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FRM: Foundations Of Risk Management

Instructions:
  • Answer 50 questions in 15 minutes.
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  • 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. When two payments are exchanged the same day and one party may default after payment is made






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






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






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






5. Changes in vol - implied or actual






6. Future price is greater than the spot price






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






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






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






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






11. 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 -






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






13. Proportion of loss that is recovered - Also referred to as "cents on the dollar"






14. Multibeta CAPM Ri - Rf =






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






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






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






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






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






21. 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






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






23. Wrong distribution - Historical sample may not apply






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






25. Quantile of an empirical distribution






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






27. Losses due to market activities ex. Interest rate changes or defaults






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






29. 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






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






31. 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






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






33. 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






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






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






36. 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






37. 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






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






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






40. Make common factor beta - Build optimal portfolios - Judge valuation of securities - Track an index but enhance with stock selection






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






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






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






44. Return is linearly related to growth rate in consumption






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






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

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






48. Hazard - Financial - Operational - Strategic






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






50. Interest rate movements - derivatives - defaults