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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. 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 -






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






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






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






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






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






7. 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






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






9. 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






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






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






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






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






14. 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






15. 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






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






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






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






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






21. 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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22. Hazard - Financial - Operational - Strategic






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






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






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






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






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






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






29. 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






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






31. When firm has so much debt that it leads to making investment decisions that benefit shareholdser but affect total firm value adversely






32. Joseph Jett exploited an accounting glitch to book 350 million of false profits (government bonds) - Massive misreporting resulted in loss of confidence in management - Failed to take into account the present value of a forward - Learn to investigate






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






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






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






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






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






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






39. Volatility of unexpected outcomes






40. 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






41. 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






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






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






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






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






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






47. Rp = XaRa + XbRb






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






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






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