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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. Absolute and relative risk - direction and non-directional






2. 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






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






4. 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






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






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






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






8. Firm may ignore known risk - Somebody in firm may know about risk - but it's not captured by models - Realization of a truly unknown risk






9. 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






10. Future price is greater than the spot price






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






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






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






14. 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






15. Quantile of an empirical distribution






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






17. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk






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






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






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






21. 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.






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






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






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






25. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)






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






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






28. 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






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






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






31. 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






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

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






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






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






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






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






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






39. Quantile of a statistical distribution






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






41. 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






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






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






44. ex. Human capital - Equilibrium return can be higher or lower than it is under standard CAPM






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






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






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






48. Hazard - Financial - Operational - Strategic






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






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