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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. 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






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






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






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






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






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






7. Hazard - Financial - Operational - Strategic






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






9. 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






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






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






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






13. 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






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






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






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






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






18. Interest rate movements - derivatives - defaults






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






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






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






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






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






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






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






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






27. 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.






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






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






30. Rp = XaRa + XbRb






31. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta






32. Strategic risk - Business risk - Reputational risk






33. Return is linearly related to growth rate in consumption






34. Volatility of unexpected outcomes






35. 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






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






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






38. 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 -






39. 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






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






41. Both probability and cost of tail events are considered






42. 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






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






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






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






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






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






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






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






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