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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. Volatility of unexpected outcomes






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






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






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






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






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






7. 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






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






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






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






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






12. Unanticipated movements in relative prices of assets in hedged position






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






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






15. 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






16. Strategic risk - Business risk - Reputational risk






17. Quantile of a statistical distribution






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






19. 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






20. Rp = XaRa + XbRb






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






22. Wrong distribution - Historical sample may not apply






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






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






25. 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






26. Changes in vol - implied or actual






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






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






29. 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






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






31. Multibeta CAPM Ri - Rf =






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






33. Future price is greater than the spot price






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






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






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






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






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






39. Market risk - Liquidity risk - Credit risk - Operational risk






40. 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 -






41. Return is linearly related to growth rate in consumption






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






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






44. Both probability and cost of tail events are considered






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






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






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






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






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






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