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






2. Wrong distribution - Historical sample may not apply






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






4. 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.






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






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






7. 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






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






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






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






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






12. 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






13. Volatility of unexpected outcomes






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






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






16. Both probability and cost of tail events are considered






17. Multibeta CAPM Ri - Rf =






18. 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 -






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






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






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






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






23. Changes in vol - implied or actual






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






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






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






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






28. 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






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






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






31. 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






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






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






34. 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






35. Asset-liability/market-liquidity risk






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






37. Quantile of an empirical distribution






38. Future price is greater than the spot price






39. 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






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






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






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






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






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






45. 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






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






47. Firm may ignore known risk - Somebody in firm may know about risk - but it's not captured by models - Realization of a truly unknown risk






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






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






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