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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. Quantile of a statistical distribution






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






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






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






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






6. Return is linearly related to growth rate in consumption






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






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






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






10. Multibeta CAPM Ri - Rf =






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






12. 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






13. 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






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






15. Misleading reporting (incorrect market info) - Due to large market moves - Due to conduct of customer business






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






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






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






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






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






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






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






23. Hazard - Financial - Operational - Strategic






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






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






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






27. 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






28. Leeson took large speculative position in Nikkei 225 disguised as safe transactions by fake customers - Earthquake increased volatility and destroyed short put options - Losses of 1.25 billion and forced bankruptcy - Necessity of an independent tradi






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






30. Rp = XaRa + XbRb






31. Strategic risk - Business risk - Reputational risk






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






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






34. 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






35. 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






36. 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






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






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






39. 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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40. 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






41. 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






42. The need to hedge against risks - for firms need to speculate.






43. 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






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






45. Wrong distribution - Historical sample may not apply






46. 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






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






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






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






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