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






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






3. Need to assess risk and tell management so they can determine which risks to take on






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






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






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






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






8. Potential amount that can be lost






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






10. 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






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






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






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






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






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






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






17. 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






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






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






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






21. Return is linearly related to growth rate in consumption






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






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






24. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






27. Wrong distribution - Historical sample may not apply






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






29. Quantile of an empirical distribution






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






31. Hazard - Financial - Operational - Strategic






32. 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






33. 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






34. 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






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






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






37. 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






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






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






40. 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






41. 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






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






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






44. 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






45. Interest rate movements - derivatives - defaults






46. Cannot exit position in market due to size of the position






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






48. Joseph Jett exploited an accounting glitch to book 350 million of false profits (government bonds) - Massive misreporting resulted in loss of confidence in management - Failed to take into account the present value of a forward - Learn to investigate






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






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







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