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






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






3. Market risk - Liquidity risk - Credit risk - Operational risk






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






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

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6. 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






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






8. 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






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






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






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






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






13. Interest rate movements - derivatives - defaults






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






15. Hazard - Financial - Operational - Strategic






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






17. 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






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






19. 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






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






21. Rp = XaRa + XbRb






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






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






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






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






27. 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






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






29. 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 -






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






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






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






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






35. 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






36. 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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37. Quantile of a statistical distribution






38. Human - created: business cycles - inflation - govt policy changes - wars - Natural: weather - quakes






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






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






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






42. 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






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






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






45. Asset-liability/market-liquidity risk






46. The need to hedge against risks - for firms need to speculate.






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






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






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






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