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






2. 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






3. Volatility of unexpected outcomes






4. 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






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






6. 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.






7. Multibeta CAPM Ri - Rf =






8. 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






9. 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






10. 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






11. 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






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






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






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






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






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






17. Changes in vol - implied or actual






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






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






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






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

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22. Prices of risk are common factors and do not change - Sensitivities can change






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






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






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






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






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






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






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






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






31. Future price is greater than the spot price






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






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






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






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






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






37. 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






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






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






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






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






42. 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






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






44. Strategic risk - Business risk - Reputational risk






45. 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






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






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






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






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






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







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