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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. 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






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






3. 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






4. Wrong distribution - Historical sample may not apply






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






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






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






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






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






10. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected






11. Quantile of a statistical distribution






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






13. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)






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






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






16. 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






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






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






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






20. Return is linearly related to growth rate in consumption






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






22. Future price is greater than the spot price






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






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






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






26. 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






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






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






29. 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






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






31. Interest rate movements - derivatives - defaults






32. Quantile of an empirical distribution






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






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






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






36. Covariance = correlation coefficient std dev(a) std dev(b)






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






38. Asset-liability/market-liquidity risk






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






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






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






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






43. Multibeta CAPM Ri - Rf =






44. 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






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






46. 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






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






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






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






50. 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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