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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. Hazard - Financial - Operational - Strategic






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






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






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






5. 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






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






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






8. 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






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






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






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






12. 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






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






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






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






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






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






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






19. Return is linearly related to growth rate in consumption






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






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






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






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






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

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25. Market risk - Liquidity risk - Credit risk - Operational risk






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






27. Quantile of a statistical distribution






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






29. 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






30. 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






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






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






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






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






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






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






38. 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






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






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






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






42. 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






43. 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






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






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






46. Future price is greater than the spot price






47. 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.






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






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






50. Wrong distribution - Historical sample may not apply