FRM Part 1 - Book 1 - Foundations of Risk Management

After completing this reading you should be able to:

• Explain the concept of risk and compare risk management with risk taking.

• Describe elements, or building blocks, of the risk management process and identify problems and challenges that can arise in the risk management process.

• Evaluate and apply tools and procedures used to measure and manage risk, including quantitative measures, qualitative assessment and enterprise risk management.

• Distinguish between expected loss and unexpected loss and provide examples of each.

• Interpret the relationship between risk and reward and explain how conflicts of interest can impact risk management.

• Describe and differentiate between the key classes of risks, explain how each type of risk can arise, and assess the potential impact of each type of risk on an organization.

• Explain how risk factors can interact with each other and describe challenges in aggregating
  risk exposures.

After completing this reading, you should be able to:

• Compare different strategies a firm can use to manage its risk exposures and explain situations in which a firm would want to use each strategy.

• Explain the relationship between risk appetite and a firm’s risk management decisions.

• Evaluate some advantages and disadvantages of hedging risk exposures and explain challenges that can arise when implementing a hedging strategy.

• Apply appropriate methods to hedge operational and financial risks, including pricing, foreign currency, and interest rate risk.

• Assess the impact of risk management tools and instruments, including risk limits and derivatives.

After completing this reading you should be able to:

• Explain changes in corporate risk governance that occurred as a result of 2007-2009
  financial crisis.

• Compare and contrast best practices in corporate governance with those of risk management.

• Assess the role and responsibilities of the board of directors in risk governance.

• Evaluate the relationship between a firm’s risk appetite and its business strategy, including the role of incentives.

• Illustrate the interdependence of functional units within a firm as it relates to risk management.

• Assess the role and responsibilities of a firm’s audit committee.

After completing this reading you should be able to:

• Compare different types of credit derivatives, explain how each one transfers credit risk and describe their advantages and disadvantages.

• Explain different traditional approaches or mechanisms that firms can use to help mitigate credit risk.

• Evaluate the role of credit derivatives in the 2007-2009 financial crisis and explain changes in the credit derivative market that occurred as a result of the crisis.

• Explain the process of securitization, describe a special purpose vehicle (SPV) and assess the risk of different business models that banks can use for securitized products.

After completing this reading, you should be able to:

• Explain modern portfolio theory and interpret the Markowitz efficient frontier.

• Understand the derivation and components of the CAPM.

• Describe the assumptions underlying the CAPM.

• Interpret the capital market line.

• Apply the CAPM in calculating the expected return on an asset.

• Interpret beta and calculate the beta of a single asset or portfolio.

• Calculate, compare, and interpret the following performance measures: the Sharpe performance index, the Treynor performance index, the Jensen performance index, the tracking error, information ratio, and Sortino ratio.

After completing this reading, you should be able to

• Explain the arbitrage pricing theory (APT), describe its assumptions, and compare the APT to the CAPM.

• Describe the inputs (including factor betas) to a multifactor model.

• Calculate the expected return of an asset using a single-factor and a multifactor model.

• Explain models that account for correlations between asset returns in a multi-asset portfolio.

• Explain how to construct a portfolio to hedge exposure to multiple factors.

• Describe and apply the Fama-French three-factor model in estimating asset returns.

After completing this reading you should be able to:

• Explain the potential benefits of having effective risk data aggregation and reporting.

• Describe key governance principles related to risk data aggregation and risk reporting practices.

• Identify the data architecture and IT infrastructure features that can contribute to effective risk data aggregation and risk reporting practices.

• Describe characteristics of a strong risk data aggregation capability and demonstrate how these characteristics interact with one another.

• Describe the characteristics of effective risk reporting practices.

After completing this reading you should be able to:

• Describe Enterprise Risk Management (ERM) and compare an ERM program with a traditional silo-based risk management program.

• Compare the benefits and costs of ERM and describe the motivations for a firm to adopt an ERM initiative.

• Explain best practices for the governance and implementation of an ERM program.

• Describe important dimensions of an ERM program and relate ERM to strategic planning.

• Describe risk culture, explain characteristics of strong corporate risk culture, and describe challenges to the establishment of a strong risk culture at a firm.

• Explain the role of scenario analysis in the implementation of an ERM program and describe its advantages and disadvantages.

• Explain the use of scenario analysis in stress testing programs and in capital planning.

After completing this reading, you should be able to:

Analyze the key factors that led to and derive the lessons learned from case studies involving the following risk factors:

• Interest rate risk, including the 1980s savings and loan crisis in the US

• Funding liquidity risk, including Lehman Brothers, Continental Illinois, and Northern Rock

• Implementing hedging strategies, including the Metallgesellschaft case

• Model risk, including the Niederhoffer case, Long Term Capital Management, and the London Whale case

• Rogue trading and misleading reporting, including the Barings case

• Financial engineering and complex derivatives, including Bankers Trust, the Orange County case, and Sachsen Landesbank

• Reputational risk, including the Volkswagen case

• Corporate governance, including the Enron case

• Cyber risk, including the SWIFT case

After completing this reading, you should be able to:

• Describe the historical background and provide an overview of the 2007–2009 financial crisis.

• Describe the build-up to the financial crisis and the factors that played an important role.

• Explain the role of subprime mortgages and collateralized debt obligations (CDOs) in the crisis.

• Compare the roles of different types of institutions in the financial crisis, including banks, financial intermediaries, mortgage brokers and lenders, and rating agencies.

• Describe trends in the short-term wholesale funding markets that contributed to the financial crisis, including their impact on systemic risk.

• Describe responses taken by central banks in response to the crisis.

After completing this reading you should be able to:

• Calculate, compare, and evaluate the Treynor measure, the Sharpe measure, and Jensen’s alpha.

• Compute and interpret tracking error, the information ratio, and the Sortino ratio.