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






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






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






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






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






6. Return is linearly related to growth rate in consumption






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






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






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






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






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






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






13. May not scale over time- Historical data may be meaningless - Not designed to account for catastrophes - VaR says nothing about losses in excess of VaR - May not handle sudden illiquidity






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






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






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






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






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






19. Efficient frontier with inclusion of risk free rate - Straight line with formula Rc = Rf + ((Ra - Rf)/std dev(a))*std dev(c) - c is the total portfolio - a is the risky asset






20. Future price is greater than the spot price






21. 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






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






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






24. Quantile of an empirical distribution






25. 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






26. 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






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






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






29. Quantile of a statistical distribution






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






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






32. Relative portfolio risk (RRiskp) - Based on a one- month investment period






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






34. 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






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






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






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






38. Hazard - Financial - Operational - Strategic






39. Curve must be concave - Straight line connecting any two points must be under the curve






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






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






42. 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






43. 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






44. Both probability and cost of tail events are considered






45. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM






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






47. 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






48. 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






49. Changes in vol - implied or actual






50. 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