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Test your basic knowledge |
FRM: Foundations Of Risk Management
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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. Derives value from an underlying asset - rate - or index - Derives value from a security
Recovery rate
CAPM with taxes included (equation)
Risk types addressed by ERM
Derivative contract
2. Risk of loses owing to movements in level or volatility of market prices
Credit event
Business risks
Allied Irish Bank
Market risk
3. The uses of debt to fall into a lower tax rate
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Sovereign risk
Tax shield
Jensen's alpha
4. 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
Three main reasons for financial disasters
Shortfall risk
Business Risk
Capital market line (CML)
5. The need to hedge against risks - for firms need to speculate.
3 main types of operational risk
Shortcomings of risk metrics
Drysdale Securities (Chase Manhattan)
What lead to the exponential growth to derivatives mkt?
6. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Ways risk can be mismeasured
Treynor measure
Basis
Information ratio
7. 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
Ri = Rz + (gamma)(beta)
Treynor measure
Volatility Market risk
LTCM
8. Asses firm risks - Communicate risks - Manage and monitor risks
Roles of risk management
Contango
VaR- based analysis (formula)
Practical considerations related to ERM implementatio
9. 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
Settlement risk
Asset transformers
Business Risk
Prices of risk vs sensitivity
10. Wrong distribution - Historical sample may not apply
Ways risk can be mismeasured
Multi- period version of CAPM
CAPM with taxes included (equation)
Performance- related metrics
11. Covariance = correlation coefficient std dev(a) std dev(b)
Source of need for risk management
Formula for covariance
Financial Risk
Standard deviation of two assets
12. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Sortino ratio
Shortfall risk
Prices of risk vs sensitivity
Funding liquidity risk
13. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Risk
Performance- related metrics
Debt overhang
Options motivation on volatility
14. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Importance of communication for risk managers
CAPM assumption for EMH
Debt overhang
Derivative contract
15. Multibeta CAPM Ri - Rf =
Carry- backs and carry- forwards
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Nonmarketable asset impact on CAPM
Options motivation on volatility
16. Concave function that extends from minimum variance portfolio to maximum return portfolio
Allied Irish Bank
Efficient frontier
Tax shield
Source of need for risk management
17. 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
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Source of need for risk management
Basis risk
Ways firms can fail to account for risks
18. Probability distribution is unknown (ex. A terrorist attack)
Effect of heterogeneous expectations on CAPM
Roles of risk management
Uncertainty
VaR- based analysis (formula)
19. 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
20. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Standard deviation of two assets
Banker's Trust
Exposure
BTR - Below Target Risk
21. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Effect of heterogeneous expectations on CAPM
Shape of portfolio possibilities curve
Debt overhang
APT (equation and assumptions)
22. Asset-liability/market-liquidity risk
Liquidity risk
Nonmarketable asset impact on CAPM
CAPM with taxes included (equation)
APT for passive portfolio management
23. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Business Risk
Probability of ruin
Credit event
Asset transformers
24. 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
Shortcomings of risk metrics
Ten assumptions underlying CAPM
Valuation vs. Risk management
25. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
3 main types of operational risk
Sortino ratio
Operational risk
Tracking error
26. Relative portfolio risk (RRiskp) - Based on a one- month investment period
RAR = relative return of portfolio (RRp)
Credit event
Asset transformers
Basis
27. Strategic risk - Business risk - Reputational risk
Kidder Peabody
Debt overhang
Risks excluded from operational risk
Banker's Trust
28. Valuation focuses on mean of distribution vs risk mgmt focuses on potential variation in payoffs - needs more precision for pricing - VAR doesn't b/c noise cancels out
Carry- backs and carry- forwards
Valuation vs. Risk management
Basis risk
Risk- adjusted performance measure (RAP)
29. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Tracking error
Market imperfections that can create value
Volatility Market risk
3 main types of operational risk
30. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Firms becoming more sensitive to changes(bank deregulation)
Expected return of two assets
Settlement risk
Shape of portfolio possibilities curve
31. Modeling approach is typically between statistical analytic models and structural simulation models
Carry- backs and carry- forwards
Information ratio
Debt overhang
Models used in ERM framework
32. Volatility of unexpected outcomes
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Risk
Correlation coefficient effect on diversification
Market risk
33. 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 -
Source of need for risk management
Formula for covariance
Nonmarketable asset impact on CAPM
Settlement risk
34. Curve must be concave - Straight line connecting any two points must be under the curve
BTR - Below Target Risk
Morningstar Rating System
RAR = relative return of portfolio (RRp)
Shape of portfolio possibilities curve
35. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Where is risk coming from
Barings
EPD or ECOR - Expected Policyholder Deficit (EPD)
Nonmarketable asset impact on CAPM
36. Quantile of an empirical distribution
Parametric VaR
Carry- backs and carry- forwards
Debt overhang
Nonparametric VaR
37. Expected value of unfavorable deviations of a random variable from a specified target level
BTR - Below Target Risk
Recovery rate
Asset liquidity risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
38. 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
Barings
Importance of communication for risk managers
Roles of risk management
Valuation vs. Risk management
39. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Performance- related metrics
APT in active portfolio management
Business risks
Four major types of risk
40. Occurs the day when two parties exchange payments same day
Options motivation on volatility
Settlement risk
Differences in financial risk management for financial companies vs industrial companies
3 main types of operational risk
41. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Exposure
Asset transformers
Business risks
Zero- beta CAPM (two factor model)
42. Absolute and relative risk - direction and non-directional
Forms of Market risk
Drysdale Securities (Chase Manhattan)
CAPM with taxes included (equation)
Performance- related metrics
43. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Standard deviation of two assets
Market risk
Solvency-related metrics
APT for passive portfolio management
44. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Treynor measure
Ri = Rz + (gamma)(beta)
Traits of ERM
Exposure
45. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Where is risk coming from
Asset liquidity risk
Sharpe measure
Ways firms can fail to account for risks
46. Prices of risk are common factors and do not change - Sensitivities can change
Solve for minimum variance portfolio
Prices of risk vs sensitivity
BTR - Below Target Risk
Volatility Market risk
47. Cannot exit position in market due to size of the position
Asset liquidity risk
Banker's Trust
VaR - Value at Risk
Treynor measure
48. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Treynor measure
Effect of non- price- taking behavior on CAPM
Ways firms can fail to account for risks
Morningstar Rating System
49. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
BTR - Below Target Risk
Tracking error
Basic Market risk
Risk- adjusted performance measure (RAP)
50. Return is linearly related to growth rate in consumption
Exposure
What lead to the exponential growth to derivatives mkt?
Business risks
Multi- period version of CAPM