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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. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Sovereign risk
Recovery rate
Asset liquidity risk
Tax shield
2. CAPM requires the strong form of the Efficient Market Hypothesis = private information
Derivative contract
APT for passive portfolio management
Security (primary vs secondary)
CAPM assumption for EMH
3. Returns on any stock are linearly related to a set of indexes
APT (equation and assumptions)
Treynor measure
Ri = ai + bi1l1 + bi2l2....+ei
Settlement risk
4. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
APT (equation and assumptions)
Debt overhang
EPD or ECOR - Expected Policyholder Deficit (EPD)
Risk types addressed by ERM
5. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Parametric VaR
Standard deviation of two assets
Correlation coefficient effect on diversification
Ri = Rz + (gamma)(beta)
6. Quantile of a statistical distribution
Asset transformers
Morningstar Rating System
Parametric VaR
EPD or ECOR - Expected Policyholder Deficit (EPD)
7. Hazard - Financial - Operational - Strategic
VaR- based analysis (formula)
Tax shield
Risk types addressed by ERM
Banker's Trust
8. Unanticipated movements in relative prices of assets in hedged position
Debt overhang
Basic Market risk
Where is risk coming from
Ways firms can fail to account for risks
9. 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
Tax shield
Correlation coefficient effect on diversification
Business risks
Allied Irish Bank
10. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Ri = ai + bi1l1 + bi2l2....+ei
Parametric VaR
Nonmarketable asset impact on CAPM
Three main reasons for financial disasters
11. 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
Valuation vs. Risk management
Correlation coefficient effect on diversification
Information ratio
12. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely
Morningstar Rating System
Solve for minimum variance portfolio
Debt overhang
Ways firms can fail to account for risks
13. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
VaR - Value at Risk
Roles of risk management
APT for passive portfolio management
Banker's Trust
14. Inability to make payment obligations (ex. Margin calls)
Funding liquidity risk
Practical considerations related to ERM implementatio
BTR - Below Target Risk
Models used in ERM framework
15. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Market imperfections that can create value
Where is risk coming from
Treynor measure
Credit event
16. 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
Standard deviation of two assets
Asset transformers
Credit event
17. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized
Risk- adjusted performance measure (RAP)
Multi- period version of CAPM
Effect of non- price- taking behavior on CAPM
Valuation vs. Risk management
18. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Firms becoming more sensitive to changes(bank deregulation)
Effect of heterogeneous expectations on CAPM
Three main reasons for financial disasters
Liquidity risk
19. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Sortino ratio
Prices of risk vs sensitivity
Differences in financial risk management for financial companies vs industrial companies
Funding liquidity risk
20. Covariance = correlation coefficient std dev(a) std dev(b)
Nonparametric VaR
Ways firms can fail to account for risks
EPD or ECOR - Expected Policyholder Deficit (EPD)
Formula for covariance
21. 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 liquidity risk
Capital market line (CML)
Ri = Rz + (gamma)(beta)
Traits of ERM
22. Interest rate movements - derivatives - defaults
CAPM (formula)
Financial Risk
Funding liquidity risk
Barings
23. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
VaR- based analysis (formula)
CAPM with taxes included (equation)
Ways firms can fail to account for risks
Where is risk coming from
24. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Formula for covariance
Solve for minimum variance portfolio
LTCM
Treynor measure
25. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Standard deviation of two assets
Morningstar Rating System
Risk types addressed by ERM
CAPM assumption for EMH
26. Changes in vol - implied or actual
Volatility Market risk
Liquidity risk
Information ratio
Derivative contract
27. Relative portfolio risk (RRiskp) - Based on a one- month investment period
RAR = relative return of portfolio (RRp)
Expected return of two assets
Exposure
Risk
28. Curve must be concave - Straight line connecting any two points must be under the curve
Practical considerations related to ERM implementatio
Banker's Trust
Credit event
Shape of portfolio possibilities curve
29. Firms became multinational - - >watched xchange rates more - deregulation and globalization
Information ratio
Firms becoming more sensitive to changes(bank deregulation)
Carry- backs and carry- forwards
Recovery rate
30. Prices of risk are common factors and do not change - Sensitivities can change
Prices of risk vs sensitivity
Three main reasons for financial disasters
CAPM with taxes included (equation)
Risk- adjusted performance measure (RAP)
31. Potential amount that can be lost
Nonmarketable asset impact on CAPM
Debt overhang
Exposure
Contango
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
Risk
Business Risk
Effect of heterogeneous expectations on CAPM
Differences in financial risk management for financial companies vs industrial companies
33. When two payments are exchanged the same day and one party may default after payment is made
Settlement risk
Liquidity risk
Nonparametric VaR
Forms of Market risk
34. Probability that a random variable falls below a specified threshold level
RAR = relative return of portfolio (RRp)
Basis
Performance- related metrics
Shortfall risk
35. 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
Liquidity risk
Drysdale Securities (Chase Manhattan)
VaR- based analysis (formula)
Three main reasons for financial disasters
36. Multibeta CAPM Ri - Rf =
Settlement risk
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Risk Management Irrelevance Proposition
Four major types of risk
37. 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
Four major types of risk
Basis risk
Shortcomings of risk metrics
Risk Management Irrelevance Proposition
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
EPD or ECOR - Expected Policyholder Deficit (EPD)
Tracking error
Probability of ruin
Solvency-related metrics
39. Both probability and cost of tail events are considered
Ri = Rz + (gamma)(beta)
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Tracking error
APT in active portfolio management
40. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Volatility Market risk
3 main types of operational risk
Capital market line (CML)
Debt overhang
41. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
APT (equation and assumptions)
Settlement risk
Sharpe measure
Zero- beta CAPM (two factor model)
42. 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
APT for passive portfolio management
Financial Risk
Valuation vs. Risk management
Models used in ERM framework
43. Modeling approach is typically between statistical analytic models and structural simulation models
Derivative contract
Models used in ERM framework
Practical considerations related to ERM implementatio
Jensen's alpha
44. 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
3 main types of operational risk
Differences in financial risk management for financial companies vs industrial companies
45. Wrong distribution - Historical sample may not apply
Uncertainty
Ri = Rz + (gamma)(beta)
Information ratio
Ways risk can be mismeasured
46. Quantile of an empirical distribution
Importance of communication for risk managers
Nonparametric VaR
Recovery rate
Morningstar Rating System
47. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Importance of communication for risk managers
Shortfall risk
APT in active portfolio management
Performance- related metrics
48. Occurs the day when two parties exchange payments same day
Risk- adjusted performance measure (RAP)
Settlement risk
Asset transformers
Models used in ERM framework
49. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Formula for covariance
Importance of communication for risk managers
Valuation vs. Risk management
CAPM with taxes included (equation)
50. 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
Valuation vs. Risk management
Three main reasons for financial disasters
Expected return of two assets
EPD or ECOR - Expected Policyholder Deficit (EPD)