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






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






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






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






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






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






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






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






10. Hazard - Financial - Operational - Strategic






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






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






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






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






15. Strategic risk - Business risk - Reputational risk






16. 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






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






18. 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






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






20. 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






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






22. Asset-liability/market-liquidity risk






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






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






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






26. 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






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






28. Return is linearly related to growth rate in consumption






29. Market risk - Liquidity risk - Credit risk - Operational risk






30. Quantile of a statistical distribution






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






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






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






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






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






36. Rp = XaRa + XbRb






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

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38. 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






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






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






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






42. 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






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






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






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






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






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






48. 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






49. 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 -






50. Changes in vol - implied or actual