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Test your basic knowledge |
FRM: Foundations Of Risk Management
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Subjects
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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. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Operational risk
APT for passive portfolio management
Sharpe measure
Credit event
2. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Kidder Peabody
Debt overhang
Source of need for risk management
Formula for covariance
3. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Funding liquidity risk
Uncertainty
CAPM with taxes included (equation)
Ways firms can fail to account for risks
4. Occurs the day when two parties exchange payments same day
Settlement risk
CAPM (formula)
Shortfall risk
Kidder Peabody
5. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Standard deviation of two assets
Basis risk
APT in active portfolio management
Information ratio
6. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Exposure
Parametric VaR
Volatility Market risk
Information ratio
7. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Morningstar Rating System
Ri = Rz + (gamma)(beta)
3 main types of operational risk
Nonparametric VaR
8. 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
APT for passive portfolio management
Source of need for risk management
Ten assumptions underlying CAPM
Effect of heterogeneous expectations on CAPM
9. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Four major types of risk
Market risk
CAPM assumption for EMH
RAR = relative return of portfolio (RRp)
10. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Valuation vs. Risk management
Operational risk
Morningstar Rating System
Tax shield
11. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Debt overhang
Risk
Solvency-related metrics
Efficient frontier
12. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Jensen's alpha
Differences in financial risk management for financial companies vs industrial companies
Ways risk can be mismeasured
Sovereign risk
13. Wrong distribution - Historical sample may not apply
Ways risk can be mismeasured
Uncertainty
VaR- based analysis (formula)
Solvency-related metrics
14. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Differences in financial risk management for financial companies vs industrial companies
Parametric VaR
EPD or ECOR - Expected Policyholder Deficit (EPD)
RAR = relative return of portfolio (RRp)
15. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Business risks
Asset liquidity risk
Asset transformers
Risk types addressed by ERM
16. Probability that a random variable falls below a specified threshold level
Volatility Market risk
Debt overhang
Shortfall risk
Business risks
17. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Practical considerations related to ERM implementatio
3 main types of operational risk
VaR - Value at Risk
Risk
18. Future price is greater than the spot price
Derivative contract
Contango
Source of need for risk management
Barings
19. Asset-liability/market-liquidity risk
Solvency-related metrics
Risk
Liquidity risk
Treynor measure
20. Expected value of unfavorable deviations of a random variable from a specified target level
LTCM
Efficient frontier
Exposure
BTR - Below Target Risk
21. 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 -
Parametric VaR
Source of need for risk management
Sortino ratio
Basis risk
22. Volatility of unexpected outcomes
Risk
Formula for covariance
Security (primary vs secondary)
Solvency-related metrics
23. Interest rate movements - derivatives - defaults
Treynor measure
Financial Risk
Nonparametric VaR
Three main reasons for financial disasters
24. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Valuation vs. Risk management
Effect of heterogeneous expectations on CAPM
Sortino ratio
Efficient frontier
25. Potential amount that can be lost
Business Risk
VaR - Value at Risk
Exposure
Treynor measure
26. 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)
Risks excluded from operational risk
Performance- related metrics
Uncertainty
27. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Efficient frontier
Ten assumptions underlying CAPM
RAR = relative return of portfolio (RRp)
VaR- based analysis (formula)
28. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Ways risk can be mismeasured
Recovery rate
Zero- beta CAPM (two factor model)
Sovereign risk
29. Need to assess risk and tell management so they can determine which risks to take on
Morningstar Rating System
Uncertainty
Importance of communication for risk managers
Ten assumptions underlying CAPM
30. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Information ratio
Basis risk
Credit event
31. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Basic Market risk
Morningstar Rating System
CAPM assumption for EMH
Solvency-related metrics
32. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Source of need for risk management
Sharpe measure
Financial Risk
Three main reasons for financial disasters
33. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Tracking error
Differences in financial risk management for financial companies vs industrial companies
Firms becoming more sensitive to changes(bank deregulation)
Ways firms can fail to account for risks
34. The lower (closer to - 1) - the higher the payoff from diversification
Sortino ratio
Ten assumptions underlying CAPM
Basic Market risk
Correlation coefficient effect on diversification
35. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Efficient frontier
Ways risk can be mismeasured
Where is risk coming from
RAR = relative return of portfolio (RRp)
36. The need to hedge against risks - for firms need to speculate.
Market imperfections that can create value
Jensen's alpha
Recovery rate
What lead to the exponential growth to derivatives mkt?
37. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Asset transformers
Debt overhang
Volatility Market risk
Sharpe measure
38. Multibeta CAPM Ri - Rf =
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
LTCM
Standard deviation of two assets
VaR - Value at Risk
39. 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
Parametric VaR
Funding liquidity risk
Business Risk
Probability of ruin
40. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
APT (equation and assumptions)
Debt overhang
Performance- related metrics
41. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Practical considerations related to ERM implementatio
Four major types of risk
Firms becoming more sensitive to changes(bank deregulation)
Solvency-related metrics
42. Derives value from an underlying asset - rate - or index - Derives value from a security
EPD or ECOR - Expected Policyholder Deficit (EPD)
Three main reasons for financial disasters
Derivative contract
Effect of heterogeneous expectations on CAPM
43. Changes in vol - implied or actual
Asset liquidity risk
Volatility Market risk
Firms becoming more sensitive to changes(bank deregulation)
Settlement risk
44. When two payments are exchanged the same day and one party may default after payment is made
Debt overhang
Settlement risk
CAPM with taxes included (equation)
APT (equation and assumptions)
45. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Security (primary vs secondary)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Performance- related metrics
Risk
46. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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47. Asses firm risks - Communicate risks - Manage and monitor risks
Roles of risk management
Sovereign risk
Morningstar Rating System
Contango
48. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Risk- adjusted performance measure (RAP)
Solve for minimum variance portfolio
Recovery rate
Asset transformers
49. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Efficient frontier
Treynor measure
EPD or ECOR - Expected Policyholder Deficit (EPD)
Valuation vs. Risk management
50. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Standard deviation of two assets
Correlation coefficient effect on diversification
Ways risk can be mismeasured
Risk