## Test your basic knowledge |

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

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

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

**4. Potential amount that can be lost**

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

**6. 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 -**

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

**8. Covariance = correlation coefficient std dev(a) std dev(b)**

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

**10. 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**

**11. Rp = XaRa + XbRb**

**12. Return is linearly related to growth rate in consumption**

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

**14. Changes in vol - implied or actual**

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

**16. Probability distribution is unknown (ex. A terrorist attack)**

**17. Expected value of unfavorable deviations of a random variable from a specified target level**

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

**19. Occurs the day when two parties exchange payments same day**

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

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

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

**23. 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**

**24. Both probability and cost of tail events are considered**

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

**26. Quantile of an empirical distribution**

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

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

**29. 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**

**30. Wrong distribution - Historical sample may not apply**

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

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

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

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

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

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

**37. 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**

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

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

**40. Cannot exit position in market due to size of the position**

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

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

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

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

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

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

**47. 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**

**48. Market risk - Liquidity risk - Credit risk - Operational risk**

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

**50. Multibeta CAPM Ri - Rf =**