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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.
  • 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. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






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






5. 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






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






7. 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






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






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






10. 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






11. 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 -






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






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






14. 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






15. 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






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






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






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






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






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






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






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






23. 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






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






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






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






27. Too much debt - Causes shareholders to seek projects that create short term capital but long term losses






28. 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






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

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






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






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






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






34. 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






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






36. 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.






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






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






39. Asset-liability/market-liquidity risk






40. Quantile of an empirical distribution






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






42. Both probability and cost of tail events are considered






43. Quantile of a statistical distribution






44. 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






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






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






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






48. 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






49. 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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50. Potential amount that can be lost