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FRM: Foundations Of Risk Management

Instructions:
  • Answer 50 questions in 15 minutes.
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  • 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. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk






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






3. 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






4. 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






5. Inability to make payment obligations (ex. Margin calls)






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






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






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






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






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






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






12. Changes in vol - implied or actual






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






14. 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






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






16. 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






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






18. Asset-liability/market-liquidity risk






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






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






21. When negative taxable income is moved to a different year to offset future or past taxable income






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






23. Obtained unsecured borrowing of 300 million by exploiting flaw in computing US government bond collateral - Had only 20 million in capital - Chase absorbed losses since they brokered deal - Called for better process control and more precise methods f






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






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






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






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






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






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






31. 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






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






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

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34. Multibeta CAPM Ri - Rf =






35. Rp = XaRa + XbRb






36. 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






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






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






39. Wrong distribution - Historical sample may not apply






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






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






42. 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






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






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






45. Both probability and cost of tail events are considered






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






47. Interest rate movements - derivatives - defaults






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






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






50. Potential amount that can be lost