## Test your basic knowledge |

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

**2. Multibeta CAPM Ri - Rf =**

**3. 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**

**4. 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**

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

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

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

**8. The need to hedge against risks - for firms need to speculate.**

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

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

**11. Rp = XaRa + XbRb**

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

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

**14. Asset-liability/market-liquidity risk**

**15. Market risk - Liquidity risk - Credit risk - Operational risk**

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

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

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

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

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

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

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

**23. 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 -**

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

**25. Long in options = expecting volatility increase - Short in options = expecting volatility decrease**

**26. Interest rate movements - derivatives - defaults**

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

**28. 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**

**29. Quantile of an empirical distribution**

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

**31. 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**

**32. Covariance = correlation coefficient std dev(a) std dev(b)**

**33. 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**

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

**35. 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**

**36. 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**

**37. Absolute and relative risk - direction and non-directional**

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

**39. Probability that a random variable falls below a specified threshold level**

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

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

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

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

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

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

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

**47. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes**

**48. 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**

**49. Law of one price - Homogeneous expectations - Security returns process**

**50. Occurs the day when two parties exchange payments same day**