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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. Unanticipated movements in relative prices of assets in hedged position






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






3. 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






4. Interest rate movements - derivatives - defaults






5. 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






6. Rp = XaRa + XbRb






7. 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






8. Future price is greater than the spot price






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






10. Hazard - Financial - Operational - Strategic






11. 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






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






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






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






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






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






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






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






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






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






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






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






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






24. 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






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






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






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






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






29. 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.






30. 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






31. Changes in vol - implied or actual






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






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






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






35. 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






36. Quantile of an empirical distribution






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






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

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






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






41. 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






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






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






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






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






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






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