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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.
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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. Interest rate movements - derivatives - defaults






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






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






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

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






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. 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






8. Return is linearly related to growth rate in consumption






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






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






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






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






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






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






15. 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






16. Hazard - Financial - Operational - Strategic






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






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






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






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






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






22. Occurs the day when two parties exchange payments same day






23. 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






24. 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






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






26. 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






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






28. 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 -






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






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






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






32. Potential amount that can be lost






33. 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






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






35. Changes in vol - implied or actual






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






37. 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






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






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






40. 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






41. Both probability and cost of tail events are considered






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






43. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






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






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






48. Strategic risk - Business risk - Reputational risk






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






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







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