## Test your basic knowledge |

# 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. Hazard - Financial - Operational - Strategic**

**2. 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**

**3. Future price is greater than the spot price**

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

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

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

**7. Covariance = correlation coefficient std dev(a) std dev(b)**

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

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

**10. Unanticipated movements in relative prices of assets in a hedged position - All hedges imply some basis risk**

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

**12. Unanticipated movements in relative prices of assets in hedged position**

**13. 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**

**14. Potential amount that can be lost**

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

**16. Market risk - Liquidity risk - Credit risk - Operational risk**

**17. 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**

**18. Law of one price - Homogeneous expectations - Security returns process**

**19. Long in options = expecting volatility increase - Short in options = expecting volatility decrease**

**20. Quantile of a statistical distribution**

**21. The need to hedge against risks - for firms need to speculate.**

**22. Asset-liability/market-liquidity risk**

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

**24. 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**

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

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

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

**28. 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**

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

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

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

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

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

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

**35. Probability distribution is unknown (ex. A terrorist attack)**

**36. Cannot exit position in market due to size of the position**

**37. Absolute and relative risk - direction and non-directional**

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

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

**40. Interest rate movements - derivatives - defaults**

**41. 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**

**42. 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**

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

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

**45. Country specific - Foreign exchange controls that prohibit counterparty's obligations**

**46. 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**

**47. Volatility of unexpected outcomes**

**48. 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**

**49. 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**

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