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






2. Capital structure (financial distress) - Taxes - Agency and information asymmetries






3. 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






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






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






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






7. 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






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






9. Multibeta CAPM Ri - Rf =






10. 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






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






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






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






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






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






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






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






18. Wrong distribution - Historical sample may not apply






19. Return is linearly related to growth rate in consumption






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






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






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






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






24. 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






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






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






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






28. Quantile of a statistical distribution






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






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






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






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






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






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






35. Hazard - Financial - Operational - Strategic






36. 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






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






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






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






40. 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






41. 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






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






43. When two payments are exchanged the same day and one party may default after payment is made






44. 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.






45. Future price is greater than the spot price






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






47. Interest rate movements - derivatives - defaults






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






49. 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






50. 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