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FRM: Foundations Of Risk Management

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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. Quantile of an empirical distribution

2. Wrong distribution - Historical sample may not apply

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

4. 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

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

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

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

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

9. 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

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

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

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

13. 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

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

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

16. Future price is greater than the spot price

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

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

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

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

21. Quantile of a statistical distribution

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

23. 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

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

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

26. 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.

27. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation

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

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

30. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk

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

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

33. 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

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

35. Potential amount that can be lost

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

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

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

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

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

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

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

43. 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

44. Rp = XaRa + XbRb

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

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

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

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

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

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