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






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






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






4. Potential amount that can be lost






5. Curve must be concave - Straight line connecting any two points must be under the curve






6. 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 -






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






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






9. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses






10. 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






11. Rp = XaRa + XbRb






12. Return is linearly related to growth rate in consumption






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






14. Changes in vol - implied or actual






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






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






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






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






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






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






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






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






23. 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






24. Both probability and cost of tail events are considered






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






26. Quantile of an empirical distribution






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






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






29. 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






30. Wrong distribution - Historical sample may not apply






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






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






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






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






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






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






37. 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






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






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






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






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






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






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






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






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






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






47. 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






48. Market risk - Liquidity risk - Credit risk - Operational risk






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






50. Multibeta CAPM Ri - Rf =