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






2. 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






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






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






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






6. 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






7. Quantile of an empirical distribution






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






9. Quantile of a statistical distribution






10. Market risk - Liquidity risk - Credit risk - Operational risk






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






12. 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






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






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






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






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






17. 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






18. 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






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






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






21. 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






22. 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






23. 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






24. Asset-liability/market-liquidity risk






25. Both probability and cost of tail events are considered






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






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






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






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






30. 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






31. 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






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






33. Interest rate movements - derivatives - defaults






34. Potential amount that can be lost






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






36. Strategic risk - Business risk - Reputational risk






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






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






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






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






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






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






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






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






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






49. Wrong distribution - Historical sample may not apply






50. 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.