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






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






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






4. 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






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






6. Both probability and cost of tail events are considered






7. 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






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






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






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






11. Multibeta CAPM Ri - Rf =






12. Rp = XaRa + XbRb






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






14. 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






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






16. Changes in vol - implied or actual






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






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






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






20. Interest rate movements - derivatives - defaults






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






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






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






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

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






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. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities






28. 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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29. 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.






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






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






32. Quantile of a statistical distribution






33. 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






34. 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






35. 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






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






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






39. 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






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






41. 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 -






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






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






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






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






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






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






48. 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






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






50. Market risk - Liquidity risk - Credit risk - Operational risk