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FRM: Foundations Of Risk Management

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

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

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

4. Strategic risk - Business risk - Reputational risk

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

6. Potential amount that can be lost

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

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

9. Interest rate movements - derivatives - defaults

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

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

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

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

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

15. Volatility of unexpected outcomes

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

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

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

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

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

22. Future price is greater than the spot price

23. Quantile of a statistical distribution

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. Focus on adverse tail of distribution - Relevant for determining economic capital (EC) requirements

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

27. 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

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

29. 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

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

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

32. 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

33. 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

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

35. Rp = XaRa + XbRb

36. The lower (closer to - 1) - the higher the payoff from diversification

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

38. Return is linearly related to growth rate in consumption

39. 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

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

41. Quantile of an empirical distribution

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

43. 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 -

44. Asset-liability/market-liquidity risk

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

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

47. Hazard - Financial - Operational - Strategic

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

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

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