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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. Wrong distribution - Historical sample may not apply






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






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






5. 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






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






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






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






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






10. 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






11. 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






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






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






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






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






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






17. 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






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






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






20. Changes in vol - implied or actual






21. 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






22. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






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






26. Future price is greater than the spot price






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






28. Interest rate movements - derivatives - defaults






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






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






31. Asset-liability/market-liquidity risk






32. 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






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






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






35. 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






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






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






38. 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






39. Both probability and cost of tail events are considered






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






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






42. Potential amount that can be lost






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






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






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






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






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






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






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