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FRM: Foundations Of Risk Management

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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