Foundations of Risk Management Interactive Quiz

Question 1 of 20

Wacha Corporation is a conglomerate with three business units (Hardware, Software, and Services). An analyst has already estimated the unlevered (asset) beta of each of the firm’s business units based on data from the unit’s closest competitors, but would like to construct a beta metric that reflects the composite risk profile of the firm, taking into consideration its financing. Wacha has leverage ratio of 4.0 and a simple capital structure, where the leverage ratio is defined as Assets/Equity, and an effective corporate tax rate of 22.0%. Information about each of the firm’s business units, including percentage of revenue and the corresponding unlevered (asset) beta, is as follows:

Which is nearest to Wacha Corporation’s levered (equity) beta?

a) 0.940
b) 1.250
c) 1.770
d) 2.330

Question 2 of 20

Which of the following is LEAST likely to be a key function of members of the board of directors?

a) Build risk-adjusted valuations for each business unit in order to verify management's models
b) Review corporate strategy and oversee major capital transactions, including expenditures, acquisitions and divestitures.
c) Align key executive and board compensation (renumeration) with the longer term interests of the company and its shareholders
d) Ensure integrity of financial (and accounting) reporting systems and monitor risk management systems

Question 3 of 20

While the riskfree rate is 1.0% and the market index (e.g., S&P 1500) has an expected return of 9.0% with volatility of 20.0%, a portfolio with covariance (to the market index) of 0.030 returns 10.0%. According to the capital asset pricing model (CAPM), what is the portfolio’s alpha?

a) -2.0%
b) zero, the portfolio lies on the SML
c) +1.0%
d) +3.0%

Question 4 of 20

While the riskfree rate is 2.0% and the market risk premium is 5.0%, the price of a security which pays a $3.60 dividend and has an expected return of 9.0% is $40.00. This is due to a simple (naive) assumption of constant perpetual dividend discounted by the CAPM-based rate; i.e., $3.60/0.090 = $40.00. If the correlation between the security and the market suddenly doubles, what is the stock’s new price?

a) $17.00
b) $22.50
c) $31.75
d) $67.25

Question 5 of 20

Peter Parker is comparing the single-factor capital asset pricing model (CAPM) to the arbitrage pricing theory (APT) model. Which statement is TRUE?

a) Both CAPM and APT require a mean-variance efficient market portfolio
b) Both CAPM and APT assume normally distributed security returns
c) Both CAPM and APT recognize multiple systemic risk factors
d) Both CAPM and APT predict a security market line (SML)

Question 6 of 20

About the Fama-French (FF) three-factor model, each of the following is true, EXCEPT which is false?

a) One factor is High Minus Low (HML); i.e., the excess relative return of so-called "value" stocks with a low price-to-book (P/B) ratio
b) One factor is Industrial Production (IP); i.e., the real output in manufacturing, mining, and electric, and gas utilities
c) As a possible type of arbitrage pricing theory (APT) model, Fama-French may contain a firm-specific risk term
d) Fama-French is an empirical model where two of the variables are meant to be proxies for exposure to extramarket or systemic risks which are not themselves identified

Question 7 of 20

Gregory is analyzing the historical performance of two commodity funds (Fund I and Fund II) that each track the same index benchmark. He collated the following data below:

Please note that “excess return” is also known as “active return.” Gregory wants to compare the two funds based on their annualized information ratio (IR). On this basis, which fund performs better?

a) Fund I because its annualized IR = 0.32
b) Fund I because its annualized IR = 0.79
c) Fund II because its annualized IR = 0.18
d) Fund II because its annualized IR = 0.61

Question 8 of 20

A portfolio’s realized Jensen’s alpha is zero, which happens to match its expected alpha (the expected alpha is zero, in most cases). If the market’s excess return (a.k.a., equity risk premium) was 5.0% while the portfolio’s volatility was 12.0%, what is the portfolio’s Treynor ratio?

a) 0.050
b) 0.120
c) 0.600
d) Not enough information (need the portfolio's beta or correlation to market)

Question 9 of 20

Each of the following is true about the traditional risk-adjusted performance measures (i.e., Treynor, Sharpe, Jensen’s alpha, information ratio and Sortino) EXCEPT which statement is false?

a) Unlike the Treynor and Jensen measures, the Sharpe ratio is not subject to Roll's criticism
b) While Jensen's alpha is useful for ranking portfolios with the same beta, the Sharpe ratio is better for ranking portfolios with different levels of risk
c) If a portfolio's excess returns are regressed against its benchmark's excess returns, and the regression intercept is assumed to be the portfolio's alpha, then the correct denominator for its information ratio is the residual risk
d) If the minimum acceptable return (MAR) is set to equal the risk -free rate, then the Sortino ratio is equal to the Sharpe ratio

Question 10 of 20

Each of the following is true about Long Term Capital Management (LTCM), according to Allen, EXCEPT which is false?

a) LTCM is classified as a disaster due to large market moves rather than a disaster due to misleading reporting
b) LTCM strategy was not to hold any long-term positions; instead, they were "essentially similar to modern-day high-frequency traders"
c) LTCM was bailed out by its creditors who feared the adverse impact to themselves, and their financing clients, of closing out such large positions in such illiquid markets
d) A key lesson from the LTCM incident is that a stress scenario is needed to look at the impact of a competitor holding similar positions exiting the market

Question 11 of 20

What do these incidents have in common: Chase Manhattan Bank/Drysdale Securities, Kidder Peabody, Barings, Allied Irish Bank, and Union Bank of Switzerland (UBS) in 1997-1998?

