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






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






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






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






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






6. 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






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






8. Rp = XaRa + XbRb






9. 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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10. 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






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






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






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






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






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

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






17. Future price is greater than the spot price






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






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






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






21. 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






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






23. Wrong distribution - Historical sample may not apply






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






25. Asset-liability/market-liquidity risk






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






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






28. 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






29. 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






30. 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






31. Multibeta CAPM Ri - Rf =






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






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






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






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






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






37. Hazard - Financial - Operational - Strategic






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






39. 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






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






41. Quantile of an empirical distribution






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






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






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






45. 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






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






47. 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






48. 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






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






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