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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. 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






2. 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






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






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






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






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






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






8. 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.






9. Both probability and cost of tail events are considered






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






11. Volatility of unexpected outcomes






12. 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






13. 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






14. Changes in vol - implied or actual






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






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






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






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






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






20. 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






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






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






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






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






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






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






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






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






30. 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






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






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






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






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






35. Probability that a random variable falls below a specified threshold level






36. Quantile of a statistical distribution






37. 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






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






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






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






41. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations






42. Future price is greater than the spot price






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






44. Law of one price - Homogeneous expectations - Security returns process






45. Strategic risk - Business risk - Reputational risk






46. 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






47. Potential amount that can be lost






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






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






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