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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. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized






2. Future price is greater than the spot price






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






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






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






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






8. 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






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






10. Wrong distribution - Historical sample may not apply






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






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






13. Quantile of an empirical distribution






14. 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






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






16. Both probability and cost of tail events are considered






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






18. Rp = XaRa + XbRb






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






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






21. Quantile of a statistical distribution






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






23. Volatility of unexpected outcomes






24. 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






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






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






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






28. 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






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






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






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






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






33. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated






34. Return is linearly related to growth rate in consumption






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






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






37. 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 -






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






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






40. 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.






41. 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






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






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






44. Strategic risk - Business risk - Reputational risk






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






46. 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






47. 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






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






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






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