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






2. Asset-liability/market-liquidity risk






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






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






5. Both probability and cost of tail events are considered






6. Rp = XaRa + XbRb






7. 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






8. 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






9. 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






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






11. 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






12. 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.






13. 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






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






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






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






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






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






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






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






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






23. Multibeta CAPM Ri - Rf =






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






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






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






27. Interest rate movements - derivatives - defaults






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






29. 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






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






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






32. 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






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






34. Hazard - Financial - Operational - Strategic






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






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






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






38. Strategic risk - Business risk - Reputational risk






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






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






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






42. 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






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






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






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






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






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






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






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






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