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






2. Multibeta CAPM Ri - Rf =






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






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






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






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






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






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






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






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






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






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






13. Return is linearly related to growth rate in consumption






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






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






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






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






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






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






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






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






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






23. Interest rate movements - derivatives - defaults






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






25. Both probability and cost of tail events are considered






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






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






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






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






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






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






32. Rp = XaRa + XbRb






33. Changes in vol - implied or actual






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






35. 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






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






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






38. Asset-liability/market-liquidity risk






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






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






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






42. 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






43. Potential amount that can be lost






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






45. 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






46. Quantile of a statistical distribution






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






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






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






50. 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







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