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

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






3. 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






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






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






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






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






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






10. 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






11. Potential amount that can be lost






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






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






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






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






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






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






18. 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






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






20. Hazard - Financial - Operational - Strategic






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






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






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






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






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






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






27. 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






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






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






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






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






32. Cannot exit position in market due to size of the position






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






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






35. Interest rate movements - derivatives - defaults






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






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






38. 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






39. Future price is greater than the spot price






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






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






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






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






44. 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






45. Firm may ignore known risk - Somebody in firm may know about risk - but it's not captured by models - Realization of a truly unknown risk






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






47. Return is linearly related to growth rate in consumption






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






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






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