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

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






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






5. 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.






6. 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






7. 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






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






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






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






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






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






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






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






15. Quantile of an empirical distribution






16. 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






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






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






19. 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






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






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






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






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






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






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






26. Rp = XaRa + XbRb






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






28. Multibeta CAPM Ri - Rf =






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






30. Asses firm risks - Communicate risks - Manage and monitor risks






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






32. 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






33. Summarizes the worst loss over a period that will not be exceeded by a given level of confidence - Always one tailed






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






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






36. 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






37. Volatility of unexpected outcomes






38. 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






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






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






41. Changes in vol - implied or actual






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






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






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






45. Strategic risk - Business risk - Reputational risk






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






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






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






49. The need to hedge against risks - for firms need to speculate.






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