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






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






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






4. Volatility of unexpected outcomes






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






6. 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






7. Potential amount that can be lost






8. Future price is greater than the spot price






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






10. 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






11. Changes in vol - implied or actual






12. Relative portfolio risk (RRiskp) - Based on a one- month investment period






13. 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






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






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






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






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






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






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






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






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






22. 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






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






24. Derives value from an underlying asset - rate - or index - Derives value from a security






25. 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






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






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






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






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






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






31. 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.






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






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






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






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






36. Both probability and cost of tail events are considered






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

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38. 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






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






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






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






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






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






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






45. 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






46. 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






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






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






49. Quantile of a statistical distribution






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