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






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






3. 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






4. 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






5. Covariance = correlation coefficient std dev(a) std dev(b)






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






7. 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






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






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






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






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






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






13. Quantile of an empirical distribution






14. Asset-liability/market-liquidity risk






15. 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






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






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






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






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






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






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






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






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






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






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






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






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






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






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






30. 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






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






32. Return is linearly related to growth rate in consumption






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






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






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






36. Interest rate movements - derivatives - defaults






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






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






39. Changes in vol - implied or actual






40. 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






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






42. Potential amount that can be lost






43. Market risk - Liquidity risk - Credit risk - Operational risk






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






45. Hazard - Financial - Operational - Strategic






46. Both probability and cost of tail events are considered






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






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






49. 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






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