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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. 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






2. 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.






3. Interest rate movements - derivatives - defaults






4. 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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5. Unanticipated movements in relative prices of assets in hedged position






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






7. 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






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






11. Return is linearly related to growth rate in consumption






12. Volatility of unexpected outcomes






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






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






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






16. 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






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






18. Potential amount that can be lost






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






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






21. 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






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






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






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






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






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






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






28. 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






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






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






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






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






33. 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






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






35. Multibeta CAPM Ri - Rf =






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






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






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






39. Quantile of a statistical distribution






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






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






42. 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






43. Future price is greater than the spot price






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






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






46. Std dev between portfolio return and benchmark return TE = std dev * (Rp- Rb) - Benchmark funds






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






48. 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






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






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