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






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






3. CAPM requires the strong form of the Efficient Market Hypothesis = private information






4. Interest rate movements - derivatives - defaults






5. Future price is greater than the spot price






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






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






8. Both probability and cost of tail events are considered






9. 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






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






11. 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






12. Potential amount that can be lost






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






14. 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.






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






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






17. Volatility of unexpected outcomes






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






19. 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






20. 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






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






22. 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






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






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






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






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






27. 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






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






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






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






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






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






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






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






35. Multibeta CAPM Ri - Rf =






36. Rp = XaRa + XbRb






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






38. Return is linearly related to growth rate in consumption






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






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






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






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






43. Quantile of an empirical distribution






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






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






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






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






48. 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






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






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