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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. Hazard - Financial - Operational - Strategic






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






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






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






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






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






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






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






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






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






11. Rp = XaRa + XbRb






12. 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 -






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






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






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






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






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






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






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






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






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






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






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






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






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






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






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






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






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






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






32. 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






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






34. 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






35. Cannot exit position in market due to size of the position






36. Modeling approach is typically between statistical analytic models and structural simulation models






37. Strategic risk - Business risk - Reputational risk






38. Quantile of an empirical distribution






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






40. Potential amount that can be lost






41. Market risk - Liquidity risk - Credit risk - Operational risk






42. 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






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






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






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






46. Both probability and cost of tail events are considered






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






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






49. 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






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