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






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






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






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






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






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






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






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






9. Future price is greater than the spot price






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






11. Asset-liability/market-liquidity risk






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






13. Potential amount that can be lost






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






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






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






17. Wrong distribution - Historical sample may not apply






18. 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






19. 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






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






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






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

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23. 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






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






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






26. 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






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






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






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






30. 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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31. 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






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






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






34. Changes in vol - implied or actual






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






36. 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 -






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






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






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






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






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






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






43. Strategic risk - Business risk - Reputational risk






44. Both probability and cost of tail events are considered






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






46. Quantile of an empirical distribution






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






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






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






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