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

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2. 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






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






4. Changes in vol - implied or actual






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






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






7. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios






8. 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






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






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






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






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






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






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






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






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






17. 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






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






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






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






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






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






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






24. Wrong distribution - Historical sample may not apply






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






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






27. 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.






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






29. Asset-liability/market-liquidity risk






30. 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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31. Hazard - Financial - Operational - Strategic






32. Quantile of an empirical distribution






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






34. 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






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






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






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






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






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






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






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






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






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






44. 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






45. 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






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






47. 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






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






49. 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






50. 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