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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. 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






2. 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






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






4. Potential amount that can be lost






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






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






7. 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






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






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






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






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






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






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






14. 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






15. 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.






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






17. 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






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






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






20. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)






21. Rp = XaRa + XbRb






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






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






24. Asset-liability/market-liquidity risk






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






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






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






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






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






30. Wrong distribution - Historical sample may not apply






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






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






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






34. Future price is greater than the spot price






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






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






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






38. Quantile of an empirical distribution






39. 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






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






41. Efficient frontier with inclusion of risk free rate - Straight line with formula Rc = Rf + ((Ra - Rf)/std dev(a))*std dev(c) - c is the total portfolio - a is the risky asset






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






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






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






45. 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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46. Concave function that extends from minimum variance portfolio to maximum return portfolio






47. 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






48. 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 -






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






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