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FRM: Foundations Of Risk Management

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

2. Wrong distribution - Historical sample may not apply

3. Quantile of a statistical distribution

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

5. Strategic risk - Business risk - Reputational risk

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

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

8. Rp = XaRa + XbRb

9. Changes in vol - implied or actual

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

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

12. Volatility of unexpected outcomes

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

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

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

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

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

18. 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

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

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

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

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

23. Both probability and cost of tail events are considered

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

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

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

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

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

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

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

31. Asset-liability/market-liquidity risk

32. 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

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

34. Unanticipated movements in relative prices of assets in hedged position

35. Hazard - Financial - Operational - Strategic

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

37. Potential amount that can be lost

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

39. Efficient frontier with inclusion of risk free rate - Straight line with formula Rc = Rf + ((Ra - Rf)/std dev(a))*std dev(c) - c is the total portfolio - a is the risky asset

40. Multibeta CAPM Ri - Rf =

41. 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.

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

43. 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

44. Quantile of an empirical distribution

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

46. 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

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

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

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

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