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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.
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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. Return is linearly related to growth rate in consumption






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






3. Quantile of a statistical distribution






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






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






6. RM cannot increase firm value when it costs the same to bear a risk w/in the firm or outside the firm - For RM to increase firm value it must be more expensive to bear risks internally than to pay capital markets to bear them.






7. Potential amount that can be lost






8. CAPM requires the strong form of the Efficient Market Hypothesis = private information






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






10. Market risk - Liquidity risk - Credit risk - Operational risk






11. 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






12. Rp = XaRa + XbRb






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






14. 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






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






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






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






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






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






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






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






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






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






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






25. Future price is greater than the spot price






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






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






28. 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






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






30. Sold complex derivatives to Proctor & Gamble and Gibson - Were sued due to claims that they deceived buyers - Need for better controls for matching complexity of trade with client sophistication - Need for price quotes independent of front office Met

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






32. 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






33. 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






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






35. 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






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






37. 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






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






39. 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






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






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






42. 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






43. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk






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






45. Multibeta CAPM Ri - Rf =






46. Law of one price - Homogeneous expectations - Security returns process






47. People risk = fraud - etc. - Model risk = flawed valuation models - Legal risk = exposure to fines and lawsuits






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






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






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







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