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






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






3. 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






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






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






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






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






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






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






10. 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






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






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






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






14. 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






15. 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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16. 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






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






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






19. Wrong distribution - Historical sample may not apply






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






21. 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






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






23. Interest rate movements - derivatives - defaults






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






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






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






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






28. 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






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






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

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






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






33. 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






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






35. 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 -






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






37. 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.






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






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






40. Quantile of an empirical distribution






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






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






43. Percentile of the distribution corresponding to the point which capital is exhausted - Typically - a minimum acceptable probability of ruin is specified - and economic capital is derived from it






44. 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






45. Return is linearly related to growth rate in consumption






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






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






48. Volatility of unexpected outcomes






49. Future price is greater than the spot price






50. 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