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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. 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






2. 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






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






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






5. Future price is greater than the spot price






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






7. 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






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






9. Rp = XaRa + XbRb






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






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






12. 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






13. Asset-liability/market-liquidity risk






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






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






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






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






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






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






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






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






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






23. Interest rate movements - derivatives - defaults






24. Potential amount that can be lost






25. 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






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






27. Strategic risk - Business risk - Reputational risk






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






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






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






31. Wrong distribution - Historical sample may not apply






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






33. 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






34. 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






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






36. Hazard - Financial - Operational - Strategic






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






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






39. 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






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






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






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






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






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






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






46. 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 -






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






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






49. Quantile of an empirical distribution






50. 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