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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. Strategic risk - Business risk - Reputational risk






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






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






4. 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






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






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






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






8. 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






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






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






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






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






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






15. 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






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






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






18. 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






19. 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






20. Multibeta CAPM Ri - Rf =






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






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






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






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






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






26. Enterprise Risk Management - ERM is a discipline - culture of enterprise - ERM applies to all industries - ERM is not just defensive - adds value - ERM encompasses all risks - ERM addresses all stakeholders






27. Changes in vol - implied or actual






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






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






30. (E(Rp) - MAR)/(sqrt((1/T)summation(Rpt- MAR)^2) - MAR - minimum acceptable return






31. Interest rate movements - derivatives - defaults






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






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






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






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






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






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






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






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






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






41. Return is linearly related to growth rate in consumption






42. 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






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






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






45. Hazard - Financial - Operational - Strategic






46. 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.






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






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






49. 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






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







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