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






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






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






4. 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






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






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






7. Changes in vol - implied or actual






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






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






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






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






12. Strategic risk - Business risk - Reputational risk






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






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






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






16. 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






17. Multibeta CAPM Ri - Rf =






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






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






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






21. Interest rate movements - derivatives - defaults






22. 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






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






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






25. Quantile of an empirical distribution






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






27. 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






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






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






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






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






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






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






34. 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






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






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






37. Unanticipated movements in relative prices of assets in hedged position






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






39. 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






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






41. Volatility of unexpected outcomes






42. Return is linearly related to growth rate in consumption






43. Asset-liability/market-liquidity risk






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






45. 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






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






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






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






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






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







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