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






2. Wrong distribution - Historical sample may not apply






3. Changes in vol - implied or actual






4. 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






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






6. Quantile of an empirical distribution






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






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






9. Future price is greater than the spot price






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






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






12. 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






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






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






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






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






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






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






19. Potential amount that can be lost






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






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






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






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






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






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






26. 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






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






28. 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






29. Multibeta CAPM Ri - Rf =






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






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






32. 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 -






33. Asset-liability/market-liquidity risk






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






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






36. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation






37. 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






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






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






40. Interest rate movements - derivatives - defaults






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. Absolute and relative risk - direction and non-directional






43. 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






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






45. Derives value from an underlying asset - rate - or index - Derives value from a security






46. When two payments are exchanged the same day and one party may default after payment is made






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






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






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






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







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