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






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






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






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






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






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






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






8. Return is linearly related to growth rate in consumption






9. 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






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






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






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






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






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






15. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized






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






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






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






19. Returns on any stock are linearly related to a set of indexes






20. Both probability and cost of tail events are considered






21. 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






22. 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 -






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






24. Strategic risk - Business risk - Reputational risk






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






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






27. 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






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






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

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






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






32. Rp = XaRa + XbRb






33. Asset-liability/market-liquidity risk






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






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






36. Wrong distribution - Historical sample may not apply






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






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






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






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






41. Quantile of a statistical distribution






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






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






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






45. 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






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






47. 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






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






49. Quantile of an empirical distribution






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