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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. Expected value of unfavorable deviations of a random variable from a specified target level
BTR - Below Target Risk
Allied Irish Bank
Basic Market risk
APT (equation and assumptions)
2. 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
Allied Irish Bank
EPD or ECOR - Expected Policyholder Deficit (EPD)
Tax shield
Solvency-related metrics
3. Probability distribution is unknown (ex. A terrorist attack)
Market imperfections that can create value
Ri = Rz + (gamma)(beta)
Four major types of risk
Uncertainty
4. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages
Effect of heterogeneous expectations on CAPM
Multi- period version of CAPM
Basis
Derivative contract
5. 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
Prices of risk vs sensitivity
Ways firms can fail to account for risks
Risk
Sovereign risk
6. 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
Shape of portfolio possibilities curve
RAR = relative return of portfolio (RRp)
Traits of ERM
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
7. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Formula for covariance
Firms becoming more sensitive to changes(bank deregulation)
Security (primary vs secondary)
Differences in financial risk management for financial companies vs industrial companies
8. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Performance- related metrics
Correlation coefficient effect on diversification
Practical considerations related to ERM implementatio
Ten assumptions underlying CAPM
9. When two payments are exchanged the same day and one party may default after payment is made
Roles of risk management
Multi- period version of CAPM
Settlement risk
Carry- backs and carry- forwards
10. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Standard deviation of two assets
RAR = relative return of portfolio (RRp)
Risk Management Irrelevance Proposition
Firms becoming more sensitive to changes(bank deregulation)
11. The lower (closer to - 1) - the higher the payoff from diversification
Multi- period version of CAPM
CAPM assumption for EMH
Correlation coefficient effect on diversification
Financial risks
12. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Carry- backs and carry- forwards
EPD or ECOR - Expected Policyholder Deficit (EPD)
Options motivation on volatility
Practical considerations related to ERM implementatio
13. Hazard - Financial - Operational - Strategic
Three main reasons for financial disasters
Credit event
Operational risk
Risk types addressed by ERM
14. Concave function that extends from minimum variance portfolio to maximum return portfolio
Risk
Valuation vs. Risk management
Financial risks
Efficient frontier
15. 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
LTCM
Business Risk
Ways risk can be mismeasured
Basic Market risk
16. Returns on any stock are linearly related to a set of indexes
Market imperfections that can create value
Barings
Basis risk
Ri = ai + bi1l1 + bi2l2....+ei
17. 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
Basic Market risk
Probability of ruin
Operational risk
Ri = ai + bi1l1 + bi2l2....+ei
18. 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
Options motivation on volatility
Liquidity risk
APT for passive portfolio management
VaR - Value at Risk
19. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Correlation coefficient effect on diversification
Contango
Treynor measure
Morningstar Rating System
20. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)
Carry- backs and carry- forwards
VaR - Value at Risk
APT in active portfolio management
CAPM (formula)
21. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Financial Risk
LTCM
Sovereign risk
Information ratio
22. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Basis risk
Information ratio
Shortfall risk
VaR- based analysis (formula)
23. Volatility of unexpected outcomes
RAR = relative return of portfolio (RRp)
Nonmarketable asset impact on CAPM
VaR - Value at Risk
Risk
24. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Effect of non- price- taking behavior on CAPM
Valuation vs. Risk management
Sharpe measure
Basis risk
25. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Business Risk
Security (primary vs secondary)
Risk
Where is risk coming from
26. Wrong distribution - Historical sample may not apply
Ways risk can be mismeasured
Shortcomings of risk metrics
VaR - Value at Risk
Market risk
27. Future price is greater than the spot price
Basis
Standard deviation of two assets
Contango
Business risks
28. Asses firm risks - Communicate risks - Manage and monitor risks
APT (equation and assumptions)
Uncertainty
Roles of risk management
Correlation coefficient effect on diversification
29. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Risk Management Irrelevance Proposition
Sovereign risk
Effect of heterogeneous expectations on CAPM
Nonparametric VaR
30. 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
Debt overhang
Barings
Jensen's alpha
Business Risk
31. CAPM requires the strong form of the Efficient Market Hypothesis = private information
CAPM assumption for EMH
What lead to the exponential growth to derivatives mkt?
Allied Irish Bank
Practical considerations related to ERM implementatio
32. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
Basis risk
Financial Risk
Zero- beta CAPM (two factor model)
33. Law of one price - Homogeneous expectations - Security returns process
Expected return of two assets
EPD or ECOR - Expected Policyholder Deficit (EPD)
Funding liquidity risk
APT (equation and assumptions)
34. Multibeta CAPM Ri - Rf =
EPD or ECOR - Expected Policyholder Deficit (EPD)
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Market imperfections that can create value
Firms becoming more sensitive to changes(bank deregulation)
35. 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 -
Four major types of risk
CAPM (formula)
EPD or ECOR - Expected Policyholder Deficit (EPD)
Source of need for risk management
36. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Efficient frontier
EPD or ECOR - Expected Policyholder Deficit (EPD)
Ri = Rz + (gamma)(beta)
Asset liquidity risk
37. The need to hedge against risks - for firms need to speculate.
Where is risk coming from
Ways firms can fail to account for risks
Risk Management Irrelevance Proposition
What lead to the exponential growth to derivatives mkt?
38. Risk of loses owing to movements in level or volatility of market prices
Contango
Risk
Efficient frontier
Market risk
39. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio
Standard deviation of two assets
Debt overhang
Zero- beta CAPM (two factor model)
Expected return of two assets
40. Derives value from an underlying asset - rate - or index - Derives value from a security
Drysdale Securities (Chase Manhattan)
Derivative contract
APT for passive portfolio management
Market risk
41. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated
Risk
Kidder Peabody
VaR- based analysis (formula)
Importance of communication for risk managers
42. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Settlement risk
Parametric VaR
3 main types of operational risk
Security (primary vs secondary)
43. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Importance of communication for risk managers
Parametric VaR
Effect of non- price- taking behavior on CAPM
Risk
44. 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
Practical considerations related to ERM implementatio
Prices of risk vs sensitivity
Ten assumptions underlying CAPM
Risk
45. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Parametric VaR
Carry- backs and carry- forwards
Operational risk
Barings
46. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Ten assumptions underlying CAPM
Basis risk
Nonparametric VaR
Solve for minimum variance portfolio
47. When negative taxable income is moved to a different year to offset future or past taxable income
Recovery rate
Carry- backs and carry- forwards
Tracking error
Risk
48. 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
Treynor measure
3 main types of operational risk
Valuation vs. Risk management
Morningstar Rating System
49. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Market imperfections that can create value
Banker's Trust
Ri = Rz + (gamma)(beta)
EPD or ECOR - Expected Policyholder Deficit (EPD)
50. Capital structure (financial distress) - Taxes - Agency and information asymmetries
VaR- based analysis (formula)
Risk
Market imperfections that can create value
Parametric VaR