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






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






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






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






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






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






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






8. Asset-liability/market-liquidity risk






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






10. Quantile of a statistical distribution






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






12. 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






13. 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






14. Potential amount that can be lost






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






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






17. 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






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






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






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






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






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






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






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






25. Strategic risk - Business risk - Reputational risk






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






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






28. 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






29. Quantile of an empirical distribution






30. 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






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






32. 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






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






34. 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






35. Future price is greater than the spot price






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






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






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






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






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






41. Volatility of unexpected outcomes






42. Concave function that extends from minimum variance portfolio to maximum return portfolio






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






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






45. 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






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






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






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






49. 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






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