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FRM: Foundations Of Risk Management

Instructions:
  • Answer 50 questions in 15 minutes.
  • If you are not ready to take this test, you can study here.
  • 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. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation






2. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses






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






4. 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






5. Hazard - Financial - Operational - Strategic






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






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






8. 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






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. Proportion of loss that is recovered - Also referred to as "cents on the dollar"






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






13. Difference between forward price and spot price - Should approach zero as the contract approaches maturity






14. Strategic risk - Business risk - Reputational risk






15. 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






16. 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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17. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely






18. John Rusnak - a currency option trader - produced losses of 691 million by using imaginary trades to disguise large naked positions. - Enforced need for back office controls






19. Concentrate on mid- region of probability distribution - Relevant to owners and proxies






20. Leeson took large speculative position in Nikkei 225 disguised as safe transactions by fake customers - Earthquake increased volatility and destroyed short put options - Losses of 1.25 billion and forced bankruptcy - Necessity of an independent tradi






21. Designate ERM champion - usually CRO - Make ERM part of firm culture - Determining all possible risks - Quantifying operational and strategic risks - Integrating risks (dependencies) - Lack of risk transfer mechanisms - Monitoring






22. Rp = XaRa + XbRb






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






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






25. Both probability and cost of tail events are considered






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






27. No transaction costs - assets infinitely divisible - no personal tax - perfect competition - investors only care about mean and variance - short- selling allowed - unlimited lending and borrowing - homogeneity: single period - homogeneity: same mean






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






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






30. Quantile of an empirical distribution






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






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






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






34. CAPM requires the strong form of the Efficient Market Hypothesis = private information






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






36. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)






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






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






39. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund






40. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits






41. 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.






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






43. When negative taxable income is moved to a different year to offset future or past taxable income






44. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes






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






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






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






48. Changes in vol - implied or actual






49. Potential amount that can be lost






50. Future price is greater than the spot price