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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. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Carry- backs and carry- forwards
Prices of risk vs sensitivity
Basis risk
Ri = Rz + (gamma)(beta)
2. 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
Exposure
Solve for minimum variance portfolio
Kidder Peabody
Forms of Market risk
3. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Uncertainty
Options motivation on volatility
Efficient frontier
Kidder Peabody
4. Prices of risk are common factors and do not change - Sensitivities can change
Models used in ERM framework
Firms becoming more sensitive to changes(bank deregulation)
Ways firms can fail to account for risks
Prices of risk vs sensitivity
5. Modeling approach is typically between statistical analytic models and structural simulation models
APT for passive portfolio management
Exposure
Security (primary vs secondary)
Models used in ERM framework
6. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Morningstar Rating System
LTCM
Nonmarketable asset impact on CAPM
Standard deviation of two assets
7. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Sortino ratio
CAPM with taxes included (equation)
Allied Irish Bank
CAPM assumption for EMH
8. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
3 main types of operational risk
Market imperfections that can create value
Effect of heterogeneous expectations on CAPM
Where is risk coming from
9. 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
Parametric VaR
Business Risk
Shortcomings of risk metrics
Basis risk
10. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Shortcomings of risk metrics
Basic Market risk
Source of need for risk management
Credit event
11. Occurs the day when two parties exchange payments same day
Standard deviation of two assets
Settlement risk
Expected return of two assets
What lead to the exponential growth to derivatives mkt?
12. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Valuation vs. Risk management
Volatility Market risk
Effect of heterogeneous expectations on CAPM
Debt overhang
13. 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
Nonmarketable asset impact on CAPM
Morningstar Rating System
Ri = ai + bi1l1 + bi2l2....+ei
14. 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
Funding liquidity risk
Business Risk
Basic Market risk
Tax shield
15. Unanticipated movements in relative prices of assets in hedged position
Source of need for risk management
Multi- period version of CAPM
Models used in ERM framework
Basic Market risk
16. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Volatility Market risk
Recovery rate
Source of need for risk management
17. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Business risks
What lead to the exponential growth to derivatives mkt?
Three main reasons for financial disasters
Efficient frontier
18. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Prices of risk vs sensitivity
BTR - Below Target Risk
Contango
VaR- based analysis (formula)
19. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Information ratio
Market risk
Basis risk
Firms becoming more sensitive to changes(bank deregulation)
20. Asses firm risks - Communicate risks - Manage and monitor risks
Security (primary vs secondary)
Importance of communication for risk managers
Roles of risk management
Effect of non- price- taking behavior on CAPM
21. The lower (closer to - 1) - the higher the payoff from diversification
APT for passive portfolio management
Prices of risk vs sensitivity
Treynor measure
Correlation coefficient effect on diversification
22. Rp = XaRa + XbRb
Four major types of risk
Ways firms can fail to account for risks
Expected return of two assets
Effect of non- price- taking behavior on CAPM
23. Asset-liability/market-liquidity risk
Carry- backs and carry- forwards
Liquidity risk
Tax shield
Settlement risk
24. Cannot exit position in market due to size of the position
Firms becoming more sensitive to changes(bank deregulation)
Expected return of two assets
Asset liquidity risk
APT (equation and assumptions)
25. 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 -
Performance- related metrics
Source of need for risk management
Drysdale Securities (Chase Manhattan)
Operational risk
26. Absolute and relative risk - direction and non-directional
Forms of Market risk
Differences in financial risk management for financial companies vs industrial companies
Market risk
Debt overhang
27. The need to hedge against risks - for firms need to speculate.
Debt overhang
Solve for minimum variance portfolio
Ways firms can fail to account for risks
What lead to the exponential growth to derivatives mkt?
28. 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.
APT in active portfolio management
Sortino ratio
Risk Management Irrelevance Proposition
CAPM (formula)
29. Hazard - Financial - Operational - Strategic
Efficient frontier
Risk types addressed by ERM
Volatility Market risk
Security (primary vs secondary)
30. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Risk- adjusted performance measure (RAP)
Operational risk
Asset liquidity risk
Ways risk can be mismeasured
31. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Drysdale Securities (Chase Manhattan)
Credit event
Standard deviation of two assets
VaR- based analysis (formula)
32. When two payments are exchanged the same day and one party may default after payment is made
Source of need for risk management
Settlement risk
Recovery rate
Options motivation on volatility
33. Market risk - Liquidity risk - Credit risk - Operational risk
Nonparametric VaR
Four major types of risk
APT (equation and assumptions)
Allied Irish Bank
34. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Importance of communication for risk managers
Debt overhang
CAPM assumption for EMH
Jensen's alpha
35. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
APT in active portfolio management
Basis risk
Formula for covariance
Risk- adjusted performance measure (RAP)
36. Quantile of an empirical distribution
CAPM with taxes included (equation)
Risk- adjusted performance measure (RAP)
Exposure
Nonparametric VaR
37. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Market imperfections that can create value
Asset transformers
Debt overhang
Effect of non- price- taking behavior on CAPM
38. Returns on any stock are linearly related to a set of indexes
Importance of communication for risk managers
Ri = ai + bi1l1 + bi2l2....+ei
Options motivation on volatility
Uncertainty
39. 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
Operational risk
Allied Irish Bank
Settlement risk
Funding liquidity risk
40. Volatility of unexpected outcomes
Sharpe measure
Funding liquidity risk
Market risk
Risk
41. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Tracking error
Sharpe measure
Differences in financial risk management for financial companies vs industrial companies
Market imperfections that can create value
42. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Shortcomings of risk metrics
Asset transformers
Carry- backs and carry- forwards
Ten assumptions underlying CAPM
43. Inability to make payment obligations (ex. Margin calls)
Solve for minimum variance portfolio
Risk types addressed by ERM
Credit event
Funding liquidity risk
44. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Tracking error
CAPM (formula)
Barings
Shortfall risk
45. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Ri = ai + bi1l1 + bi2l2....+ei
CAPM with taxes included (equation)
Financial Risk
Risk types addressed by ERM
46. Strategic risk - Business risk - Reputational risk
Asset liquidity risk
Efficient frontier
Risks excluded from operational risk
Performance- related metrics
47. 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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48. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
BTR - Below Target Risk
Operational risk
Contango
Tracking error
49. Wrong distribution - Historical sample may not apply
CAPM (formula)
Risk Management Irrelevance Proposition
Ways risk can be mismeasured
Prices of risk vs sensitivity
50. Concave function that extends from minimum variance portfolio to maximum return portfolio
LTCM
What lead to the exponential growth to derivatives mkt?
Treynor measure
Efficient frontier