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Test your basic knowledge |
FRM: Foundations Of Risk Management
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business-skills
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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. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Jensen's alpha
Kidder Peabody
Prices of risk vs sensitivity
Performance- related metrics
2. Quantile of an empirical distribution
RAR = relative return of portfolio (RRp)
Valuation vs. Risk management
Information ratio
Nonparametric VaR
3. Unanticipated movements in relative prices of assets in hedged position
Basic Market risk
Debt overhang
Market imperfections that can create value
Morningstar Rating System
4. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
What lead to the exponential growth to derivatives mkt?
Asset transformers
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
VaR - Value at Risk
5. Return is linearly related to growth rate in consumption
Banker's Trust
Market risk
Multi- period version of CAPM
Risk
6. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
3 main types of operational risk
Tracking error
Market imperfections that can create value
Carry- backs and carry- forwards
7. Asset-liability/market-liquidity risk
Treynor measure
Risk
Models used in ERM framework
Liquidity risk
8. Hazard - Financial - Operational - Strategic
Kidder Peabody
Risk types addressed by ERM
Ri = Rz + (gamma)(beta)
Recovery rate
9. 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
Credit event
Jensen's alpha
Probability of ruin
Business risks
10. When two payments are exchanged the same day and one party may default after payment is made
BTR - Below Target Risk
Settlement risk
Effect of non- price- taking behavior on CAPM
Firms becoming more sensitive to changes(bank deregulation)
11. 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
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Importance of communication for risk managers
Kidder Peabody
Risk- adjusted performance measure (RAP)
12. The lower (closer to - 1) - the higher the payoff from diversification
Correlation coefficient effect on diversification
Sortino ratio
LTCM
Capital market line (CML)
13. Losses due to market activities ex. Interest rate changes or defaults
Financial risks
Practical considerations related to ERM implementatio
Derivative contract
Information ratio
14. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Ri = Rz + (gamma)(beta)
Basis risk
Tracking error
Risk Management Irrelevance Proposition
15. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Debt overhang
Sharpe measure
Prices of risk vs sensitivity
Shortfall risk
16. 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)
Barings
Efficient frontier
Asset liquidity risk
17. 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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18. 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
Capital market line (CML)
Treynor measure
Kidder Peabody
Valuation vs. Risk management
19. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Firms becoming more sensitive to changes(bank deregulation)
Three main reasons for financial disasters
Solvency-related metrics
Liquidity risk
20. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Ways risk can be mismeasured
Tracking error
Banker's Trust
Nonmarketable asset impact on CAPM
21. Strategic risk - Business risk - Reputational risk
Risk Management Irrelevance Proposition
Firms becoming more sensitive to changes(bank deregulation)
Risks excluded from operational risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
22. 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
Market imperfections that can create value
APT (equation and assumptions)
Barings
Settlement risk
23. Law of one price - Homogeneous expectations - Security returns process
Traits of ERM
Nonparametric VaR
APT (equation and assumptions)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
24. 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
Solvency-related metrics
Business risks
Shape of portfolio possibilities curve
Business Risk
25. Wrong distribution - Historical sample may not apply
Volatility Market risk
Basic Market risk
Financial Risk
Ways risk can be mismeasured
26. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Kidder Peabody
Standard deviation of two assets
Banker's Trust
Solvency-related metrics
27. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Sortino ratio
Forms of Market risk
Ways risk can be mismeasured
CAPM with taxes included (equation)
28. Changes in vol - implied or actual
Volatility Market risk
Multi- period version of CAPM
Source of need for risk management
Formula for covariance
29. CAPM requires the strong form of the Efficient Market Hypothesis = private information
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Ri = Rz + (gamma)(beta)
CAPM assumption for EMH
Tax shield
30. Need to assess risk and tell management so they can determine which risks to take on
CAPM assumption for EMH
Importance of communication for risk managers
Risk types addressed by ERM
Business Risk
31. Cannot exit position in market due to size of the position
Financial risks
Allied Irish Bank
Importance of communication for risk managers
Asset liquidity risk
32. Concave function that extends from minimum variance portfolio to maximum return portfolio
Prices of risk vs sensitivity
Risk
Efficient frontier
Models used in ERM framework
33. Modeling approach is typically between statistical analytic models and structural simulation models
Risk types addressed by ERM
Sovereign risk
Risk
Models used in ERM framework
34. Rp = XaRa + XbRb
Expected return of two assets
CAPM with taxes included (equation)
Correlation coefficient effect on diversification
Practical considerations related to ERM implementatio
35. Covariance = correlation coefficient std dev(a) std dev(b)
Derivative contract
Debt overhang
Jensen's alpha
Formula for covariance
36. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Ten assumptions underlying CAPM
Tracking error
Ri = ai + bi1l1 + bi2l2....+ei
Information ratio
37. Expected value of unfavorable deviations of a random variable from a specified target level
CAPM assumption for EMH
Traits of ERM
Practical considerations related to ERM implementatio
BTR - Below Target Risk
38. 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
Practical considerations related to ERM implementatio
Shape of portfolio possibilities curve
VaR - Value at Risk
Volatility Market risk
39. Absolute and relative risk - direction and non-directional
Forms of Market risk
Debt overhang
BTR - Below Target Risk
Expected return of two assets
40. Quantile of a statistical distribution
Security (primary vs secondary)
Parametric VaR
Importance of communication for risk managers
Derivative contract
41. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Recovery rate
Settlement risk
Derivative contract
CAPM assumption for EMH
42. 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
Risk types addressed by ERM
Ways firms can fail to account for risks
Derivative contract
Asset transformers
43. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Solve for minimum variance portfolio
CAPM with taxes included (equation)
Volatility Market risk
Options motivation on volatility
44. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Treynor measure
Security (primary vs secondary)
Market imperfections that can create value
APT in active portfolio management
45. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
EPD or ECOR - Expected Policyholder Deficit (EPD)
Models used in ERM framework
BTR - Below Target Risk
CAPM assumption for EMH
46. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Multi- period version of CAPM
Nonmarketable asset impact on CAPM
Effect of non- price- taking behavior on CAPM
Drysdale Securities (Chase Manhattan)
47. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Liquidity risk
Drysdale Securities (Chase Manhattan)
Morningstar Rating System
Sovereign risk
48. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return
Business risks
Nonparametric VaR
Sortino ratio
EPD or ECOR - Expected Policyholder Deficit (EPD)
49. 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
Financial Risk
Ten assumptions underlying CAPM
Operational risk
Shortfall risk
50. Probability that a random variable falls below a specified threshold level
Shortfall risk
What lead to the exponential growth to derivatives mkt?
Source of need for risk management
RAR = relative return of portfolio (RRp)