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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. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
CAPM with taxes included (equation)
Ways firms can fail to account for risks
Traits of ERM
Where is risk coming from
2. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
Security (primary vs secondary)
Risk Management Irrelevance Proposition
Drysdale Securities (Chase Manhattan)
Basis risk
3. Interest rate movements - derivatives - defaults
Efficient frontier
Financial Risk
Risk types addressed by ERM
Risks excluded from operational risk
4. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Nonmarketable asset impact on CAPM
Barings
Carry- backs and carry- forwards
Recovery rate
5. Changes in vol - implied or actual
Financial risks
Uncertainty
Volatility Market risk
Settlement risk
6. Losses due to market activities ex. Interest rate changes or defaults
Financial risks
Contango
Tax shield
Business risks
7. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
CAPM assumption for EMH
VaR - Value at Risk
Tracking error
Practical considerations related to ERM implementatio
8. Need to assess risk and tell management so they can determine which risks to take on
Asset liquidity risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Importance of communication for risk managers
Risk Management Irrelevance Proposition
9. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Ri = Rz + (gamma)(beta)
Funding liquidity risk
Basis
Efficient frontier
10. Market risk - Liquidity risk - Credit risk - Operational risk
APT (equation and assumptions)
Correlation coefficient effect on diversification
3 main types of operational risk
Four major types of risk
11. Asset-liability/market-liquidity risk
APT (equation and assumptions)
Business Risk
Liquidity risk
Derivative contract
12. Covariance = correlation coefficient std dev(a) std dev(b)
Formula for covariance
Valuation vs. Risk management
Asset transformers
Effect of heterogeneous expectations on CAPM
13. 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 -
Basic Market risk
Source of need for risk management
Ri = Rz + (gamma)(beta)
Kidder Peabody
14. 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
Ways firms can fail to account for risks
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Operational risk
Debt overhang
15. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Derivative contract
Asset transformers
3 main types of operational risk
BTR - Below Target Risk
16. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Settlement risk
Risk Management Irrelevance Proposition
APT in active portfolio management
Traits of ERM
17. Potential amount that can be lost
Exposure
Financial risks
Nonparametric VaR
Business Risk
18. 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
Asset transformers
Ri = ai + bi1l1 + bi2l2....+ei
Contango
Capital market line (CML)
19. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Basis
Roles of risk management
Allied Irish Bank
Funding liquidity risk
20. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
CAPM (formula)
Risk
Sharpe measure
Financial Risk
21. Occurs the day when two parties exchange payments same day
EPD or ECOR - Expected Policyholder Deficit (EPD)
Settlement risk
Volatility Market risk
Jensen's alpha
22. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
EPD or ECOR - Expected Policyholder Deficit (EPD)
Exposure
Standard deviation of two assets
Risk
23. Concave function that extends from minimum variance portfolio to maximum return portfolio
Standard deviation of two assets
Efficient frontier
VaR- based analysis (formula)
Source of need for risk management
24. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations
Models used in ERM framework
Differences in financial risk management for financial companies vs industrial companies
Where is risk coming from
Asset transformers
25. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
BTR - Below Target Risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
Basic Market risk
Performance- related metrics
26. 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
Differences in financial risk management for financial companies vs industrial companies
Drysdale Securities (Chase Manhattan)
Probability of ruin
Risks excluded from operational risk
27. Quantile of an empirical distribution
Nonparametric VaR
Information ratio
Efficient frontier
Forms of Market risk
28. The uses of debt to fall into a lower tax rate
Volatility Market risk
Multi- period version of CAPM
Tax shield
Importance of communication for risk managers
29. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
APT (equation and assumptions)
Basis risk
Funding liquidity risk
Effect of heterogeneous expectations on CAPM
30. Curve must be concave - Straight line connecting any two points must be under the curve
Risk- adjusted performance measure (RAP)
Funding liquidity risk
Valuation vs. Risk management
Shape of portfolio possibilities curve
31. Multibeta CAPM Ri - Rf =
Tracking error
APT for passive portfolio management
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Four major types of risk
32. Prices of risk are common factors and do not change - Sensitivities can change
Prices of risk vs sensitivity
Business risks
Roles of risk management
Shortcomings of risk metrics
33. Volatility of unexpected outcomes
Formula for covariance
Traits of ERM
Risk
BTR - Below Target Risk
34. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Asset transformers
Tax shield
Debt overhang
Credit event
35. Hazard - Financial - Operational - Strategic
Ten assumptions underlying CAPM
Risk types addressed by ERM
Forms of Market risk
Allied Irish Bank
36. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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37. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Asset liquidity risk
Sortino ratio
Morningstar Rating System
Shortcomings of risk metrics
38. 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
Traits of ERM
Risk types addressed by ERM
Models used in ERM framework
Valuation vs. Risk management
39. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Operational risk
Performance- related metrics
Roles of risk management
VaR- based analysis (formula)
40. 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.
Parametric VaR
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Risk
Risk Management Irrelevance Proposition
41. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Risk Management Irrelevance Proposition
Barings
VaR- based analysis (formula)
Risk
42. Absolute and relative risk - direction and non-directional
Financial risks
Risk- adjusted performance measure (RAP)
Forms of Market risk
Formula for covariance
43. Quantile of a statistical distribution
Allied Irish Bank
Parametric VaR
APT for passive portfolio management
Efficient frontier
44. 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
Funding liquidity risk
Allied Irish Bank
Business Risk
Shortcomings of risk metrics
45. Probability that a random variable falls below a specified threshold level
Differences in financial risk management for financial companies vs industrial companies
Shortfall risk
Risks excluded from operational risk
Market imperfections that can create value
46. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
Market risk
Multi- period version of CAPM
Recovery rate
Treynor measure
47. Returns on any stock are linearly related to a set of indexes
Ri = ai + bi1l1 + bi2l2....+ei
Barings
Derivative contract
Roles of risk management
48. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Prices of risk vs sensitivity
Multi- period version of CAPM
Business risks
Information ratio
49. Cannot exit position in market due to size of the position
Risks excluded from operational risk
Asset transformers
Asset liquidity risk
Liquidity risk
50. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Drysdale Securities (Chase Manhattan)
Effect of non- price- taking behavior on CAPM
Ways risk can be mismeasured
Debt overhang