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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. Xmvp = ((variance of b) - covariance)/((variance of a) + (variance of b) - 2 * covariance)






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






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






4. Strategic risk - Business risk - Reputational risk






5. 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.






6. Return is linearly related to growth rate in consumption






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






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






9. 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






10. Covariance = correlation coefficient std dev(a) std dev(b)






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






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






13. IR = (E(Rp) - E(Rb))/(std dev(Rp- Rb)) - Evaluate manager of a benchmark fund






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






15. 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






16. 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






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






18. Both probability and cost of tail events are considered






19. 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






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






21. Changes in vol - implied or actual






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






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






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






26. 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






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






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






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






30. 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






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






32. Interest rate movements - derivatives - defaults






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






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






35. Multibeta CAPM Ri - Rf =






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






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






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






39. 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

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






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






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






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






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






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






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






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






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

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






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