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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.
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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. 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






2. Future price is greater than the spot price






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






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






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






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






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






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






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






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






11. Both probability and cost of tail events are considered






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






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






14. 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






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






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






17. 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






18. Hazard - Financial - Operational - Strategic






19. Excess return equated to alpha plus expected systematic return E(Rp) - Rf = alpha + beta(E(Rm) - Rf)

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






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






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






23. Asset-liability/market-liquidity risk






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






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






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






27. 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






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






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






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






31. 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






32. Multibeta CAPM Ri - Rf =






33. 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






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






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






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






37. 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






38. Return is linearly related to growth rate in consumption






39. 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 -






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






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






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






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






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






45. 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.






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






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






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






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






50. 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







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