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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. Volatility of unexpected outcomes






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






3. 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






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






5. 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






6. Return is linearly related to growth rate in consumption






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






8. Asset-liability/market-liquidity risk






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






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






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






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






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

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






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






16. 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






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






18. Multibeta CAPM Ri - Rf =






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






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






21. Hazard - Financial - Operational - Strategic






22. 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






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






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






25. Both probability and cost of tail events are considered






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






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






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






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






30. 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






31. 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






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






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






34. 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






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






36. 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






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






38. Future price is greater than the spot price






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






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






41. 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






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






43. Curve must be concave - Straight line connecting any two points must be under the curve






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






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






46. Potential amount that can be lost






47. Cannot exit position in market due to size of the position






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






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






50. Excess return divided by portfolio volatility (std dev) Sp = (E(Rp) - Rf)/(std dev of Rp) - Better for non- diversified portfolios