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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. Volatility of unexpected outcomes






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






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






4. Quantile of an empirical distribution






5. Potential amount that can be lost






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






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






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






9. 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






10. 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.






11. 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






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






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






14. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation






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






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






17. Future price is greater than the spot price






18. 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






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






20. Strategic risk - Business risk - Reputational risk






21. 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 -






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






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






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






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






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






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






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






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






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






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






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






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






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






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






36. Quantile of a statistical distribution






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






38. Hazard - Financial - Operational - Strategic






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






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






41. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations






42. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business






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






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






45. Asset-liability/market-liquidity risk






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






47. 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






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






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






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