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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. Quantile of a statistical distribution
Practical considerations related to ERM implementatio
Parametric VaR
Risk- adjusted performance measure (RAP)
Recovery rate
2. Law of one price - Homogeneous expectations - Security returns process
Performance- related metrics
Solve for minimum variance portfolio
APT (equation and assumptions)
EPD or ECOR - Expected Policyholder Deficit (EPD)
3. 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
CAPM (formula)
VaR - Value at Risk
APT for passive portfolio management
Solvency-related metrics
4. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Three main reasons for financial disasters
Basis risk
Risk Management Irrelevance Proposition
Options motivation on volatility
5. Inability to make payment obligations (ex. Margin calls)
Debt overhang
Multi- period version of CAPM
Funding liquidity risk
Prices of risk vs sensitivity
6. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Operational risk
3 main types of operational risk
Morningstar Rating System
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
7. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Solve for minimum variance portfolio
Contango
Business risks
VaR - Value at Risk
8. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Sortino ratio
Efficient frontier
Recovery rate
Jensen's alpha
9. Cannot exit position in market due to size of the position
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Asset liquidity risk
Kidder Peabody
Standard deviation of two assets
10. Quantile of an empirical distribution
Formula for covariance
Zero- beta CAPM (two factor model)
Nonparametric VaR
Risk- adjusted performance measure (RAP)
11. The lower (closer to - 1) - the higher the payoff from diversification
Correlation coefficient effect on diversification
CAPM assumption for EMH
Jensen's alpha
Risk
12. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Tracking error
Prices of risk vs sensitivity
CAPM (formula)
Jensen's alpha
13. Risk of loses owing to movements in level or volatility of market prices
Expected return of two assets
Market risk
Settlement risk
Parametric VaR
14. 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
Where is risk coming from
Basic Market risk
Valuation vs. Risk management
Sovereign risk
15. 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
Correlation coefficient effect on diversification
Shortcomings of risk metrics
Options motivation on volatility
Funding liquidity risk
16. Derives value from an underlying asset - rate - or index - Derives value from a security
Derivative contract
Sortino ratio
Allied Irish Bank
Business risks
17. Wrong distribution - Historical sample may not apply
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Three main reasons for financial disasters
Ways risk can be mismeasured
Funding liquidity risk
18. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Uncertainty
Morningstar Rating System
Sharpe measure
Basis
19. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Credit event
EPD or ECOR - Expected Policyholder Deficit (EPD)
Settlement risk
Where is risk coming from
20. Hazard - Financial - Operational - Strategic
Barings
Risk types addressed by ERM
Risk
Banker's Trust
21. Concave function that extends from minimum variance portfolio to maximum return portfolio
Efficient frontier
Performance- related metrics
Parametric VaR
Ri = Rz + (gamma)(beta)
22. 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
RAR = relative return of portfolio (RRp)
Practical considerations related to ERM implementatio
Kidder Peabody
Four major types of risk
23. Future price is greater than the spot price
Sovereign risk
VaR- based analysis (formula)
Derivative contract
Contango
24. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Uncertainty
Business Risk
Effect of heterogeneous expectations on CAPM
Risk- adjusted performance measure (RAP)
25. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Tail VaR or TCE - Tail Conditional Expectation(TCE)
What lead to the exponential growth to derivatives mkt?
Nonmarketable asset impact on CAPM
Information ratio
26. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Solvency-related metrics
Capital market line (CML)
Ri = Rz + (gamma)(beta)
Operational risk
27. Occurs the day when two parties exchange payments same day
Source of need for risk management
Financial risks
Settlement risk
Risk types addressed by ERM
28. Absolute and relative risk - direction and non-directional
Forms of Market risk
Performance- related metrics
CAPM (formula)
Business Risk
29. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Sortino ratio
VaR- based analysis (formula)
Funding liquidity risk
Jensen's alpha
30. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Exposure
Firms becoming more sensitive to changes(bank deregulation)
What lead to the exponential growth to derivatives mkt?
Parametric VaR
31. Curve must be concave - Straight line connecting any two points must be under the curve
Nonparametric VaR
Shape of portfolio possibilities curve
Financial Risk
Drysdale Securities (Chase Manhattan)
32. Need to assess risk and tell management so they can determine which risks to take on
Recovery rate
Solvency-related metrics
Importance of communication for risk managers
Models used in ERM framework
33. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Credit event
EPD or ECOR - Expected Policyholder Deficit (EPD)
Risk
Zero- beta CAPM (two factor model)
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
Exposure
Risks excluded from operational risk
Market imperfections that can create value
Traits of ERM
35. The need to hedge against risks - for firms need to speculate.
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
What lead to the exponential growth to derivatives mkt?
Risks excluded from operational risk
Ri = ai + bi1l1 + bi2l2....+ei
36. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Ri = Rz + (gamma)(beta)
CAPM with taxes included (equation)
Banker's Trust
Options motivation on volatility
37. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Risk- adjusted performance measure (RAP)
Nonmarketable asset impact on CAPM
Tracking error
CAPM (formula)
38. 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
Morningstar Rating System
Sharpe measure
Probability of ruin
Nonmarketable asset impact on CAPM
39. Potential amount that can be lost
Effect of heterogeneous expectations on CAPM
Exposure
Settlement risk
APT (equation and assumptions)
40. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
41. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Ways firms can fail to account for risks
3 main types of operational risk
CAPM assumption for EMH
CAPM with taxes included (equation)
42. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Risk
Operational risk
Roles of risk management
Importance of communication for risk managers
43. Both probability and cost of tail events are considered
Tax shield
CAPM (formula)
Risk
Tail VaR or TCE - Tail Conditional Expectation(TCE)
44. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Volatility Market risk
Formula for covariance
Allied Irish Bank
Debt overhang
45. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Market imperfections that can create value
Sharpe measure
Debt overhang
Basis
46. 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
Sovereign risk
Allied Irish Bank
Security (primary vs secondary)
Derivative contract
47. Interest rate movements - derivatives - defaults
Roles of risk management
Financial Risk
Effect of non- price- taking behavior on CAPM
Models used in ERM framework
48. 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
Expected return of two assets
Security (primary vs secondary)
Information ratio
49. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Solve for minimum variance portfolio
Credit event
Three main reasons for financial disasters
Banker's Trust
50. Modeling approach is typically between statistical analytic models and structural simulation models
Drysdale Securities (Chase Manhattan)
Models used in ERM framework
Basis
Jensen's alpha