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






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






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






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






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






6. 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






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






8. Interest rate movements - derivatives - defaults






9. 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






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






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






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






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






14. 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


15. Strategic risk - Business risk - Reputational risk






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






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






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






19. Wrong distribution - Historical sample may not apply






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






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






22. Rp = XaRa + XbRb






23. 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






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






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






27. Changes in vol - implied or actual






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






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






30. 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






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






32. 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 -






33. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds






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






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






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






37. Multibeta CAPM Ri - Rf =






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






39. 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






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






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. 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






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






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






45. 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.






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






47. Potential amount that can be lost






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






49. The need to hedge against risks - for firms need to speculate.






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