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






2. Potential amount that can be lost






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

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5. 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






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






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






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






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






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






11. 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






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






13. 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






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






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






16. Rp = XaRa + XbRb






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






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






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






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






21. 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






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






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






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






25. Quantile of an empirical distribution






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






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






28. Strategic risk - Business risk - Reputational risk






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






30. Return is linearly related to growth rate in consumption






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






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






33. 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






34. 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 -






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






36. Both probability and cost of tail events are considered






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






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






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






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






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






42. Volatility of unexpected outcomes






43. 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






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






45. Multibeta CAPM Ri - Rf =






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






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






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






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






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