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






2. 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.






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






4. 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






5. Wrong distribution - Historical sample may not apply






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






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






8. 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






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






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






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






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






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






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






15. Future price is greater than the spot price






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






17. Changes in vol - implied or actual






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






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






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






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






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






23. 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






24. Strategic risk - Business risk - Reputational risk






25. Return is linearly related to growth rate in consumption






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






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






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






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






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






31. 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






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






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






34. Security is a financial claim issued to raise capital - Primary securities are backed by real assets - Secondary securities are backed by primary securities






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






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






37. Capital Asset Pricing Model Ri = Rf + beta*(Rm - Rf)






38. Both probability and cost of tail events are considered






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






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






41. 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






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






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






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






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






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






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






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






49. Asset-liability/market-liquidity risk






50. Potential amount that can be lost







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