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






2. 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






3. 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






4. Probability that a random variable falls below a specified threshold level






5. Future price is greater than the spot price






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






7. Volatility of unexpected outcomes






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






9. Enterprise Risk Management - ERM is a discipline - culture of enterprise - ERM applies to all industries - ERM is not just defensive - adds value - ERM encompasses all risks - ERM addresses all stakeholders






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






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






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






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






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






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






16. Quantile of a statistical distribution






17. 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






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






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






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






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

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






23. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






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






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






28. Quantile of an empirical distribution






29. 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.






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






31. Changes in vol - implied or actual






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






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






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






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






36. Sold complex derivatives to Proctor & Gamble and Gibson - Were sued due to claims that they deceived buyers - Need for better controls for matching complexity of trade with client sophistication - Need for price quotes independent of front office Met

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






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






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






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






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






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






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






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






45. Rp = XaRa + XbRb






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






47. 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






48. Valuation focuses on mean of distribution vs risk mgmt focuses on potential variation in payoffs - needs more precision for pricing - VAR doesn't b/c noise cancels out






49. Asset-liability/market-liquidity risk






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