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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. 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






2. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






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






6. 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






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






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






9. Strategic risk - Business risk - Reputational risk






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






11. 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






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






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






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






15. Wrong distribution - Historical sample may not apply






16. Potential amount that can be lost






17. 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






18. Future price is greater than the spot price






19. Return is linearly related to growth rate in consumption






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






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






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






23. 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






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






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






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






27. 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






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






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






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






32. 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






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






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






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






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






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






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






39. 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.






40. Volatility of unexpected outcomes






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






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






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






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






45. Asset-liability/market-liquidity risk






46. 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






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






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






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






50. 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