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FRM: Foundations Of Risk Management

Instructions:
  • Answer 50 questions in 15 minutes.
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  • Match each statement with the correct term.
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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. Volatility of unexpected outcomes






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






3. 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






4. Asset-liability/market-liquidity risk






5. 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






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






7. Potential amount that can be lost






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






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






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






11. 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






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






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






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






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






16. Sqrt((Xa^2)(variance of a) + (1- Xa)^2(variance of b) + 2(Xa)(1- Xa)(covariance))






17. Both probability and cost of tail events are considered






18. 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






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






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






21. 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






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






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

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24. Prices of risk are common factors and do not change - Sensitivities can change






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






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






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






28. 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






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






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. Return is linearly related to growth rate in consumption






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






33. 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






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






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






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






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






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






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






40. Quantile of an empirical distribution






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






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






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






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






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






47. Rp = XaRa + XbRb






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






49. Future price is greater than the spot price






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







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