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






2. The uses of debt to fall into a lower tax rate






3. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)

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4. Absolute and relative risk - direction and non-directional






5. Potential amount that can be lost






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






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






8. 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






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






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






11. Interest rate movements - derivatives - defaults






12. 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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13. Cannot exit position in market due to size of the position






14. Ri = Rz + (Rm - Rz)*beta - Rz = return on zero- beta portfolio






15. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities






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






17. Returns on any stock are linearly related to a set of indexes






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






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






20. Quantile of an empirical distribution






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






22. Probability distribution is unknown (ex. A terrorist attack)






23. Volatility of unexpected outcomes






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






25. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated






26. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized






27. Long in options = expecting volatility increase - Short in options = expecting volatility decrease






28. Rp = XaRa + XbRb






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






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






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






32. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection






33. Risks that are assumed willingly - to gain a competitive edge or add shareholder value






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






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






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






37. RM cannot increase firm value when it costs the same to bear a risk w/in the firm or outside the firm - For RM to increase firm value it must be more expensive to bear risks internally than to pay capital markets to bear them.






38. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return






39. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






42. Changes in vol - implied or actual






43. 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






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






45. Multibeta CAPM Ri - Rf =






46. Probability that a random variable falls below a specified threshold level






47. Losses due to market activities ex. Interest rate changes or defaults






48. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds






49. The need to hedge against risks - for firms need to speculate.






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







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