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






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






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






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






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






6. 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






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






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






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






10. Strategic risk - Business risk - Reputational risk






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






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






13. Wrong distribution - Historical sample may not apply






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






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






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






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






18. Volatility of unexpected outcomes






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






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






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






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






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






24. Quantile of a statistical distribution






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






26. 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






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






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






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






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






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






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






33. 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






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






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






36. 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






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






38. Potential amount that can be lost






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






40. Changes in vol - implied or actual






41. 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






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






43. 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






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






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






46. Both probability and cost of tail events are considered






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






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






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






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







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