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






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






3. 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






4. 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






5. 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






6. Losses due to market activities ex. Interest rate changes or defaults






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






8. 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






9. 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






10. 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






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






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






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






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






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






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






17. Market risk - Liquidity risk - Credit risk - Operational risk






18. Return is linearly related to growth rate in consumption






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






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






21. 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






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






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






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






25. Potential amount that can be lost






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






27. Expected value of unfavorable deviations of a random variable from a specified target level






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






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






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






31. 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






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






33. Both probability and cost of tail events are considered






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






35. 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






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






37. 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 -






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






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






40. Wrong distribution - Historical sample may not apply






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






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






43. 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






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






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






46. 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






47. Quantile of a statistical distribution






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






49. Quantile of an empirical distribution






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