## Test your basic knowledge |

# 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. Probability distribution is unknown (ex. A terrorist attack)**

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

**4. Strategic risk - Business risk - Reputational risk**

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

**6. Potential amount that can be lost**

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

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

**9. Interest rate movements - derivatives - defaults**

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

**11. Absolute and relative risk - direction and non-directional**

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

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

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

**15. Volatility of unexpected outcomes**

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

**17. 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**

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

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

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

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

**22. Future price is greater than the spot price**

**23. Quantile of a statistical distribution**

**24. 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**

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

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

**27. 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**

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

**29. 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**

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

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

**32. 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**

**33. 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**

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

**35. Rp = XaRa + XbRb**

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

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

**38. Return is linearly related to growth rate in consumption**

**39. 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**

**40. Unanticipated movements in relative prices of assets in hedged position**

**41. Quantile of an empirical distribution**

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

**43. 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 -**

**44. Asset-liability/market-liquidity risk**

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

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

**47. Hazard - Financial - Operational - Strategic**

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

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

**50. Asses firm risks - Communicate risks - Manage and monitor risks**