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






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






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






4. 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






5. Interest rate movements - derivatives - defaults






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






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






8. Potential amount that can be lost






9. Both probability and cost of tail events are considered






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






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






12. 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






13. 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






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






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

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






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






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






19. Wrong distribution - Historical sample may not apply






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






21. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk






22. 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






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






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






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






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






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






29. Quantile of an empirical distribution






30. 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






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






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






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






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






35. Changes in vol - implied or actual






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






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






38. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed






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






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






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






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






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






44. Prices of risk are common factors and do not change - Sensitivities can change






45. Quantile of a statistical distribution






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






47. Market risk - Liquidity risk - Credit risk - Operational risk






48. 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






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






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