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






2. 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






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






4. Multibeta CAPM Ri - Rf =






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






6. Wrong distribution - Historical sample may not apply






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






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






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






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






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






12. Changes in vol - implied or actual






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

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14. Rp = XaRa + XbRb






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






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






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






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






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






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






21. Future price is greater than the spot price






22. 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






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






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






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






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






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






28. Quantile of an empirical distribution






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






30. Strategic risk - Business risk - Reputational risk






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






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






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. 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






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






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






37. 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 -






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






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






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






41. Interest rate movements - derivatives - defaults






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






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






45. Both probability and cost of tail events are considered






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






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






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






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






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