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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. 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 -






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






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






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






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






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






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






8. Interest rate movements - derivatives - defaults






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






10. 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






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






12. Quantile of a statistical distribution






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






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






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






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






17. Both probability and cost of tail events are considered






18. Market risk - Liquidity risk - Credit risk - Operational risk






19. Asset-liability/market-liquidity risk






20. 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






21. Rp = XaRa + XbRb






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






23. 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






24. 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






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






26. Quantile of an empirical distribution






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






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






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






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






31. Strategic risk - Business risk - Reputational risk






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






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






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






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






36. 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






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






38. 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






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






40. Changes in vol - implied or actual






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






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






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






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






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






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






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






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






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






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