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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.
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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. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Prices of risk vs sensitivity
Solve for minimum variance portfolio
EPD or ECOR - Expected Policyholder Deficit (EPD)
Information ratio
2. Risk of loses owing to movements in level or volatility of market prices
Market risk
Shape of portfolio possibilities curve
EPD or ECOR - Expected Policyholder Deficit (EPD)
Shortcomings of risk metrics
3. Asset-liability/market-liquidity risk
Formula for covariance
Morningstar Rating System
Liquidity risk
APT in active portfolio management
4. Probability that a random variable falls below a specified threshold level
Shortfall risk
Multi- period version of CAPM
Uncertainty
Volatility Market risk
5. Inability to make payment obligations (ex. Margin calls)
Financial Risk
Tracking error
Zero- beta CAPM (two factor model)
Funding liquidity risk
6. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Contango
Options motivation on volatility
Multi- period version of CAPM
Ten assumptions underlying CAPM
7. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Efficient frontier
Valuation vs. Risk management
Credit event
VaR- based analysis (formula)
8. 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
3 main types of operational risk
Prices of risk vs sensitivity
Risk
Practical considerations related to ERM implementatio
9. Cannot exit position in market due to size of the position
Correlation coefficient effect on diversification
Debt overhang
Tax shield
Asset liquidity risk
10. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Treynor measure
Roles of risk management
Financial Risk
What lead to the exponential growth to derivatives mkt?
11. Future price is greater than the spot price
VaR - Value at Risk
Risk Management Irrelevance Proposition
Contango
Risk types addressed by ERM
12. 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
Expected return of two assets
Shortfall risk
Valuation vs. Risk management
What lead to the exponential growth to derivatives mkt?
13. Concave function that extends from minimum variance portfolio to maximum return portfolio
Financial risks
Efficient frontier
Market imperfections that can create value
Security (primary vs secondary)
14. Rp = XaRa + XbRb
Expected return of two assets
Drysdale Securities (Chase Manhattan)
VaR- based analysis (formula)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
15. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Drysdale Securities (Chase Manhattan)
Performance- related metrics
Ways risk can be mismeasured
Operational risk
16. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
APT in active portfolio management
Zero- beta CAPM (two factor model)
Uncertainty
Asset liquidity risk
17. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Ways risk can be mismeasured
APT (equation and assumptions)
Settlement risk
Solvency-related metrics
18. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Source of need for risk management
Market risk
Recovery rate
Expected return of two assets
19. Volatility of unexpected outcomes
Risk
Traits of ERM
Formula for covariance
Ten assumptions underlying CAPM
20. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Allied Irish Bank
Carry- backs and carry- forwards
Morningstar Rating System
What lead to the exponential growth to derivatives mkt?
21. 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
Shape of portfolio possibilities curve
APT for passive portfolio management
Practical considerations related to ERM implementatio
Allied Irish Bank
22. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Formula for covariance
Business Risk
Security (primary vs secondary)
Sovereign risk
23. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Volatility Market risk
Importance of communication for risk managers
RAR = relative return of portfolio (RRp)
Effect of heterogeneous expectations on CAPM
24. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
APT for passive portfolio management
RAR = relative return of portfolio (RRp)
Financial Risk
Basis
25. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Jensen's alpha
Information ratio
Basis risk
Drysdale Securities (Chase Manhattan)
26. Potential amount that can be lost
Sovereign risk
APT (equation and assumptions)
APT for passive portfolio management
Exposure
27. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Contango
Performance- related metrics
3 main types of operational risk
Financial risks
28. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Basis risk
Asset transformers
Drysdale Securities (Chase Manhattan)
Source of need for risk management
29. 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
Options motivation on volatility
Ri = ai + bi1l1 + bi2l2....+ei
Barings
Financial risks
30. 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
Prices of risk vs sensitivity
LTCM
Financial risks
VaR - Value at Risk
31. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Security (primary vs secondary)
Three main reasons for financial disasters
Roles of risk management
Formula for covariance
32. 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
Correlation coefficient effect on diversification
Settlement risk
Business Risk
Importance of communication for risk managers
33. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Derivative contract
Where is risk coming from
Risk- adjusted performance measure (RAP)
Effect of heterogeneous expectations on CAPM
34. Quantile of a statistical distribution
Parametric VaR
Liquidity risk
Market imperfections that can create value
Options motivation on volatility
35. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Importance of communication for risk managers
Business risks
APT (equation and assumptions)
Options motivation on volatility
36. 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.
Roles of risk management
Solve for minimum variance portfolio
Risk Management Irrelevance Proposition
Allied Irish Bank
37. Market risk - Liquidity risk - Credit risk - Operational risk
Four major types of risk
Recovery rate
EPD or ECOR - Expected Policyholder Deficit (EPD)
Debt overhang
38. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Formula for covariance
Nonmarketable asset impact on CAPM
Market imperfections that can create value
Practical considerations related to ERM implementatio
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
CAPM (formula)
Jensen's alpha
Probability of ruin
Risks excluded from operational risk
40. Probability distribution is unknown (ex. A terrorist attack)
Shape of portfolio possibilities curve
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Risk
Uncertainty
41. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Standard deviation of two assets
Information ratio
Operational risk
Risk- adjusted performance measure (RAP)
42. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
RAR = relative return of portfolio (RRp)
Ri = Rz + (gamma)(beta)
Basis risk
CAPM (formula)
43. Modeling approach is typically between statistical analytic models and structural simulation models
Parametric VaR
Models used in ERM framework
Capital market line (CML)
Ri = ai + bi1l1 + bi2l2....+ei
44. Hazard - Financial - Operational - Strategic
Risk Management Irrelevance Proposition
Risk types addressed by ERM
Risk- adjusted performance measure (RAP)
Risk
45. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Valuation vs. Risk management
Settlement risk
Information ratio
CAPM with taxes included (equation)
46. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Debt overhang
Effect of non- price- taking behavior on CAPM
Credit event
Ri = Rz + (gamma)(beta)
47. Losses due to market activities ex. Interest rate changes or defaults
Morningstar Rating System
Financial risks
APT in active portfolio management
Firms becoming more sensitive to changes(bank deregulation)
48. The lower (closer to - 1) - the higher the payoff from diversification
Probability of ruin
Correlation coefficient effect on diversification
Parametric VaR
Debt overhang
49. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
Importance of communication for risk managers
VaR - Value at Risk
Volatility Market risk
CAPM with taxes included (equation)
50. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Market imperfections that can create value
Prices of risk vs sensitivity
Sortino ratio
Risk