Mixed Deck — All FRM Topics Flashcards

What is a short squeeze?

Answer: A rapid price increase that occurs when short sellers are forced to buy back shares, driving the price even higher

When a heavily shorted asset's price rises, short sellers rush to buy back (cover) their positions to limit losses, which further drives up the price in a feedback loop.

Expected Shortfall (ES) is considered superior to VaR primarily because:

Answer: It measures the average loss in the tail beyond the VaR threshold and is sub-additive

ES captures the average severity of tail losses beyond the VaR cutoff and satisfies sub-additivity, meaning portfolio ES ≤ sum of individual ESs, unlike VaR.

What is the value of industry certifications?

Answer: They validate knowledge, demonstrate commitment to the profession, and may be required by employers or regulations

Certifications provide third-party validation of your knowledge and skills, showing employers and clients that you meet recognized professional standards.

A risk review identifies that a strategy has negative skew and positive carry. What is the typical hidden danger?

Answer: Steady small gains punctuated by rare large losses

Negative-skew carry strategies often earn small steady profits but are exposed to infrequent severe losses.

Under Basel III, what is the standard multiplier applied to the 10-day 99% VaR for market risk capital requirements?

Answer: 3

Basel III requires banks to hold capital equal to at least 3 times the 10-day 99% VaR, subject to supervisory add-ons for backtesting exceptions.

In the context of options, what does 'delta hedging' involve?

Answer: Continuously rebalancing a position in the underlying asset to offset changes in option value

Delta hedging involves taking an offsetting position in the underlying asset equal to the option's delta, which must be rebalanced as the delta changes.

Which credit risk model uses a factor model where asset correlations are driven by common market factors?

Answer: CreditMetrics / Vasicek one-factor model

The Vasicek one-factor model and CreditMetrics use a single or multi-factor framework where asset returns of different borrowers co-move through shared systematic factors.

What role does networking play in professional development?

Answer: Networking provides opportunities for learning, mentorship, referrals, and staying current with industry trends

Professional networking connects you with peers, mentors, and opportunities while keeping you informed about industry developments and best practices.

If a portfolio has a 1-day 95% VaR of $1 million, the approximate 10-day 95% VaR (assuming i.i.d. returns) is:

Answer: $3.16 million

Using the square-root-of-time rule, 10-day VaR = 1-day VaR × √10 = $1M × 3.162 ≈ $3.16 million.

What happens if risk managers aren't certain of all of the company's risks?

Answer: This can be a source of risk management failure, but not in all cases.

Not being aware of all risks (unknown unknowns) is a significant challenge in risk management and can indeed lead to failures, as unmanaged risks can materialize unexpectedly. However, it's unrealistic to expect perfect foresight of every single potential risk. While it's a vulnerability, it doesn't always lead to failure, as some unknown risks might be minor or might not materialize, or the firm might have sufficient resilience to absorb them.

Stress testing differs from VaR primarily because it:

Answer: Examines impacts of specific extreme or hypothetical scenarios

Stress testing assesses portfolio impacts under defined extreme scenarios rather than statistical confidence thresholds.

Which of the following is the least likely criteria for an arbitrage opportunity? Which of the following is a result of the arbitrage situation?

Answer: Return in excess of the risk-free rate opportunity.

Explanation: An arbitrage situation exists if a risk-free, zero net investment can be created that produces a positive profit. The arbitrage return need not exceed the risk-free rate.

The Gaussian copula was widely criticized after the 2008 crisis mainly because it:

Answer: Underestimated tail dependence among defaults

The Gaussian copula has zero tail dependence, so it understated the probability of joint extreme defaults in structured products.

Expected shortfall (ES) is generally preferred over VaR as a risk measure mainly because ES is:

Answer: A coherent risk measure that is subadditive

Expected shortfall satisfies subadditivity and the other coherence axioms, which VaR can violate.

Multicollinearity among predictors in a regression model causes:

Answer: Inflated standard errors of the affected coefficients

Multicollinearity inflates the standard errors of correlated predictors' coefficients, making it hard to isolate individual effects, though OLS estimates remain unbiased.

The market portfolio, or M, is the universally agreed upon optimal risky portfolio. Which of the following best describes the term "market portfolio M"?

Answer: It is defined as the investors of all marketable assets weighted in proportion to their relative market values.

The market portfolio is a theoretical construct in finance that represents a portfolio of all marketable assets in the economy. Each asset is weighted in proportion to its total market value relative to the total market value of all assets. This comprehensive portfolio is considered the optimal risky portfolio, as it captures all systematic risk. Option A, despite a likely typo ('investors' instead of 'portfolio'), aims to describe this fundamental concept.

A swap's value to the fixed-rate payer increases when:

Answer: Interest rates rise

The fixed-rate payer benefits when rates rise because the floating payments they receive increase in value.

What is the importance of workplace safety in any profession?

Answer: Every workplace has safety considerations, and maintaining safety protects people, reduces costs, and ensures compliance

Workplace safety is everyone's responsibility across all industries. Injuries affect individuals, teams, and organizations through human suffering and financial costs.

A review of economic capital versus regulatory capital concludes that economic capital is:

Answer: An internal estimate of capital needed for the bank's actual risk profile

Economic capital is the institution's own assessment of capital required to remain solvent given its specific risks.

A bank using the standardized approach for market risk under the Fundamental Review of the Trading Book (FRTB) replaces VaR with which measure?

Answer: Expected shortfall at 97.5%

FRTB adopts expected shortfall at a 97.5% confidence level as the primary market-risk measure, replacing VaR.