a) They are cases in which the firm or its investors and lenders were seriously misled about the size and nature of the positions it had (Disasters due to misleading reporting)
b) They are cases in which the firm and its investors and lenders had reasonable knowledge of its positions, but had losses result from unexpectedly large market moves (Disasters due to large market moves)
c) They are cases in which losses did not result from positions held by the firm, but instead resulted from fiduciary or reputational exposure to positions held by the firm’s customers (Disasters due to the conduct of customer business)
d) None of the above

Question 12 of 20

Which of the following most accurately reflects a key risk that was realized in the Metallgesellschaft case study?

a) Eventually interest rate spreads are likely to revert to mean
b) Value at risk (VaR) is not necessarily reliable without scenario analysis complements
c) Roll return (roll yield) for a long futures position is negative in contango
d) A firm which does not choose the theoretical minimum variance hedge is economically speculating

Question 13 of 20

According to COSO, which of the following risks is defined as “the acceptable level of variation relative to achievement of a specific objective, and often is best measured in the same units as those used to measure the related objective?”

a) Risk appetite
b) Risk tolerance
c) Risk profile
d) Risk capacity

Question 14 of 20

Each of the following is a key dimension of data quality EXCEPT which is not?

a) Accuracy measures the degree to which data instances compare to the real-life entities they are intended to model.
b) Completeness specifies expectations regarding the population of data attributes, according to varying levels of constraint: mandatory attributes that require a value; data elements with conditionally optional values; and inapplicable attribute values.
c) Reasonableness measures conformance to consistency expectations relevant within specific operational contexts. For example, one might expect that the total sales value of all the transactions each day is not expected to exceed 105 percent of the running average total sales for the previous 30 days.
d) Uniqueness is measured in terms of agreement with an identified reference source of correct information such as a system of record

Question 15 of 20

In contrast to managers at non-financial firms (according to Stulz), risk managers at FINANCIAL firms encounter which of the following special challenges?

a) Financial firms hold many derivative positions and their risk properties can change very rapidly with no trading whatsoever; e.g., due to extreme sensitivity to market conditions
b) In financial firms, operational risk tends to uniquely transcend business unit delineations such that bottom-up approaches tend to omit key operational risks
c) Due to their inherent complexity, financial firms are more naturally prone to communication failures especially communications flows that are sent up the management chain
d) Due to their uniquely competitive context, financial firms must "move move faster and with more flexibility, and this agility requires risk management that is structured to know everything at all times."

Question 16 of 20

In regard to Conflicts of Interest, which is TRUE in principle about the responsibility of members:

a) Members will not knowingly perform risk management services directly or indirectly involving an actual (but not potential) conflict of interest, under any conditions
b) Members will not knowingly perform risk management services directly or indirectly involving an actual or potential conflict of interest, under any conditions
c) Members will not knowingly perform risk management services directly or indirectly involving an actual or potential conflict of interest, unless full disclosure has been provided to GARP
d) Members will not knowingly perform risk management services directly or indirectly involving an actual or potential conflict of interest, unless full disclosure has been provided to all affected parties of any actual or apparent conflict of interest

Question 17 of 20

Which is true of the Professional Standards which GARP Members agree to uphold and implement?

a) Members can delegate their ethical responsibility to others; are not responsible for the wider impact of their assessments and actions; and cannot be expected to achieve "perfection" in their expertise
b) Members can delegate their ethical responsibility to others; are responsible for the wider impact of their assessments and actions; but cannot be expected to achieve "perfection" in their expertise
c) Members cannot out-source or delegate their ethical responsibility to others; should consider the wider impact of their assessments and actions; and should always continue to perfect their expertise
d) Members cannot out-source or delegate their ethical responsibility to others; but they are not responsible for the wider impact of their assessments and actions; and cannot be expected to achieve "perfection" in their expertise

Question 18 of 20

GARP Members agree to uphold and implement Rules of Conduct, which includes each of the following EXCEPT for:

a) Shall exercise reasonable judgment in the provision of risk services while maintaining independence of thought and direction.
b) Shall be knowledgeable about probable future regulations in order to ensure their recommendations can endure future developments
c) Shall be diligent about not overstating the accuracy or certainty of results or conclusions and shall clearly disclose the relevant limits of their specific knowledge and expertise concerning risk assessment, industry practices and applicable laws and regulations
d) Shall endeavor to be mindful of cultural differences regarding ethical behavior and customs, and to avoid any actions that are, or may have the appearance of being unethical according to local customs.

Question 19 of 20

When approaching financial derivatives–e.g., stock options–which are common hedging instruments, there is a thematic distinction between valuation (a.k.a, pricing) and risk measurement. While the approaches to pricing and risk measurement often share much in common (e.g., risk factors), there are some key differences. Each of the following is true about a difference between valuation and risk measurement approaches EXCEPT which is NOT true?

a) Risk measurement tends to estimate a distribution of future values, which derivatives valuation tends to compute a discounted expected present value (PV)
b) Risk measurement is focused on distributional tails (and second or higher moments), while derivatives valuation is focused on the center of the distribution
c) Risk measurement requires high precision, while derivatives valuation is satisfied with approximations
d) Risk measurement prefers actual (aka, physical) distributions, while derivatives valuation prefers risk-neutral distributions

Question 20 of 20

Each of the following is an obvious, blatant failure of risk management EXCEPT which of the following by itself does not necessarily imply a risk management failure?

a) The firm realizes a loss of more than 20% of its capital in the period of only a single year
b) Risk models assume positions are independent, but in reality the firm's positions are highly correlated
c) Market, credit, and operational risks are measured, but liquidity risk is forgotten (and therefore inadvertently omitted) due to this three-bucket typology
d) The firm's risk managers correctly specify the firm's risk profile but they fail to successfully and timely communicate these risks to the firm's executives and the board of directors.

Foundations of Risk Management Interactive Quiz

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