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






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






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






5. Changes in vol - implied or actual






6. 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.






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






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






9. 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






10. 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






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






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






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






14. Firms became multinational - - >watched xchange rates more - deregulation and globalization






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






16. E(Ri) = Rf + beta[(E(Rm)- Rf)- (tax factor)(dividend yield for market - Rf)] + (tax factor)(dividend yield for stock - Rf)






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






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






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






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






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






23. Return is linearly related to growth rate in consumption






24. 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






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






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






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






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






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






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






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






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

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34. Volatility of unexpected outcomes






35. Interest rate movements - derivatives - defaults






36. Market risk - Liquidity risk - Credit risk - Operational risk






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






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






39. 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






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






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






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






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






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






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






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






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






48. Asset-liability/market-liquidity risk






49. Hazard - Financial - Operational - Strategic






50. Rp = XaRa + XbRb