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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. Unanticipated movements in relative prices of assets in hedged position






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






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






4. Quantile of an empirical distribution






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






6. Return is linearly related to growth rate in consumption






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






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

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






10. Simple form of CAPM - but market price of risk is lower than if all investors were price takers






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






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






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






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






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






16. 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






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






18. 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






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






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






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






22. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






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






26. Gamma = market price of the consumption beta - Beta = E(r) of zero consumption beta






27. Volatility of unexpected outcomes






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






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






30. 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






31. Future price is greater than the spot price






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






33. Changes in vol - implied or actual






34. 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.






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






36. Wrong distribution - Historical sample may not apply






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






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






39. Interest rate movements - derivatives - defaults






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






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






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






43. 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






44. 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






45. 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






46. Relationship drawn from CML - RAP = [(market std dev)/(portfolio std dev)]*(Portfolio return - risk free rate) + risk free rate - annualized






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






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






49. 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 -






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