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






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






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






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






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






6. Hazard - Financial - Operational - Strategic






7. Unanticipated movements in relative prices of assets in hedged position






8. 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






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






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






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






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






13. 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






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






15. 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






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






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






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






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






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






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






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






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






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






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






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






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






28. 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






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






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






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






32. 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






33. 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.






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






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






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






37. 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






38. 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






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






40. 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






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






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






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






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






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






46. 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






47. Multibeta CAPM Ri - Rf =






48. Potential amount that can be lost






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






50. Quantile of a statistical distribution







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