - Straight line connecting any two points must be under the curve
Shape of portfolio possibilities curve
Drysdale Securities (Chase Manhattan)
Asset liquidity risk
Valuation vs. Risk management
19. 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
Business Risk
Options motivation on volatility
Settlement risk
Effect of non- price- taking behavior on CAPM
20. 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
Risks excluded from operational risk
Derivative contract
Firms becoming more sensitive to changes(bank deregulation)
21. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
CAPM with taxes included (equation)
Settlement risk
CAPM (formula)
Forms of Market risk
22. 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
Basis
Business risks
Debt overhang
Allied Irish Bank
23. Asset-liability/market-liquidity risk
Liquidity risk
Contango
Market risk
Valuation vs. Risk management
24. Expected value of unfavorable deviations of a random variable from a specified target level
BTR - Below Target Risk
Sharpe measure
Asset transformers
CAPM (formula)
25. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Traits of ERM
APT in active portfolio management
Basis risk
Roles of risk management
26. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Importance of communication for risk managers
CAPM assumption for EMH
Treynor measure
Barings
27. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
3 main types of operational risk
Sortino ratio
Prices of risk vs sensitivity
Practical considerations related to ERM implementatio
28. Quantile of an empirical distribution
Valuation vs. Risk management
Zero- beta CAPM (two factor model)
Solvency-related metrics
Nonparametric VaR
29. The lower (closer to - 1) - the higher the payoff from diversification
Ways firms can fail to account for risks
Correlation coefficient effect on diversification
Uncertainty
CAPM with taxes included (equation)
30. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Basic Market risk
Security (primary vs secondary)
Liquidity risk
Tax shield
31. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Traits of ERM
Tracking error
Solve for minimum variance portfolio
Performance- related metrics
32. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Kidder Peabody
Tracking error
Treynor measure
Morningstar Rating System
33. When negative taxable income is moved to a different year to offset future or past taxable income
Tax shield
Funding liquidity risk
Carry- backs and carry- forwards
Correlation coefficient effect on diversification
34. 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
Traits of ERM
Solvency-related metrics
Barings
Business Risk
35. Prices of risk are common factors and do not change - Sensitivities can change
Ri = Rz + (gamma)(beta)
Prices of risk vs sensitivity
Tax shield
Capital market line (CML)
36. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
3 main types of operational risk
Options motivation on volatility
Debt overhang
Risk
37. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
VaR - Value at Risk
Effect of non- price- taking behavior on CAPM
Standard deviation of two assets
Forms of Market risk
38. 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
Valuation vs. Risk management
Kidder Peabody
Solve for minimum variance portfolio
Business Risk
39. 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
Capital market line (CML)
Forms of Market risk
Where is risk coming from
Tracking error
40. Strategic risk - Business risk - Reputational risk
Tracking error
Risks excluded from operational risk
CAPM assumption for EMH
Options motivation on volatility
41. Concave function that extends from minimum variance portfolio to maximum return portfolio
Allied Irish Bank
Shortfall risk
LTCM
Efficient frontier
42. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Exposure
Security (primary vs secondary)
Operational risk
Models used in ERM framework
43. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Firms becoming more sensitive to changes(bank deregulation)
Financial risks
Tracking error
Expected return of two assets
44. 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
Business Risk
Ways risk can be mismeasured
LTCM
Derivative contract
45. Rp = XaRa + XbRb
Expected return of two assets
Correlation coefficient effect on diversification
Ri = Rz + (gamma)(beta)
Ri = ai + bi1l1 + bi2l2....+ei
46. When two payments are exchanged the same day and one party may default after payment is made
Settlement risk
Tracking error
Source of need for risk management
Nonparametric VaR
47. Need to assess risk and tell management so they can determine which risks to take on
Exposure
Ways risk can be mismeasured
Ri = ai + bi1l1 + bi2l2....+ei
Importance of communication for risk managers
48. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Asset transformers
Probability of ruin
Security (primary vs secondary)
Shortfall risk
49. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Treynor measure
Credit event
Probability of ruin
Effect of heterogeneous expectations on CAPM
50. 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
Debt overhang
Where is risk coming from
CAPM assumption for EMH