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FRM: Foundations Of Risk Management

Instructions:
  • Answer 50 questions in 15 minutes.
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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. Percentile of the distribution corresponding to the point which capital is exhausted - Typically - a minimum acceptable probability of ruin is specified - and economic capital is derived from it






2. 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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3. 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






4. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks






5. Expected value of unfavorable deviations of a random variable from a specified target level






6. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations






7. 1971: Fixed Exchange rate system broke down and was replaced by more volatile floating rate - 1973: Oil price shocks - - >high inflation - - >interest rate swings - 1987: Black Monday - OCt 19 - mkt fell 23% - 1989: Japanese stock price bubble -






8. Hazard - Financial - Operational - Strategic






9. Simple form of CAPM - but market price of risk is lower than if all investors were price takers






10. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))






11. Covariance = correlation coefficient std dev(a) std dev(b)






12. Modeling approach is typically between statistical analytic models and structural simulation models






13. Occurs the day when two parties exchange payments same day






14. Concave function that extends from minimum variance portfolio to maximum return portfolio






15. Unanticipated movements in relative prices of assets in hedged position






16. The lower (closer to - 1) - the higher the payoff from diversification






17. Risk of loses owing to movements in level or volatility of market prices






18. 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






19. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)






20. Multibeta CAPM Ri - Rf =






21. Strategic risk - Business risk - Reputational risk






22. Law of one price - Homogeneous expectations - Security returns process






23. Those which corporations assume whillingly to create competitive advantage/add shareholder value - Business Decisions: investment decisions - prod - dev choices - marketing strategies - organizational struct. - Business Environment: competitive and






24. Firms became multinational - - >watched xchange rates more - deregulation and globalization






25. Rp = XaRa + XbRb






26. Potential amount that can be lost






27. Inability to make payment obligations (ex. Margin calls)






28. Long Term Capital Management - Renowned quants produced great returns with arbitrage- type trades - Unexpected and extreme events resulted in devaluation of Russian Rouble - resulting in a 3.65 billion dollar bailout - Failure to account for illiquid






29. Equilibrium can still be expressed in returns - covariance - and variance - but they become complex weighted averages






30. Need to assess risk and tell management so they can determine which risks to take on






31. Asset-liability/market-liquidity risk






32. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations






33. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected






34. Country specific - Foreign exchange controls that prohibit counterparty's obligations






35. 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






36. Valuation focuses on mean of distribution vs risk mgmt focuses on potential variation in payoffs - needs more precision for pricing - VAR doesn't b/c noise cancels out






37. Wrong distribution - Historical sample may not apply






38. Obtained unsecured borrowing of 300 million by exploiting flaw in computing US government bond collateral - Had only 20 million in capital - Chase absorbed losses since they brokered deal - Called for better process control and more precise methods f






39. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk






40. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios






41. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business






42. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)






43. Cannot exit position in market due to size of the position






44. Capital structure (financial distress) - Taxes - Agency and information asymmetries






45. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios






46. Asses firm risks - Communicate risks - Manage and monitor risks






47. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta






48. Risk replaced with VaR (Portfolio return - risk free rate)/(portfolio VaR/initial value of portfolio)






49. 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






50. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements