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






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






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






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






5. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business






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






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






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






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






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






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






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






13. 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






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






15. Return is linearly related to growth rate in consumption






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






17. Quantile of an empirical distribution






18. Interest rate movements - derivatives - defaults






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






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






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






22. 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






23. 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






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






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






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






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






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






29. Asset-liability/market-liquidity risk






30. Quantile of a statistical distribution






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






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






33. 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.






34. Changes in vol - implied or actual






35. Potential amount that can be lost






36. 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






37. 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






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






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






40. 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 -






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






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






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

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44. Both probability and cost of tail events are considered






45. 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






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






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






48. 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






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






50. 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







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