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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. 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






2. 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






3. Return is linearly related to growth rate in consumption






4. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios






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






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






7. Asset-liability/market-liquidity risk






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






9. 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






10. Rp = XaRa + XbRb






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






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






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






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






15. 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






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






17. 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






18. Quantile of a statistical distribution






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






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






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






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






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






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






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






26. Volatility of unexpected outcomes






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






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

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






30. 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






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






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






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






34. Strategic risk - Business risk - Reputational risk






35. Changes in vol - implied or actual






36. 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






37. 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






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






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






40. 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






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






42. 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






43. 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






44. Wrong distribution - Historical sample may not apply






45. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






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






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






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






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