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






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






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






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






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






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






7. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected






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






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






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






11. 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






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






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






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






15. Rp = XaRa + XbRb






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






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






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






19. 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






20. Hazard - Financial - Operational - Strategic






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






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






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






24. Liquidity and maturity transformation - Brokers - Reduces transaction and information costs between households and corporations






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






26. 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






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






28. 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.






29. Future price is greater than the spot price






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






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






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






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






34. Volatility of unexpected outcomes






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






36. 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






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






38. 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






39. Quantile of an empirical distribution






40. Inability to make payment obligations (ex. Margin calls)






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






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






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






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

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






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






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






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






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






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