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Test your basic knowledge |
FRM: Foundations Of Risk Management
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business-skills
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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. 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
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Funding liquidity risk
Effect of non- price- taking behavior on CAPM
Capital market line (CML)
2. Occurs the day when two parties exchange payments same day
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Settlement risk
Where is risk coming from
Differences in financial risk management for financial companies vs industrial companies
3. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Tracking error
Risk Management Irrelevance Proposition
Traits of ERM
VaR- based analysis (formula)
4. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits
Expected return of two assets
3 main types of operational risk
Prices of risk vs sensitivity
Jensen's alpha
5. 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
Ri = Rz + (gamma)(beta)
Funding liquidity risk
Kidder Peabody
Tax shield
6. Wrong distribution - Historical sample may not apply
Ways risk can be mismeasured
APT for passive portfolio management
Debt overhang
Credit event
7. When negative taxable income is moved to a different year to offset future or past taxable income
Carry- backs and carry- forwards
Volatility Market risk
Settlement risk
Risk types addressed by ERM
8. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities
Security (primary vs secondary)
Tracking error
Sovereign risk
RAR = relative return of portfolio (RRp)
9. Relative portfolio risk (RRiskp) - Based on a one- month investment period
Basis
RAR = relative return of portfolio (RRp)
Effect of heterogeneous expectations on CAPM
Prices of risk vs sensitivity
10. Concave function that extends from minimum variance portfolio to maximum return portfolio
Settlement risk
Efficient frontier
Risk
Where is risk coming from
11. Simple form of CAPM - but market price of risk is lower than if all investors were price takers
Three main reasons for financial disasters
VaR- based analysis (formula)
Effect of non- price- taking behavior on CAPM
Derivative contract
12. 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
Sharpe measure
Credit event
Forms of Market risk
13. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed
LTCM
Risks excluded from operational risk
Shortfall risk
VaR - Value at Risk
14. Derives value from an underlying asset - rate - or index - Derives value from a security
Derivative contract
Risks excluded from operational risk
Financial Risk
Firms becoming more sensitive to changes(bank deregulation)
15. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected
Asset transformers
Standard deviation of two assets
EPD or ECOR - Expected Policyholder Deficit (EPD)
CAPM (formula)
16. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund
3 main types of operational risk
Sovereign risk
Information ratio
Financial risks
17. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds
Tracking error
Settlement risk
Kidder Peabody
Sharpe measure
18. Probability distribution is unknown (ex. A terrorist attack)
Uncertainty
Ways firms can fail to account for risks
Treynor measure
Performance- related metrics
19. Inability to make payment obligations (ex. Margin calls)
CAPM with taxes included (equation)
Effect of non- price- taking behavior on CAPM
Risk
Funding liquidity risk
20. Strategic risk - Business risk - Reputational risk
Risks excluded from operational risk
Ways firms can fail to account for risks
What lead to the exponential growth to derivatives mkt?
Market imperfections that can create value
21. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses
Debt overhang
Settlement risk
Efficient frontier
APT (equation and assumptions)
22. Risk of loses owing to movements in level or volatility of market prices
Jensen's alpha
Market risk
Drysdale Securities (Chase Manhattan)
Debt overhang
23. Cannot exit position in market due to size of the position
Asset liquidity risk
Settlement risk
Uncertainty
Settlement risk
24. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk
Expected return of two assets
Performance- related metrics
Morningstar Rating System
RAR = relative return of portfolio (RRp)
25. Expected value of unfavorable deviations of a random variable from a specified target level
APT for passive portfolio management
Barings
BTR - Below Target Risk
Ri = Rz + (gamma)(beta)
26. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))
Barings
Where is risk coming from
Standard deviation of two assets
LTCM
27. Quantile of an empirical distribution
Parametric VaR
Risk types addressed by ERM
VaR - Value at Risk
Nonparametric VaR
28. Country specific - Foreign exchange controls that prohibit counterparty's obligations
Sovereign risk
Effect of heterogeneous expectations on CAPM
Shape of portfolio possibilities curve
Carry- backs and carry- forwards
29. Long in options = expecting volatility increase - Short in options = expecting volatility decrease
Basis
Source of need for risk management
Basis risk
Options motivation on volatility
30. Sold complex derivatives to Proctor & Gamble and Gibson - Were sued due to claims that they deceived buyers - Need for better controls for matching complexity of trade with client sophistication - Need for price quotes independent of front office Met
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31. Difference between forward price and spot price - Should approach zero as the contract approaches maturity
Basis
EPD or ECOR - Expected Policyholder Deficit (EPD)
Ways firms can fail to account for risks
Importance of communication for risk managers
32. 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)
Morningstar Rating System
Financial risks
Differences in financial risk management for financial companies vs industrial companies
33. Risks that are assumed willingly - to gain a competitive edge or add shareholder value
Nonmarketable asset impact on CAPM
LTCM
Debt overhang
Business risks
34. 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.
Risk Management Irrelevance Proposition
Ways firms can fail to account for risks
Zero- beta CAPM (two factor model)
Firms becoming more sensitive to changes(bank deregulation)
35. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks
CAPM assumption for EMH
Effect of heterogeneous expectations on CAPM
Jensen's alpha
Differences in financial risk management for financial companies vs industrial companies
36. Need to assess risk and tell management so they can determine which risks to take on
Importance of communication for risk managers
Solve for minimum variance portfolio
Operational risk
Asset transformers
37. Unanticipated movements in relative prices of assets in hedged position
Asset transformers
Risk
Basic Market risk
Tax shield
38. When two payments are exchanged the same day and one party may default after payment is made
Valuation vs. Risk management
Settlement risk
Uncertainty
APT in active portfolio management
39. Volatility of unexpected outcomes
Risk
Business risks
Multi- period version of CAPM
BTR - Below Target Risk
40. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios
Funding liquidity risk
Sharpe measure
Treynor measure
VaR - Value at Risk
41. Prices of risk are common factors and do not change - Sensitivities can change
LTCM
Recovery rate
Contango
Prices of risk vs sensitivity
42. Both probability and cost of tail events are considered
Zero- beta CAPM (two factor model)
Roles of risk management
Sortino ratio
Tail VaR or TCE - Tail Conditional Expectation(TCE)
43. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios
Banker's Trust
APT in active portfolio management
Treynor measure
Basic Market risk
44. 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
Shortcomings of risk metrics
Barings
Credit event
Roles of risk management
45. Interest rate movements - derivatives - defaults
Roles of risk management
APT (equation and assumptions)
Morningstar Rating System
Financial Risk
46. Multibeta CAPM Ri - Rf =
VaR- based analysis (formula)
Solve for minimum variance portfolio
(market beta)(Rm - Rf) + (sensitivity to inflation risk)(price of inflation risk)
Derivative contract
47. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection
Asset transformers
APT in active portfolio management
RAR = relative return of portfolio (RRp)
Carry- backs and carry- forwards
48. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements
Where is risk coming from
Security (primary vs secondary)
Solvency-related metrics
Basis risk
49. Market risk - Liquidity risk - Credit risk - Operational risk
Ri = Rz + (gamma)(beta)
Sortino ratio
CAPM with taxes included (equation)
Four major types of risk
50. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation
Volatility Market risk
Sortino ratio
Operational risk
Source of need for risk management