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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. Difference between forward price and spot price - Should approach zero as the contract approaches maturity






2. Future price is greater than the spot price






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






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






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






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






8. 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






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






10. Asset-liability/market-liquidity risk






11. 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






12. Hazard - Financial - Operational - Strategic






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






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






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






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






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






18. 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






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






20. Interest rate movements - derivatives - defaults






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






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






23. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)






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






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






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






27. Market risk - Liquidity risk - Credit risk - Operational risk






28. Changes in vol - implied or actual






29. Loss resulting from inadequate/failed internal processes - people or systems - back-office problems - settlement - etc - reconciliation






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






31. 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






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






33. 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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34. 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






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






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






37. 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






38. 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






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






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






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






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






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






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






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






46. Volatility of unexpected outcomes






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






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






49. Excess return divided by portfolio beta Tp = (E(Rp) - Rf)/portfolio beta - Better for well diversified portfolios






50. Quantile of a statistical distribution