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

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






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






4. 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






5. 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






6. 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






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






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






9. Future price is greater than the spot price






10. Rp = XaRa + XbRb






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






12. Return is linearly related to growth rate in consumption






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






14. 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






15. Hazard - Financial - Operational - Strategic






16. 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






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






18. 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






19. 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 -






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






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






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






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






24. 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






25. Obtained unsecured borrowing of 300 million by exploiting flaw in computing US government bond collateral - Had only 20 million in capital - Chase absorbed losses since they brokered deal - Called for better process control and more precise methods f






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






27. Returns on any stock are linearly related to a set of indexes






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






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






30. Volatility of unexpected outcomes






31. 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






32. Both probability and cost of tail events are considered






33. Potential amount that can be lost






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






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






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






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






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






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






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






41. Strategic risk - Business risk - Reputational risk






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






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






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






45. 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






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






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






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






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






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