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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. 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






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






3. Economic Cost of Ruin(ECOR) - Enhancement to probability of ruin where severity of ruin is reflected






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






5. Future price is greater than the spot price






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






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






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






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






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






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






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






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






14. 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






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






16. 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






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






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






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






20. 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






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






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






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






24. Asset-liability/market-liquidity risk






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






26. Quantile of an empirical distribution






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






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






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






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






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






32. Interest rate movements - derivatives - defaults






33. Strategic risk - Business risk - Reputational risk






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






35. 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






36. 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






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






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






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






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






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






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






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






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






45. Return is linearly related to growth rate in consumption






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






47. 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 -






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






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






50. Volatility of unexpected outcomes