FRM Exam 1 UPDATED ACTUAL Exam
Questions and CORRECT Answers
Shortcomings of risk metrics - CORRECT ANSWER - -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
Importance of communication for risk managers - CORRECT ANSWER - Need to assess
risk and tell management so they can determine which risks to take on
Ways firms can fail to account for risks - CORRECT ANSWER - -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 risk can be mismeasured - CORRECT ANSWER - -Wrong distribution
-Historical sample may not apply
Roles of risk management - CORRECT ANSWER - -Asses firm risks
-Communicate risks
-Manage and monitor risks
Practical considerations related to ERM implementation - CORRECT ANSWER --
Designate ERM champion - usually CRO
-Make ERM part of firm culture
-Determining all possible risks
-Quantifying operational and strategic risks
,-Integrating risks (dependencies)
-Lack of risk transfer mechanisms
-Monitoring
Models used in ERM framework - CORRECT ANSWER - Modeling approach is typically
between statistical analytic models and structural simulation models
Risk types addressed by ERM - CORRECT ANSWER - -Hazard
-Financial
-Operational
-Strategic
Traits of ERM - CORRECT ANSWER - -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
Risk-adjusted performance measure (RAP) - CORRECT ANSWER - -Relationship drawn
from CML
-RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate
-annualized
VaR-based analysis (formula) - CORRECT ANSWER - -Risk replaced with VaR
(Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Sortino ratio - CORRECT ANSWER - Sortino ratio = (E(Rp) -R_min)/sqrt(MSD_min)
,MSD_min=summation(R_pt-R_min)^2/N
where R_pt is return of the portfolio at time t
-MAR - minimum acceptable return also denoted as R_min is the diff between Sortino and
Sharpe
Information ratio - CORRECT ANSWER - IR = (E(Rp) - E(Rb))/(std dev(Rp-Rb))
-Evaluate manager of a benchmark fund
Tracking error - CORRECT ANSWER - -Std dev between portfolio return and benchmark
return
TE = std dev * (Rp-Rb)
-Benchmark funds
Treynor measure - CORRECT ANSWER - -Excess return divided by portfolio beta
Tp = (E(Rp) - Rf)/portfolio beta
-Better for well diversified portfolios
Sharpe measure - CORRECT ANSWER - -Excess return divided by portfolio volatility
(std dev)
Sp = (E(Rp) - Rf)/(std dev of Rp)
-Better for non-diversified portfolios
Jensen's alpha - CORRECT ANSWER - -Excess return equated to alpha plus expected
systematic return
alpha_p=
E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
Arbitrage Pricing Theory - CORRECT ANSWER - a theory of risk-return relationships
derived from no-arbitrage considerations in large capital markets
, 1. Create factor portfolio
2.Derive returns for each factor portfolio
3. Calculate risk premiums for each factor portfolio
APT for passive portfolio management - CORRECT ANSWER - -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 (equation and assumptions) - CORRECT ANSWER -
E(R_i)=R_f+B_i1RP1+B_i2RP2+...+B_ikRPk
-Returns on any stock are linearly related to a set of indexes
-Law of one price
-Returns follow k-factor process
-Well diversified portfolios can be formed
-No arbitrage opp exists
Prices of risk vs sensitivity - CORRECT ANSWER - -Prices of risk are common factors
and do not change
-Sensitivities can change
Multibeta CAPM - CORRECT ANSWER - Ri - Rf = (market beta)(Rm - Rf) + (sensitivity
to inflation risk)(price of inflation risk)...
Effect of non-price-taking behavior on CAPM - CORRECT ANSWER - Simple form of
CAPM, but market price of risk is lower than if all investors were price takers
Effect of heterogeneous expectations on CAPM - CORRECT ANSWER - Equilibrium can
still be expressed in returns, covariance, and variance, but they become complex weighted
averages
Questions and CORRECT Answers
Shortcomings of risk metrics - CORRECT ANSWER - -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
Importance of communication for risk managers - CORRECT ANSWER - Need to assess
risk and tell management so they can determine which risks to take on
Ways firms can fail to account for risks - CORRECT ANSWER - -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 risk can be mismeasured - CORRECT ANSWER - -Wrong distribution
-Historical sample may not apply
Roles of risk management - CORRECT ANSWER - -Asses firm risks
-Communicate risks
-Manage and monitor risks
Practical considerations related to ERM implementation - CORRECT ANSWER --
Designate ERM champion - usually CRO
-Make ERM part of firm culture
-Determining all possible risks
-Quantifying operational and strategic risks
,-Integrating risks (dependencies)
-Lack of risk transfer mechanisms
-Monitoring
Models used in ERM framework - CORRECT ANSWER - Modeling approach is typically
between statistical analytic models and structural simulation models
Risk types addressed by ERM - CORRECT ANSWER - -Hazard
-Financial
-Operational
-Strategic
Traits of ERM - CORRECT ANSWER - -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
Risk-adjusted performance measure (RAP) - CORRECT ANSWER - -Relationship drawn
from CML
-RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate
-annualized
VaR-based analysis (formula) - CORRECT ANSWER - -Risk replaced with VaR
(Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)
Sortino ratio - CORRECT ANSWER - Sortino ratio = (E(Rp) -R_min)/sqrt(MSD_min)
,MSD_min=summation(R_pt-R_min)^2/N
where R_pt is return of the portfolio at time t
-MAR - minimum acceptable return also denoted as R_min is the diff between Sortino and
Sharpe
Information ratio - CORRECT ANSWER - IR = (E(Rp) - E(Rb))/(std dev(Rp-Rb))
-Evaluate manager of a benchmark fund
Tracking error - CORRECT ANSWER - -Std dev between portfolio return and benchmark
return
TE = std dev * (Rp-Rb)
-Benchmark funds
Treynor measure - CORRECT ANSWER - -Excess return divided by portfolio beta
Tp = (E(Rp) - Rf)/portfolio beta
-Better for well diversified portfolios
Sharpe measure - CORRECT ANSWER - -Excess return divided by portfolio volatility
(std dev)
Sp = (E(Rp) - Rf)/(std dev of Rp)
-Better for non-diversified portfolios
Jensen's alpha - CORRECT ANSWER - -Excess return equated to alpha plus expected
systematic return
alpha_p=
E(Rp) - Rf = alpha + beta(E(Rm) - Rf)
Arbitrage Pricing Theory - CORRECT ANSWER - a theory of risk-return relationships
derived from no-arbitrage considerations in large capital markets
, 1. Create factor portfolio
2.Derive returns for each factor portfolio
3. Calculate risk premiums for each factor portfolio
APT for passive portfolio management - CORRECT ANSWER - -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 (equation and assumptions) - CORRECT ANSWER -
E(R_i)=R_f+B_i1RP1+B_i2RP2+...+B_ikRPk
-Returns on any stock are linearly related to a set of indexes
-Law of one price
-Returns follow k-factor process
-Well diversified portfolios can be formed
-No arbitrage opp exists
Prices of risk vs sensitivity - CORRECT ANSWER - -Prices of risk are common factors
and do not change
-Sensitivities can change
Multibeta CAPM - CORRECT ANSWER - Ri - Rf = (market beta)(Rm - Rf) + (sensitivity
to inflation risk)(price of inflation risk)...
Effect of non-price-taking behavior on CAPM - CORRECT ANSWER - Simple form of
CAPM, but market price of risk is lower than if all investors were price takers
Effect of heterogeneous expectations on CAPM - CORRECT ANSWER - Equilibrium can
still be expressed in returns, covariance, and variance, but they become complex weighted
averages
