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






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






3. Strategic risk - Business risk - Reputational risk






4. 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






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






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






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






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






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






10. Interest rate movements - derivatives - defaults






11. 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






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






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






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






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






16. Potential amount that can be lost






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






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






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






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






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






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






23. 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






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






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






26. Sold complex derivatives to Proctor & Gamble and Gibson - Were sued due to claims that they deceived buyers - Need for better controls for matching complexity of trade with client sophistication - Need for price quotes independent of front office Met

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27. Simple form of CAPM - but market price of risk is lower than if all investors were price takers






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






29. Long Term Capital Management - Renowned quants produced great returns with arbitrage- type trades - Unexpected and extreme events resulted in devaluation of Russian Rouble - resulting in a 3.65 billion dollar bailout - Failure to account for illiquid






30. 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






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

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






33. Volatility of expected outcomes - Outcomes are random but distribution is known or approximated






34. Wrong distribution - Historical sample may not apply






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






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






37. Quantile of an empirical distribution






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






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






40. 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






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






42. 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






43. Both probability and cost of tail events are considered






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






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






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






47. 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






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






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






50. Return is linearly related to growth rate in consumption