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Test your basic knowledge |
FRM: Foundations Of Risk Management
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Subjects
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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. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
Effect of heterogeneous expectations on CAPM
Asset liquidity risk
Differences in financial risk management for financial companies vs industrial companies
Shortcomings of risk metrics
2. 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
Financial risks
APT for passive portfolio management
Roles of risk management
Treynor measure
3. Probability that a random variable falls below a specified threshold level
Three main reasons for financial disasters
Volatility Market risk
Ways firms can fail to account for risks
Shortfall risk
4. 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
Valuation vs. Risk management
Allied Irish Bank
Tracking error
Standard deviation of two assets
5. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business
Three main reasons for financial disasters
CAPM with taxes included (equation)
Standard deviation of two assets
Financial risks
6. 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
Uncertainty
Kidder Peabody
RAR = relative return of portfolio (RRp)
Banker's Trust
7. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM
Sovereign risk
Risk Management Irrelevance Proposition
Standard deviation of two assets
Nonmarketable asset impact on CAPM
8. When negative taxable income is moved to a different year to offset future or past taxable income
Settlement risk
Carry- backs and carry- forwards
Funding liquidity risk
VaR- based analysis (formula)
9. Law of one price - Homogeneous expectations - Security returns process
Risk
Efficient frontier
APT (equation and assumptions)
Nonparametric VaR
10. Capital structure (financial distress) - Taxes - Agency and information asymmetries
Risk Management Irrelevance Proposition
Operational risk
Derivative contract
Market imperfections that can create value
11. Quantile of a statistical distribution
Parametric VaR
Jensen's alpha
Basic Market risk
Formula for covariance
12. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Drysdale Securities (Chase Manhattan)
Debt overhang
3 main types of operational risk
Where is risk coming from
13. 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
Ten assumptions underlying CAPM
Drysdale Securities (Chase Manhattan)
CAPM assumption for EMH
Solve for minimum variance portfolio
14. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Importance of communication for risk managers
Tax shield
Recovery rate
Sovereign risk
15. Relative portfolio risk (RRiskp) - Based on a one- month investment period
RAR = relative return of portfolio (RRp)
Sortino ratio
Source of need for risk management
Differences in financial risk management for financial companies vs industrial companies
16. Absolute and relative risk - direction and non-directional
BTR - Below Target Risk
VaR - Value at Risk
Ri = ai + bi1l1 + bi2l2....+ei
Forms of Market risk
17. Proportion of loss that is recovered - Also referred to as "cents on the dollar"
EPD or ECOR - Expected Policyholder Deficit (EPD)
What lead to the exponential growth to derivatives mkt?
Debt overhang
Recovery rate
18. Concave function that extends from minimum variance portfolio to maximum return portfolio
Options motivation on volatility
Efficient frontier
Market risk
Valuation vs. Risk management
19. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
Volatility Market risk
Risk types addressed by ERM
Information ratio
Multi- period version of CAPM
20. Inability to make payment obligations (ex. Margin calls)
Tax shield
Funding liquidity risk
Debt overhang
Importance of communication for risk managers
21. Asset-liability/market-liquidity risk
Ways risk can be mismeasured
Options motivation on volatility
Market risk
Liquidity risk
22. Return is linearly related to growth rate in consumption
3 main types of operational risk
Tax shield
Multi- period version of CAPM
Debt overhang
23. Risk of loses owing to movements in level or volatility of market prices
Differences in financial risk management for financial companies vs industrial companies
Carry- backs and carry- forwards
Funding liquidity risk
Market risk
24. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Basis
RAR = relative return of portfolio (RRp)
Parametric VaR
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
25. 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
Business Risk
Financial Risk
CAPM (formula)
Parametric VaR
26. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Ten assumptions underlying CAPM
3 main types of operational risk
Sharpe measure
Exposure
27. Potential amount that can be lost
Ri = ai + bi1l1 + bi2l2....+ei
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Exposure
Ri = Rz + (gamma)(beta)
28. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)
Solve for minimum variance portfolio
CAPM assumption for EMH
Ways firms can fail to account for risks
Market risk
29. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta
Prices of risk vs sensitivity
Recovery rate
Ri = Rz + (gamma)(beta)
LTCM
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
Barings
Morningstar Rating System
Credit event
Roles of risk management
31. Unanticipated movements in relative prices of assets in hedged position
Basic Market risk
Sharpe measure
Settlement risk
VaR- based analysis (formula)
32. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Sovereign risk
Ways firms can fail to account for risks
Treynor measure
EPD or ECOR - Expected Policyholder Deficit (EPD)
33. Modeling approach is typically between statistical analytic models and structural simulation models
EPD or ECOR - Expected Policyholder Deficit (EPD)
Models used in ERM framework
Shortfall risk
Ri = ai + bi1l1 + bi2l2....+ei
34. Market risk - Liquidity risk - Credit risk - Operational risk
Four major types of risk
Asset transformers
Valuation vs. Risk management
Firms becoming more sensitive to changes(bank deregulation)
35. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Ten assumptions underlying CAPM
Standard deviation of two assets
Uncertainty
Debt overhang
36. When two payments are exchanged the same day and one party may default after payment is made
Risk Management Irrelevance Proposition
Tail VaR or TCE - Tail Conditional Expectation(TCE)
Settlement risk
Debt overhang
37. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes
Financial Risk
Market imperfections that can create value
Where is risk coming from
Asset transformers
38. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Solvency-related metrics
Asset transformers
Tax shield
Jensen's alpha
39. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Tracking error
Risks excluded from operational risk
Asset liquidity risk
VaR- based analysis (formula)
40. Cannot exit position in market due to size of the position
Sharpe measure
Kidder Peabody
EPD or ECOR - Expected Policyholder Deficit (EPD)
Asset liquidity risk
41. Concentrate on mid- region of probability distribution - Relevant to owners and proxies
Treynor measure
Performance- related metrics
Risk
Settlement risk
42. 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 -
Formula for covariance
Source of need for risk management
EPD or ECOR - Expected Policyholder Deficit (EPD)
Ri = Rz + (gamma)(beta)
43. Interest rate movements - derivatives - defaults
Financial Risk
Importance of communication for risk managers
Parametric VaR
Sharpe measure
44. Occurs the day when two parties exchange payments same day
Basis risk
3 main types of operational risk
Settlement risk
EPD or ECOR - Expected Policyholder Deficit (EPD)
45. Returns on any stock are linearly related to a set of indexes
Uncertainty
Ri = ai + bi1l1 + bi2l2....+ei
Risks excluded from operational risk
Funding liquidity risk
46. Future price is greater than the spot price
Uncertainty
Standard deviation of two assets
Contango
Market risk
47. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)
Financial risks
Tax shield
CAPM with taxes included (equation)
Prices of risk vs sensitivity
48. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
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49. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations
Risk
Roles of risk management
Importance of communication for risk managers
Credit event
50. 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
Asset liquidity risk
Probability of ruin
Allied Irish Bank
Risk