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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. 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






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






3. 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






4. Managing risks is a core activity at financial companies - Industrial companies hedge financial risks






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






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






7. Quantile of an empirical distribution






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






9. Expected value of unfavorable deviations of a random variable from a specified target level






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






11. Volatility of unexpected outcomes






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






13. Rp = XaRa + XbRb






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






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






16. Potential amount that can be lost






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






18. 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






19. Hazard - Financial - Operational - Strategic






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






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






22. 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.






23. 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






24. Long in options = expecting volatility increase - Short in options = expecting volatility decrease






25. 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






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






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






28. 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






29. 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






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






31. Interest rate movements - derivatives - defaults






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






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






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






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






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






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






39. 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






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






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

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






43. Changes in vol - implied or actual






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






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






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






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






48. Quantile of a statistical distribution






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






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