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






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






3. Interest rate movements - derivatives - defaults






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






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






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






7. 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






8. Future price is greater than the spot price






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






10. Market risk - Liquidity risk - Credit risk - Operational risk






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






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

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






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






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






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






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






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






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






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






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. Potential amount that can be lost






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






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






25. 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






26. Return is linearly related to growth rate in consumption






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






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






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






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






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






32. 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






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






34. 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






35. 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.






36. Volatility of unexpected outcomes






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






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






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






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






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






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






43. 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






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. Asset-liability/market-liquidity risk






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






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






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






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






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