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






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






3. Return is linearly related to growth rate in consumption






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






5. 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






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






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






8. 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






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






10. 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






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






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






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






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






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






16. Rp = XaRa + XbRb






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






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






19. Asset-liability/market-liquidity risk






20. 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






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






22. 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






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






24. 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 -






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






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






28. 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






29. Quantile of an empirical distribution






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






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






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






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






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






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






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






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






38. 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






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






40. Changes in vol - implied or actual






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






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






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






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






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






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






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






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






49. Both probability and cost of tail events are considered






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