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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. 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






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






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






4. 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






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






6. Asset-liability/market-liquidity risk






7. 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






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






9. Quantile of an empirical distribution






10. 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






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






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






13. Unanticipated movements in relative prices of assets in hedged position






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






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






17. 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 -






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






19. Both probability and cost of tail events are considered






20. Multibeta CAPM Ri - Rf =






21. Quantile of a statistical distribution






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






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






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






25. Future price is greater than the spot price






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






27. 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






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






29. Wrong distribution - Historical sample may not apply






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






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






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






33. 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






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






35. Strategic risk - Business risk - Reputational risk






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






37. Rp = XaRa + XbRb






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






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

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40. 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






41. 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






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






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






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






45. Volatility of unexpected outcomes






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






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






48. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations






49. 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






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