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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. Occurs the day when two parties exchange payments same day






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






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






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






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






6. Volatility of unexpected outcomes






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






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






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






10. 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






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






12. 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






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






14. 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






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






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






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






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






19. 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.






20. Both probability and cost of tail events are considered






21. 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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22. Strategic risk - Business risk - Reputational risk






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






24. Quantile of an empirical distribution






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






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






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






28. 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






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






30. Changes in vol - implied or actual






31. 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






32. Interest rate movements - derivatives - defaults






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






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






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






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






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






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






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






40. 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 -






41. 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






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






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






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






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






46. 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






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






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






49. Quantile of a statistical distribution






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