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






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






3. 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






4. Quantile of a statistical distribution






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






6. Multibeta CAPM Ri - Rf =






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






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






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






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






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






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






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






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






16. Future price is greater than the spot price






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






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

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






20. 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






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






22. 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 -






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






24. Strategic risk - Business risk - Reputational risk






25. 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






26. 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






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






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






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






30. 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






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






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






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






34. Quantile of an empirical distribution






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






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






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






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






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






40. Return is linearly related to growth rate in consumption






41. Changes in vol - implied or actual






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






43. 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






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






45. 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






46. 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






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






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






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






50. Market risk - Liquidity risk - Credit risk - Operational risk







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