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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. 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






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






3. Rp = XaRa + XbRb






4. 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






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






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






7. Hazard - Financial - Operational - Strategic






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






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






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






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






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






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






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






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






16. 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 -






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






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






19. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated






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






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






22. Future price is greater than the spot price






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






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






25. Asset-liability/market-liquidity risk






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






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






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






29. 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






30. Interest rate movements - derivatives - defaults






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






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






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






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






35. 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






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






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






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






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






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






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






42. Quantile of an empirical distribution






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






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






45. Quantile of a statistical distribution






46. Wrong distribution - Historical sample may not apply






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






48. 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






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






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