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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. Return is linearly related to growth rate in consumption






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






3. 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






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






5. 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






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






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






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






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






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






11. 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.






12. Rp = XaRa + XbRb






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






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






15. Changes in vol - implied or actual






16. 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






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






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






20. 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






21. Quantile of a statistical distribution






22. 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






23. 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






24. Quantile of an empirical distribution






25. Strategic risk - Business risk - Reputational risk






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






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






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






29. 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






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






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






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






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






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






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






37. 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






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






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






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






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






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






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






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






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






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






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






49. 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






50. 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