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






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






3. 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






4. Interest rate movements - derivatives - defaults






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






6. 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






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






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






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






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






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






12. Rp = XaRa + XbRb






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






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






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






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






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






18. Strategic risk - Business risk - Reputational risk






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






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






21. 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.






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






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






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






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






26. Volatility of unexpected outcomes






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






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






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






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






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






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






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






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






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






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






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






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






39. 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






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






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






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






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






44. 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






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






46. 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






47. 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






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






49. 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






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