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






2. Asset-liability/market-liquidity risk






3. 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






4. Quantile of an empirical distribution






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






6. Wrong distribution - Historical sample may not apply






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






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






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






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






11. Quantile of a statistical distribution






12. 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






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






14. Future price is greater than the spot price






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






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






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






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






20. 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.






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






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

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23. 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






24. 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






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






26. Interest rate movements - derivatives - defaults






27. Potential amount that can be lost






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






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






30. 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






31. Changes in vol - implied or actual






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






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






34. Multibeta CAPM Ri - Rf =






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






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






37. Strategic risk - Business risk - Reputational risk






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






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






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






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






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






43. 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






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






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






46. Volatility of unexpected outcomes






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






48. Credit risk that occurs when there is a change in the counterparty's ability to perform its obligations






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






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