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






2. Losses due to market activities ex. Interest rate changes or defaults






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






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






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






6. 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






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






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






9. Multibeta CAPM Ri - Rf =






10. Quantile of a statistical distribution






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






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






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






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






15. Future price is greater than the spot price






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






17. 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






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






19. Interest rate movements - derivatives - defaults






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






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






22. 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 -






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






24. Potential amount that can be lost






25. 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






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






27. Asset-liability/market-liquidity risk






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






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






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






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






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






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






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






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






36. 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






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






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






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






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






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






42. Wrong distribution - Historical sample may not apply






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






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






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






46. Returns on any stock are linearly related to a set of indexes






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






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






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






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

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