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. 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






2. Multibeta CAPM Ri - Rf =






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






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






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






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






7. 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






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






9. 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






10. Derives value from an underlying asset - rate - or index - Derives value from a security






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






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






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






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






15. Quantile of a statistical distribution






16. Strategic risk - Business risk - Reputational risk






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






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






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






22. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business






23. Volatility of unexpected outcomes






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






25. 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






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






27. Both probability and cost of tail events are considered






28. Interest rate movements - derivatives - defaults






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






30. 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 -






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






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






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






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






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






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






37. Quantile of an empirical distribution






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






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






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






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






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






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






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






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






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






47. 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






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






49. 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






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