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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. Absolute and relative risk - direction and non-directional






2. Return is linearly related to growth rate in consumption






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






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






5. 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






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

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






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






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






10. 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 -






11. Rp = XaRa + XbRb






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






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






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






15. 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






16. Both probability and cost of tail events are considered






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






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






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






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






21. 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






22. Strategic risk - Business risk - Reputational risk






23. 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






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






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






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






27. Obtained unsecured borrowing of 300 million by exploiting flaw in computing US government bond collateral - Had only 20 million in capital - Chase absorbed losses since they brokered deal - Called for better process control and more precise methods f






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






29. Interest rate movements - derivatives - defaults






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






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






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






33. Wrong distribution - Historical sample may not apply






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






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






36. Hazard - Financial - Operational - Strategic






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






39. Quantile of an empirical distribution






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






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






42. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))






43. 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






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






45. 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






46. 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






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






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






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






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