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FRM: Foundations Of Risk Management

Instructions:
  • Answer 50 questions in 15 minutes.
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  • 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. Capital structure (financial distress) - Taxes - Agency and information asymmetries






3. Sold complex derivatives to Proctor & Gamble and Gibson - Were sued due to claims that they deceived buyers - Need for better controls for matching complexity of trade with client sophistication - Need for price quotes independent of front office Met

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






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






6. Return is linearly related to growth rate in consumption






7. 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






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






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






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






11. Need to assess risk and tell management so they can determine which risks to take on






12. 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






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






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






15. 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






16. 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






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






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






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






20. 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






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






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






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






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






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






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






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






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






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






30. 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






31. Changes in vol - implied or actual






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. 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






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






35. John Rusnak - a currency option trader - produced losses of 691 million by using imaginary trades to disguise large naked positions. - Enforced need for back office controls






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






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






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






39. Market risk - Liquidity risk - Credit risk - Operational risk






40. Rp = XaRa + XbRb






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






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






43. Wrong distribution - Historical sample may not apply






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






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






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






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






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






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






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







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