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






2. Strategic risk - Business risk - Reputational risk






3. Multibeta CAPM Ri - Rf =






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






5. 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






6. Rp = XaRa + XbRb






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

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






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






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






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






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






13. 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






14. 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






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






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






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






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






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






20. Both probability and cost of tail events are considered






21. 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






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






23. 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






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






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






26. 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






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






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






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






30. 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.






31. 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






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






33. 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 -






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






35. 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






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






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






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






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






41. Future price is greater than the spot price






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






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






44. Potential amount that can be lost






45. 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






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






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






48. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund






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






50. Return is linearly related to growth rate in consumption