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






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






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






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






5. Volatility of unexpected outcomes






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






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






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






9. 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






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






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






12. 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 -






13. Risk- adjusted rating (RAR) - Difference between relative returns and relative risk






14. Interest rate movements - derivatives - defaults






15. Changes in vol - implied or actual






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






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






18. 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






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






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






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






22. Both probability and cost of tail events are considered






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






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






25. Quantile of a statistical distribution






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






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






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






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






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






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






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






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






34. 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






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






36. 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






37. 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






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

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






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






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






42. 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






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






44. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






47. Future price is greater than the spot price






48. 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






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






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